The Obey War Tax Proposal: Sensible?

David Obey, a representative from Wisconsin, has renewed his call for a war tax to fund any increase in expenditures to finance the war in Afghanistan. According to various reports, including this one, though he considers the war, as being presently fought, to be futile, he argues that his tax proposal would “create a sense of shared sacrifice that has been missing in the last eight years.” According to this report, almost all of the proposed tax would be raised from upper income taxpayers.

Obey is not the first member of Congress to call for a war tax. Several years ago, Senator Joe Lieberman suggested that a special tax be enacted to pay for the war against terrorism, an idea on which I commented in War Taxes: Even A Discussion Can Teach Lessons. Four years ago, I took the same position, though I doubt my MauledAgain post had any influence on Lieberman or Obey. What I said in Taxes and Sustaining a Civilized Society, still holds true:

Whether or not one supports none, one, or all of the various military actions undertaken in connection with this war, it is inconceivable to me how one can disagree with the notion that if there is a war the war must be funded because wars cost money.

Nine months later, in A Memorial Day Essay on War and Taxation, I made the same point and noted the risks that the nation would face if it continued to cut taxes while fighting a war:

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

I have come back to this point repeatedly, quoting myself, for example, in War Taxes: Even A Discussion Can Teach Lessons, in Peacetime Tax Policy While Waging War = Economic Mess, in Does It Matter Who or What is to Blame?, and in Leaders as Teachers: Fixing the Financial Fiasco.

For the most part, my focus has been on the economic disequilibrium generated by the incompatibility of cutting taxes and refusing to raise taxes while increasing expenditures, whether for war or pretty much any other purpose. But there’s another aspect to the war tax idea, and it is the notion mentioned by Obey and repeated in commentary such as this one, that “the notion of shared sacrifice has somehow gotten lost in the shuffle.” As Joe Klein points out in that editorial, “In a war, every citizen should have to contribute something to the effort.” If I differ with Klein, it’s that I would replace the word “something” with the word “enough” because every taxpayer is already paying something. The question is whether taxpayers are paying enough. What exacerbates the problem is that the sacrifice falls disproportionately on the poor, and to a lesser extent, on the middle class. The children of the wealthy and of the elite are far less likely to be found on the battlefield. Perhaps if some of the speculators, day traders, mortgage gamblers, toxic debt bundlers, Ponzi scheme operators, security fraud perpetrators, and other negative contributors to the economy were experiencing the risk of death and injury at every turn, the pursuit of money that so motivates them would be tempered with an appreciation for the intangibles, such as freedom, self-sacrifice, and responsibility, that money cannot purchase, and without which, in the long run, money loses its ultimate value.

A few of the comments posted to Klein’s commentary are interesting for a variety of reasons. One respondent suggested that it would be better to have conscription than new taxes, though it isn’t clear to me how conscription eliminates the need for funding. Even conscripted soldiers are paid. But it is an interesting insight into the disadvantages of hiring people to fight one’s wars, whether those hired are volunteer citizens – some, perhaps, motivated by an economic mess that makes other employment almost impossible to find – or foreign mercenaries. Very few nations have done well, or even survived, trying to rely on mercenaries and volunteers to do the work of a citizenry. Another respondent took the opportunity to trumpet the seeming eternal proposal to “pass legislation that downsizes the IRS and put on a flat tax for ALL citizens to pay,” without explaining how a flat tax simplifies the rules for exclusions, deductions, credits, timing, assignment of income, or any of the many tax issues that have nothing to do with the tax rate. Another respondent explained, “I would love to see taxation tied directly to spending and programs. Fund the war with a war tax. Fund education with an education tax. Fund healthcare with a healthcare tax.” This idea has some merit but would make the tax law absurdly complicated. The advantage is that it puts into the spotlight the cost of a program and the tax impact it would cause. The disadvantage is that it would require as many tax computations as there are programs, and even a government operating under libertarian principles would involve dozens, if not hundreds, of programs. A better alternative is to provide each taxpayer with a “receipt” when a tax return is filed, showing how much of the taxpayer’s tax liability is channeled to each program, and also showing how much money the taxpayer, as a citizen of a deficit-spending government, has “borrowed” to pay for unfunded programs.

The repeal of the ill-advised tax cuts is long overdue. The alternative, keeping them in place, promises nothing but continued economic turmoil, steadily increasing debt, escalated infrastructure failures, deteriorated national security, increasing numbers of people living in poverty, eroding educational achievement, and eventual national decline. Defenders of those tax cuts, and of the irresponsible waging of war while piling on more tax cuts, ought to ask themselves who really benefits from those unwise actions. Why do they put so much effort into defending the greed of the greedy? Why are they investing so much energy into shielding from taxation people whose incomes are multiples of their own, and whose stewardship of the nation and its economy has been worse than abysmal? Is it a futile hope that they will join their economic masters? Is it a matter of surviving by being paid to push their agenda? Do they, like the flat tax advocates, simply not understand taxation and economic principles?

We’re told, in this report, that Senator Carl Levin, who initially supported Obey’s proposal, has retreated somewhat, saying, "Well in the middle of a recession we're probably not going to be able to increase taxes, [something that] should have happened some time ago." Indeed. Better late than never, and as for the recession, repealing those tax cuts from a decade ago will do more to help the economy than to hurt it.

Poll on Tax and Spending Illustrates Voter Inconsistency

In New Jersey to Follow in California's Tax Footsteps?, I noted that "Now New Jersey gets a chance to see what happens when tax revenues are reduced but demand for government spending continues unabated" and asked "how much spending will be cut from each New Jersey program on account of the governor-elect’s planned spending cuts?" The folks who run the Quinnipiac University polls were thinking the same thing, and last week released the results of a series of questions they posed to New Jersey residents.

According to the poll, 68% of the respondents favor cutting programs and services, whereas only 23% advocate increased taxes. Of those answering the poll questions, 75% support a wage freeze for state workers, and 61% advocate laying off state workers. Not one of several state programs nominated for reduced state funding gathered the support of a majority of the poll's respondents. Only 41% wanted to cut economic development spending, 30% would vote for reduced social services funding, a mere 11% favored cuts in education spending, and a scant 7% stood up for reduced health care expenditures.

This lack of unified focus shows up in how New Jersey residents dealt with specific questions. With respect to state spending for local government and schools, 60% want it to remain the same, 20% want an increase, and only 16% favor a reduction. Though 54% oppose school vouchers and 55% do not want to expand charter schools, 51% want increases in state spending on early childhood education.

When compelled to suggest a tax that should be raised if tax increases were to be part of the solution to the state's fiscal mess, 30% went for tolls, 28% chose the sales tax, 15% opted for gasoline taxes, and 13% selected the income tax. Asked specifically about state tax rebates, 45% want to keep them and 29% want to increase them, but only 21% favor cutting them. When asked if the gasoline tax should be increased to pay for highway and mass transit improvements, 62% said no.

About the only thing on which the respondents overwhelmingly reached agreement was the condition of the state's budget problems. A whopping 97% agreed that those problems are very serious or somewhat serious. Yet voters in the poll seem somewhat optimistic that the situation can be resolved, as 49% agree that the governor-elect and the legislature will be able to cooperate in solving the problems.

The poll reinforces my contention that the underlying problem is the continued demand for government spending on programs that benefit state residents coupled with a continued resistance to the idea of paying taxes in order to fund those programs. The results of the poll suggest the extent to which various programs benefit residents. That explains the support for maintaining or increasing tax rebates even though it requires higher taxes on someone in order to do that. It also explains why so few favor cuts in health care, education, and social services funding, why gasoline tax increases aren't preferred, and why so many were quick to target state employees for pay freezes and furloughs.

This sort of entitlement mentality, a vision that grows out of the "I want, I got, I will continue to get" experience of too many people, suggests that finding a common ground to resolve the tax and spend debate in New Jersey, and elsewhere, will be difficult if not impossible. It's amusing to see that almost everyone understands there is a problem, almost half think it will get fixed, but fewer than half can rally around any specific solution to the fiscal mess. It may be a simple matter of what the residents of New Jersey want being something that collectively is more than what the residents of New Jersey have. I repeat my inquiry shared in New Jersey to Follow in California's Tax Footsteps?: "Is no one taught the skills required to balance budgets? Are fiscal discipline and common sense lost abilities? Are there any political leaders still standing who have the courage to explain the true cost, tax-wise and otherwise, of the things that the people demand? Is the nation paying the price for too many years of too many people refusing to say 'no' to the demands of those who are unable to comprehend that money does not grow on trees?"

As enlightening as it was to read the poll and its results, it's going to be far more interesting to observe the proceedings when the governor-elect is sworn in, and he and the legislature sit down to work on the problem. As proposals are floated, leaked, and debated, the controversy and tension between "spend on this" and "don't raise taxes" is going to become heated and nasty. About the only advantage New Jersey holds in this crisis is the ability to look at California and learn some lessons about what not to do. It remains to be seen if this happens.

An Orphan Tax Provision?

Section 30B of the Internal Revenue Code provides a credit for alternative motor vehicles. Section 30B(h)(3) provides that, “The terms ‘automobile’, ‘passenger automobile’, ‘medium duty passenger vehicle’, ‘light truck’, and ‘manufacturer’ have the meanings given such terms in regulations prescribed by the Administrator of the Environmental Protection Agency for purposes of the administration of title II of the Clean Air Act (42 U.S.C. 7521 et seq.).” With one exception, each of these terms is used elsewhere in section 30B, and it makes perfectly good sense for these terms to be given definitions, and it is efficient and logical to provide those definitions through a cross-reference to definitions in another federal law.

The puzzle, though, is why “medium duty passenger vehicle” is given a definition, because that term does not appear anywhere else in section 30B. In fact, a search of the entire Internal Revenue Code reveals that the term “medium duty passenger vehicle” does not appear in any Code section. Thinking that perhaps the term is used in some bifurcated manner, I searched for “medium duty” in the Internal Revenue Code. It turned up once, in section 30B(h)(3), as part of “medium duty passenger vehicle.”

The next task was to examine the legislative history of the provision. As introduced in the House of Representatives, section 1316 of H.R. 6, the Energy Policy Tax Act of 2005, provided for a new section 30B, which would allow an “advanced lean burn technology motor vehicle credit. Section 30B(d)(6) of the proposed new Code section provided that, “The terms ‘passenger vehicle’, ‘light truck’, and ‘manufacturer’ shall have the meanings given such terms in regulations prescribed by the Administrator of the Environmental Protection Agency for purposes of the administration of title II of the Clean Air Act (42 U.S.C. 7521 et seq.).” The term “medium duty passenger vehicle” wasn’t there. As passed by the House, and as placed on the calendar in the Senate, the language of proposed section 30B remained the same.

In the Senate, the credit was renamed the “alternative motor vehicle credit,” several other types of vehicles were added to the list of those qualifying for the credit, and there was a provision in proposed section 30B(c)(2)(A) that set forth different credit amounts, specifically, “In the case of a new qualified hybrid motor vehicle which is a passenger automobile, medium duty passenger vehicle, or light truck.” In section 30B(c)(4)(A), the definition of “new qualified hybrid motor vehicle” was separated into different types, and section 30B(c)(4)(A) set forth the conditions that needed to be met by a “passenger automobile, medium duty passenger vehicle, or light truck.” Because the term “maximum available power” was used in the definition of “new qualified hybrid motor vehicle,” it, too, needed to be defined, and again, was defined separately, in section 30B(c)(4)(C)(i) for any passenger automobile, medium duty passenger vehicle, or light truck. One of the types of new qualified hybrid motor vehicles was a “heavy duty hybrid motor vehicle,” and its definition excluded any “medium duty hybrid motor vehicle.” Understandably, the definition provision, then in section 30B(f)(3), was changed to include medium duty passenger vehicle.

In the House-Senate Conference, subsection (c) became subsection (d), and paragraph (2)(A) was rewritten to provide different credit amounts “In the case of a new qualified hybrid motor vehicle which is a passenger automobile of light truck and which has a gross vehicle weight rating of not more than 8,500 pounds.” That removed the need for the other definitions that referred to “medium duty passenger vehicle” and so those definitions were removed. However, nothing was done to the definition provision, which by this point had become section 30B(h)(3), and the definition of “medium duty passenger vehicle” remained, even though the phrase had been taken out of the various places it had appeared in what became subsection (d).

Oops.

There are lessons to be learned. It’s good to be thoroughly familiar with the document on which one is working, but that doesn’t happen when tax legislation passes from committee to committee, with all sorts of people hovering over people’s shoulders, figuratively, at least. It’s good to let a document sit, and to go through it again, but that doesn’t happen with tax legislation, and lots of other drafting tasks, because not enough time is budgeted for the process. It’s good to have a reviewer who can look at the document with fresh eyes, an advantage I have for some, but not all, of my writing, and the difference can be significant.

Fortunately, this drafting error does not appear to have any adverse consequences other than making the Internal Revenue Code four words longer than it needs to be. I’m confident that fixing the error will not raise any revenue.

A question that probably has wandered into the brains of at least some readers is, “How, or perhaps why, did you find this?” I found this as I worked my way through section 30B while preparing soon-to-be-published Tax Management, Inc. portfolio 512, Tax Incentives for Production and Conservation of Energy and Natural Resources. As I make certain I’ve dealt with every provision in an applicable Code section, and decide where to position my “translation” of the language, I necessarily ask myself how the term fits in with the overall “outline” of the section. It was during that process that I encountered a defined term that was not being used.

The question that now occurs to me is whether these four words are “deadwood.” Perhaps, but perhaps not. After all, can wood be dead if it’s never been alive? This isn’t a provision that was effective at some point and then rendered meaningless. It was never effective. But it’s there, living in its own little world.

What happens next? Someone on Capitol Hill reads this, and arranges for the deletion of the phrase. Yes, I can dream. What’s more likely is that someone will read this, and then mention it to someone who will make a remark about it to someone else, and eventually it gets to someone on Capitol Hill who remembers it at some point and puts an amendment to section 30B(h)(3) into some pending tax legislation. Likely, but not guaranteed. So all of us now have something to which we can look forward, namely, the “medium duty passenger vehicle” death watch.

And if I'm wrong about this being an orphan provision, please let me, and the rest of us, know. It will be an interesting explanation.

Gratias Vectigalibus

“Tomorrow is Thanksgiving. I don't plan to post tomorrow, and I have a feeling many regular readers won't be checking in. So though it's a day early, here's my annual Thanksgiving litany.”

That’s how I began my 2007 Thanksgiving offering, Actio Gratiarum. I spoke too soon, because my reference to an annual Thanksgiving litany became an inaccuracy one year later, for none of my posts in late November of 2008 dealt with Thanksgiving. What happened? All sorts of tax stories distracted me, though if I wanted to be flip I’d suggest that I intended to give readers of MauledAgain a reason to give thanks, namely, no more Thanksgiving litanies with Latin titles and Latin text. But this post’s title does away with that possibility, doesn’t it?

In 2007, using lawyering terms, I “incorporated by reference” my Thanksgiving posts from 2004, Giving Thanks, 2005, A Tax Thanksgiving, and 2006, Giving Thanks, Again. To that list can be add the fourth Thanksgiving post, the one in 2007, Actio Gratiarum.

Everything mentioned in those previous Thanksgiving posts continues to be something for which I am thankful. The list has been getting longer, as it should, but it’s time to add a few more:

I am thankful for taxes. Taxes bring balance to what would otherwise be an unbalanced economic system. Without taxes, much of what gets taken for granted would not exist, or would command a higher price. It might be trite to claim that taxes represent what must be paid for a civilized society, but it’s true.

I am thankful that as bad as our federal, state, and local tax systems are, that I don’t live in a place that would subject me to the sort of tax systems found elsewhere in the world. Not that the existence of worse systems should give our tax systems a free pass, but it’s time to acknowledge that at some of the tax law writers get some of the provisions right some of the time.

I am thankful that I live in a country where a mistake on a tax return or tax assessment doesn’t bring an immediate transportation to prison, or worse.

I am thankful that I don’t live in the past, in societies that had no tax systems because they relied on serfdom, plunder, and confiscation by royals, nobles, and ecclesiastics, none of whom were selected by ballot or referendum.

I am thankful that I continue to be subjected to user fees that are imposed and collected with little or no inconvenience to me. I appreciate that I have the ability to drive through a toll booth without completing a 10-page form, and often can do so without stopping and fishing for coins or paper currency.

I am thankful that I can criticize the various tax systems in this nation without having my passport revoked, my goods seized, my property invaded, or my liberty constrained.

I am thankful that I can criticize Congress, state legislatures, and local government officials for their woeful record on tax policy and tax legislation. If they were doing the top-notch job that I prefer that they do, I’d have much less about which to write. There are only so many things one can say about chocolate.

I repeat what I wrote three years ago, in Giving Thanks, Again:

Have a Happy Thanksgiving. Set aside the hustle and bustle of life. Meet up with people who matter to you. Share your stories. Enjoy a good meal. Tell jokes. Sing. Laugh. Watch a parade or a football game, or both, or many. Pitch in. Carve the turkey. Wash some dishes. Help a little kid cut a piece of pie. Go outside and take a deep breath. Stare at the sky for a minute. Listen for the birds. Count the stars. Then go back inside and have seconds or thirds. Record the day in memory, so that you can retrieve it in several months when you need some strength.

As I was going through my Thanksgiving posts from earlier years, I saw that and thought to myself, “Every once in a while I do manage to crank out something that’s worth repeating. This is one of them. I’m thankful I’m still around to have the opportunity to repeat it.” And I’m glad all of you are around to read it, whether for the first time, or yet again.

Do We Get What Our Taxes Pay For?

My short essay on The Math of Tax and Spend brought a very perceptive response from Daniel Hoebeke, J.D., a reader who is Gift Planning Officer for the Jewish Home in San Francisco:

As usual, I have found this column most thought-provoking. I wonder, though, if we aren't missing something here. On a personal level, I have no problem with getting less than I have contributed. The proper function of government is, as you note, to rely on some in order to benefit others. However, the missing element in this discussion of the budgetary process is accountability. We are keenly aware in the non-profit world that simply expressing a need is not enough. Even the most consistent donors are demanding that effective stewardship of their gifts is shown. In those cases where non-profits appear to be heavily invested in administrative versus program expenses, we must re-evaluate in order to provide an optimum ROI. Should we expect less from those whom we are supporting with our tax dollars?

This comment did its job, in causing me to think more about this question. Here’s my reply:

You make a good point. Perhaps it's not the budget that needs the close examination. Perhaps it's the "financial statement" or whatever it could be called, prepared after the fact to show what use actually was made of taxpayer dollars, much the same, as you describe, as non-profits set forth their expenditures. I'm fairly certain governments at all levels prepare such reports, but I wonder how public they are. I wonder if they get much attention, considering that budgets tend to get much more focus from the media.

The timing of the comment was almost serendipitous, or should I say that the timing of a major transportation snarl last Thursday was the event that should be tagged as serendipitous, at least with respect to this question of what happens with tax dollars.

As almost everyone knows, last Thursday air traffic was brought to a near halt because of a glitch in the system that is used to control airline flights. The system is responsible for keeping track of airplanes, flight plans, and all the other details that must be monitored so that there isn’t total chaos in the sky. According to this Philadelphia Inquirer story, the problem was caused by a circuit board in a computer system. According to the story, tens of millions of dollars have been invested by the FAA in a “nationwide communications system” intended to “modernize air-traffic control.” However, the project is “over budget” and “plagued by outages.” What is required, whether computers are being used to regulate air traffic or heart-lung machines, is a set of adequate backup equipment and systems. It’s called redundancy, and it’s no surprise that the aviation experts quoted in the story used that word.

According to another Philadelphia Inquirer story, Senator Charles Schumer or New York declared the “country's aviation system [to be] ‘in shambles’” and explained that more money is needed to prevent a repeat of the failure: "If we don't deliver the resources, manpower, and technology the FAA it needs to upgrade the system, these technical glitches that cause cascading delays and chaos across the country are going to become a very regular occurrence." The question that Daniel Hoebeke’s comment suggests is this: “Why, considering the tens of millions already spent, is the system not working?” Was the project underfunded? Is the quality of the equipment below par? Is the software as reliable as much of what most of us use every day when glitches of every sort slow down or crash computers? Or is it simply a matter of a complicated project having its original funding amount cut in order to offset tax reductions, or to satisfy those who oppose government spending?

A preliminary issue that must be addressed is whether government should be in the business of regulating air traffic. There are several alternatives. One is to ban air traffic so that there is no need for regulation. That is, of course, silly. Another is to permit air traffic but dismiss regulation of it. That, too, is foolish. Yet another is to permit the “private” sector to regulate air traffic. As a practical matter, this would require the creation of a monopoly. The cost to air travelers would increase because the cost of running the system would include not only the cost of the equipment, software, personnel, etc., but also the cost of generating the profits that the private sector would seek. Proponents of “privatizing” air traffic regulation claim that there are “efficiencies” in having the private sector take over the task, but what guarantee is there that the private sector would avoid failed circuit boards when the private sector approach is to “purchase on the cheap”? The pitfall of privatization of any monopolistic activity is the lack of accountability and responsiveness on the part of the monopoly. There’s no way for the public to “vote out” the monopoly or the private individuals running it and profiting from it. There’s no competition to keep it in line. That’s a serious weakness in the so-called free market, though a market consisting of a monopoly isn’t a market because there’s no arena in which to dicker over terms and conditions. Those, instead, are imposed by the monopoly.

Turning to the question of taxing and spending, how does one ensure, or at least ensure a high probability of, fiscal efficiency? Whether the funds come from general taxes such as the income tax, or from user fees imposed on airlines and air travelers, concluding that the federal government should operate the air traffic control system does not, in and of itself, tell us anything about the path to tax and expenditure levels for that operation. If the public, through the government, owns a less capable and less reliable system than is required because insufficient funds were expended, how is that remedied? What mistakes were made, and what lessons can be learned from those errors? If the public, through the government, owns a less capable and less reliable system than is required because it took delivery of defective materials or because it overspent by entering into contracts that overcompensated the contractors, how is that remedied? What mistakes were made, and what lessons can be learned from those errors? But none of these questions can be answered until the information is acquired. What happened? How does the public find out? Will the public find out? If the system is underfunded, is it a matter of trying to get by on too few dollars? Was it a bad design, one lacking, for example, redundancy? Was it a good design that fell victim to bad implementation? Were funds diverted to other projects that were no less necessary, in more critical need of funding, and overlooked by Congress? So should government spending on the FAA be reduced to accommodate tax cuts? Or should it be increased as Senator Schumer suggests? The answer depends on information not (yet) available.

Some sort of independent, transparent, information-intense audit of government is required, something far wider in scope and much deeper in review than what currently exists. Ought not governments be subjected to at least the same level of audit and review that it requires non-profit organizations to undergo? The twist is that such an audit might not generate, as some think, nothing more than identification of areas in which government spending can be reduced without adversely affecting programs that the government needs to fund and operate. Such an audit might also discover instances in which insufficient government spending is generating long-term economic costs far exceeding the reductions in government expenditures, and accompanying tax reductions or rejected tax increases. One good example is deferred maintenance on infrastructure. This latest air traffic control fiasco is another good example, although using the word “good” in a sentence describing what happened last Thursday is painful. But imagine how painful it could have been, and how other situations may turn out to be, if the goals of the tax cutters are accomplished.

The Devil’s in the Tax and Spending Details

On Wednesday, in The Math of Tax and Spend, I noted that “The world continues to wait for an answer to the question, ‘So if state taxes are cut, what spending programs should be reduced or eliminated?’ I had asked that question in New Jersey to Follow in California’s Tax Footsteps?.

It seems I’m not the only one with this question. It was posed to one of the candidates in the Republican primary campaign for U.S. Senator from Florida. Mario Rubio is challenging Charlie Crist, currently governor of the state, and an intense argument has developed between each of them, and their supporters, on, among other things, economic issues. The debate pits Rubio’s classic attack on taxes and spending – cut both, he says – against Crist’s decision, as governor, to accept federal stimulus monies to balance the Florida budget. The segment of the Republican party backing Rubio holds firm to the “cut taxes, cut spending” ideology, and Rubio claims that he would have refused the federal stimulus funds. According to this report, Rubio claims he would have cut $6 billion from the $65 billion Florida budget. According to this essay, “When asked by the press to specify how he would have pulled the state out of the economic emergency, Rubio reportedly replied, ‘I don't have the budget in front of me.’” Brilliant. Just brilliant.

Permit me to translate. “I don’t know. I haven’t studied the budget even though I’m quick to denounce the spending authorized by it. All I know is that I should stand up here and preach tax cuts and spending cuts. I’m certainly not going to identify any spending cuts because that would either cost me votes or make me look like an unsympathetic fool who has no understanding of what spending cuts would to do people.” According to the essay, a governor who takes steps to deal with his state’s economic collapse, who knows the budget must be balanced, who knows there’s little if any revenue available from the few fees and taxes that the legislature agreed to increase, who knows that spending cuts would hamper public schools, impair public health, require the dismissal of state workers, reduce jobless benefits, and curtail state services, was “caught in a classic dilemma.” It’s easy, the essay notes, to sing the praises of cutting taxes while campaigning, but it’s not easy to act responsibly when dealing with reality. Didn’t Marie Antoinette have a similar problem in understanding life as it was for the tens of millions not wallowing in untaxed luxury?

The classic “cut taxes” philosophy strikes me as just that. It reminds me of so many other instances in postmodern culture where theory holds sway, but provides little, if anything, of practical value. Think of those folks who are quick to criticize something, but when asked what they would do instead, mumble, “I don’t know.” To those folks, I respond, "Then figure it out, and couple the criticism with at least one constructive suggestion." In other words, don’t simply criticize government spending. Go through the budget, identify the items that should be cut, and then stand up to make an argument for those spending reductions. Maybe it’s possible for one hook and ladder company to cover the entire city. Demonstrate how that could be accomplished. Perhaps it makes sense to eliminate all spending that assists the impoverished. The alternative, sick, dying, and criminally behaving individuals, might appear to be a better alternative for those voters hung up on taxation levels. Perhaps taxes could be reduced if all prisons were closed and prisoners released. Stand up and make that argument. And if the fall-back of “cut waste and mismanagement” becomes the tax cut advocates’ only hope, step up with specific identification of the waste and mismanagement, identifying those who are mismanaging, explaining what should be done differently, and sharing the computation of savings that would permit the sorts of tax cuts that are being advocated. At least the late Senator William Proxmire blessed the nation with his Golden Fleece Award, though the amounts involved were less than a drop in the ocean of federal spending. Though he had to recant on some of them, at least he tried. That's far more than what Rubio and his colleagues in the cut-taxes-and-spending camp are offering us.

There is a difference between demagoguery and leadership. Demagogues rely on sound bites that encapsulate fear, prejudice, and gross oversimplification. Good leadership offers solutions that work, shares specificity that allows evaluation of the proposed solutions, sets an example by engaging in careful study of problems and possible solutions, and understands the needs and concerns of those who are asked to follow. Attachment to abstract ideas for which no practical implementation plans or analysis of consequences are set forth is not political leadership. Resolving the tax and spending problem in this country, at every level of government, requires something more than platitudes and ideological slogans.

The Math of Tax and Spend

The world continues to wait for an answer to the question, “So if state taxes are cut, what spending programs should be reduced or eliminated?” This is a question I asked a few weeks ago in New Jersey to Follow in California’s Tax Footsteps?. At the federal level, there are two additional choices not available to the states, namely, deficit spending and printing money. States, though, need to cut spending if they cut taxes.

The latest show in the “cut taxes” parade took place in Harrisburg last weekend. According to this report, several thousand protesters swarmed the state capital to condemn tax increases and proposals for tax increases. Though sponsored by the Pennsylvania Tea Party Patriots, an organization with an agenda focused on tax reduction and elimination, the protesters who showed up carried signs dealing with all sorts of other issues. It must have been noisy, because one politician tried to influence interpretation of the event by noting, “Although you hear hooting and hollering, these are not radicals. The silent majority is waking up.” I might buy into that perception had tens of millions of people attended the event. Several thousand isn’t a majority in any state. It’s not even close.

The article mentions a woman who expressed concerns about “government spending and the future of her five grandchildren.” She ought to be concerned. She ought to think how tax cuts would affect her children’s future. She should be asked, “If taxes are cut, which programs should be curtailed? Do you want the state to reduce or eliminate funding for education? What would that do for your grandchildren’s future? How about the health department? Or the state police? Or highway and infrastructure expenditures? Do you think your grandchildren have a great future in a place that doesn’t tend to public health, provides reduced or non-existent crime prevention, detection, and solving, or that lets its citizens drive over crumbling highways and failing bridges and overpasses?” After the usual theoretical platitudes and emotional screeds are heard, she, and her colleagues in the anti-tax business, ought to be asked to describe how the country and the state would function in their utopia of no or low taxes.

I wonder if this woman would be happy to have her Social Security cut. There’s a way to reduce spending. I’m sure she would scream that she “paid for it” and that she would have difficulty understanding, or accepting, that what she is getting far exceeds the sum of what she put in plus the earnings on that investment. I wonder if she can see that most citizens are taking more from government than they are contributing to it, and that most of those screaming about high taxes would scream even more loudly when their time at the public trough ends. The challenge is getting people to understand that when they drive on allegedly free highways they are consuming government expenditure dollars, that when they do business or converse with an educated person they are benefitting from the government dollars invested in that person’s education, when they walk their relatively safe suburban and rural streets they are benefitting from taxpayer-financed police protection, and when they purchase gasoline from a pump that claims to dispense the stated number of gallons they are benefitting from tax-funded government inspection of fueling stations. Hidden benefits are rampant. The proof lies in the deficits and budget shortfalls afflicting every level of government throughout the nation.

Many of those drawn to these various anti-tax rallies have convinced themselves that they are getting the short end of the deal, that much of what they are paying in tax dollars isn’t being returned to them. That’s because they cannot or refuse to see the tangible and intangible benefits they accrue from government spending. It is possible, of course, that some individuals could demonstrate that they don’t get as much back as they pay in, though the huge scale of government spending deficits and budget shortfalls suggests that very few would fall into this category. Even in an ideal world, there are individuals who take more than they give, particularly when they are afflicted with needs surpassing their resources. Society, through government, has an obligation to step in, and fulfilling that obligation costs money. Some anti-tax advocates claim that the private sector can and should deal with these situations, but history tells us that the private sector, though sometimes performing admirably, consistently comes up short.

What it comes down to might be a matter of allocation. Many of the haves, on whom most tax burdens rest, want taxes to benefit the haves, and not the have-nots. Is it coincidence that the anti-tax groups have become enlivened during the past year? Is it a reaction to the election results of a year ago? Is it an outlet for the emotional distress of discovering how eight years of tax cutting contributed to an economic disaster the effects of which will continue to threaten the country long after experts declare the recession to be over? Whatever it is, many of us continue to await their proposals. I know I’d like to see a list along the lines of “Cut $x from program y” so that discussion could take place with respect to these ideas. But the only thing I hear, see, or read is a “cut taxes” chant that has become the mantra of a group seemingly incapable of contributing to both sides of the tax-and-spend equation.

Who Appreciates This Tax Complexity?

Last week, in Partnership Taxation, I alerted students to the trap that exists in section 751 and the need for them to be very careful when dealing with the identification of partnership assets subject to section 751. There is a wrinkle that seems to serve no purpose other than to confuse taxpayers, tax practitioners, and tax students. Some background is helpful.

When a partner “sells” a partnership interest for tax purposes, the tax law (section 751(a), to be specific) treats the gain or loss recognized on the sale as capital gain or loss, except to the extent it is attributable to the partner’s share of section 751 assets in the partnership. The purpose of this provision is to prevent the partner from “converting” ordinary income into capital gain. Accordingly, even though the partner is treated as having sold a thing called a partnership interest, which reflects an “entity” approach similar to a shareholder selling stock in a corporation, an “aggregate approach” is used with respect to section 751 assets. In effect, the analysis “looks through” the partnership interest to the underlying asset.

A similar provision (section 751(b), to be specific) applies to distributions to a partner that changes the partner’s interest in section 751 assets. The purpose of the provision is the same, to prevent the partner from obtaining capital gain treatment with respect to assets that would generate ordinary income.

So what’s the catch?

The catch is that the definition of section 751 assets differs for purposes of section 751(a) and section 751(b). The definitions are identical except with respect to inventory items. For purposes of section 751(a), which applies to sales of partnership interests, all inventory items are treated as section 751 assets. But for purposes of section 751(b), which applies to distributions, inventory items are treated as section 751 assets only if they are “substantially appreciated.” To be substantially appreciated, the inventory items must have a fair market value that exceeds 120 percent of their adjusted basis, with a rule disregarding inventory items acquired to manipulate these numbers.

Why the difference? The short answer is that I don’t know. Once upon a time, the definition of section 751 assets was the same for purposes of both section 751(a) and section 751(b). Inventory items were included only if they were substantially appreciated. Why not include all inventory items? I cannot think of a legitimate, reasonable, worthwhile, defensible reason. If the goal is to prevent the conversion of ordinary income into capital gain, it ought not matter whether the inventory is 104% appreciated or 123% appreciated. It’s not a de minimis rule, because inventory can flunk the substantial appreciation test while having tens or hundreds of millions of dollars of ordinary income inherent in the inventory. Putting aside the fact that this entire discussion would be irrelevant if capital gains and ordinary income were not treated differently, it makes no sense to treat some ordinary income as ordinary income and other ordinary not as ordinary income, but that is how things stood until Congress amended section 751.

When news broke that section 751 was going to be amended, I rejoiced. Well, I didn’t really rejoice, but I was glad, because it meant I could free up some class time because the definition and computation of substantial appreciation would be tossed out of the course. Unfortunately, when the amending legislation worked its way through Congress on its route to enactment, the amendment was tweaked so that we ended up with the “dual definition” of section 751 assets. Why? Again, I don’t know. Why should the ordinary income in inventory that is 104% appreciated be ordinary income when dealing with a selling partner but not ordinary income when dealing with a distributee partner? It’s tough to visualize the special interest group behind this one, because partners rarely know ahead of time whether they’ll end up as a selling partner or distributee partner.

The effect of this difference is to confuse people. True, it creates exam material for tax law professors. That provides the opportunity to identify students who are careful and precise and those who are not, but I prefer to do that using Code provisions that require care and precision for explicable reasons. Nonetheless, I’ve been known to include section 751 asset definition questions on exams and in semester exercises.

Not only is there confusion in terms of the dual definition, there’s also a variety of circumstances where the substantial appreciation rule generates surprise results. For example, assume a partnership has actual inventory with an adjusted basis of 100 and a fair market value of 110, and assume it also has unrealized receivables of 30. Standing alone, the inventory is not substantially appreciated, but when the inventory items, which include the receivables, are aggregated, the inventory items are substantially appreciated. Considering that section 751 assets are often referred to as “hot assets,” (don’t ask), one can refer to this situation as “receivables heating up the inventory.” Consider a partnership that owns inventory with an adjusted basis of 100 and a fair market value of 130. Standing alone, the inventory is substantially appreciated. But assume the partnership also has realized receivables of 60. When aggregated, the inventory items (adjusted basis 160, fair market value 190) are not substantially appreciated. The receivables have “cooled down the hot inventory.” Why should the ordinary income treatment, or not, of a distributee partner turn on theses sorts of “computational games”?

Something else I do not know is how much revenue would be raised if all inventory were treated as section 751 assets for purposes of both sales of partnership interests and distributions to partners. Surely it is some positive number, but whether it is in the tens of millions, hundreds of millions, or even low billions is a question I cannot answer. Perhaps someone else, perhaps a revenue estimator, could crank out the numbers. What I do know is that the tax law would be simplified, by a smidgen, if the definition of section 751 assets for the purposes of sales of partnership interests were extended to distributions. So I return to the question, why not do so? Whatever may have been the reason for not doing so when section 751 was amended, assuming there was a reason, it surely wasn’t and isn’t one that justifies this sort of complexity.

So here’s a proposal that brings simplification and revenue increases, and that can be justified on the grounds that the income in inventory that is not substantially appreciated ought not be taxed at capital gains rates even if one accepts the idea of special low tax rates for capital gains. This sounds like a “shelf project” for Calvin Johnson. Yes, when this is posted, I’m passing on to him the URL for the post. I wouldn’t be surprised to learn he’s “already on it.” Even if it’s a small revenue increase, he keeps telling us we’re going to need every dollar to deal with a looming budget deficit crisis that will severely threaten the nation. He’s right. So I guess I’m going to become a lobbyist, arguing for this change to section 751. But I’d like to think that I’m lobbying for the nation’s economic and budgetary welfare. Of course, I’d rather be lobbying for repeal of the special low tax rates, but it’s worth having a backup plan in the unfortunately likely event Congress cannot be persuaded to ditch a disproven rate giveaway.

Hopefully, someone will appreciate this effort. Perhaps even substantially.

Funding City Services to Tax-Exempt Schools: Impose User Fees, not Taxes

Pittsburgh’s having tax problems again. In No One Drinks to This Tax, I explained how the governor of Pennsylvania tried to soothe the owners of small pubs and bars facing implementation of a newly-enacted drink tax in Pittsburgh by suggesting that Pittsburgh would follow the same selective enforcement approach used in Philadelphia. I followed that post with Another Sip of the Drink Tax, I explored information shared with me by a Pittsburgh-area reader, who alerted me to the purpose of the tax, namely, to fund the financially-troubled Port Authority Transit system. In what should not be a surprise to those who are familiar with my perspective on user fees and taxes, I objected to the shifting of transportation funding from transit users to bartenders and wait staff, which is what studies indicated happens in these situations.

Apparently Pittsburgh officials haven’t learned anything, though surely they don’t read this blog, because they’re now proposing another foolish tax idea, namely, a tax imposed on college tuition. According to this story in the Philadelphia Inquirer from the Pittsburgh Post-Gazette, the mayor and his staff are asking Pittsburgh City Council to approve a budget that includes a one percent tax on tuition received by Pittsburgh colleges and universities. According to the mayor, because institutions of higher education have raised tuition by more than one percent, the city’s proposal “falls right in line with orientation fees, with transportation and security fees, with lab fees,” and he suggests the schools could reconsider other charges.

According to the Pittsburgh Post-Gazette story, the tax would not be a tax on the students. It would not be a tax on the schools. It would be a tax “on the privilege of getting a higher education in Pittsburgh.” Can someone tell me how the city of Pittsburgh can take credit for the education provided by the schools that located themselves in the city? Perhaps the schools should be charging Pittsburgh a fee for bringing jobs and business activity to Pittsburgh. What would happen to Pittsburgh if all of the institutions of higher learning in that city moved elsewhere? Surely Johnstown, Erie, Altoona, and other places would welcome the jobs and economic activity that the schools would bring.

Now, as an advocate of user fees, I can understand the City of Pittsburgh charging schools, and other organizations, within its borders for the services it renders. Even though the schools, and some of the other institutions are tax-exempt, it makes sense to require them to pay for water provided by city water works, for trash pickups made by city refuse collection crews, for police services rendered on the campus, and so on. In the past, the schools in Pittsburgh, acting collectively through an organization called the Pittsburg Public Service Fund, contributed millions of dollars to the city. But last year the city refused to accept the donation, presumably because $5.5 million was insufficient.

Why is the mayor proposing this tax? First, there’s a deficit in the city budget. Second, he thinks that adding another one percent hike to college tuition is “just a nibble compared with the bite that college fees and tuition hikes take out of student and parent wallets.” It would be helpful to his position if he set forth a cost accounting analysis of the services provided to the colleges and their students. Whether that turns out to be one percent of tuition, ten percent of tuition, or one-tenth of one percent of tuition remains to be seen. Picking a number out of thin air, specifically one percent, suggests that not much thought has gone into the proposal. Certainly not persuasive, rational, analytical, specific thinking. The mayor suggested that if it’s acceptable for colleges and universities to charge fees, they ought to charge a fee for the city. How’s that? If a college charges a fee for providing meals to students, it’s providing something for something. Why should the schools charge a fee “for the city”? If the city wants to charge for services, it ought to do so by charging a fee that reflects the cost of providing the services. Do I detect a lack of logic? I surely do.

Where would the tax revenue raised by the tuition tax go? Almost all of it would provided funding for the city’s pension fund and for capital improvements. Hello? Why would it not be used to pay for services provided to the schools?

The mayor claims that he is prepared for “a fight, or a battle, if you will” to deal with the budget deficit. That was his reaction when the institutions of higher learning in Pittsburgh “blasted” the proposal. To the assertion that the tax would reduce the institutions’ competitiveness, and it would, the mayor responded that “if there was a competitiveness issue, it was the schools' fault.” Brilliant. Absolutely brilliant. In the meantime, the mayor has set aside proposals to impose taxes on hospital bills, parking fee surcharges, and water rate increases.

The schools in Pittsburgh claim that the proposed tuition tax is illegal. It is likely that if Pittsburgh’s City Council enacts the tuition tax, litigation will follow. One of the issues is whether the state legislature needs to endorse the tax, because cities and other localities are limited to enacting taxes within the scope of state legislation giving them power to do so. Arguably, there is no state law allowing the imposition of a tuition tax. The controversy over the proposed tuition tax won’t be the first brouhaha of the 29-year-old mayor’s short political career. Far from it, if even half the reports summarized and cited in his Wikipedia biography are true. Reportedly, it’s not his first foray into a tax controversy, though the previous one involved allegations of tax benefits for certain non-profit entities in exchange for sponsorship of participation in a golf tournament.

Some schools, however, claim that any sort of tax is “an attack” on nonprofit status. However, the issue is clouded by use of the term tax, and would be clarified by the use of the term “user fee.” The schools in Providence claimed that they were dealing with their own budget deficits, but it seems to me that schools ought to be paying fair value for what they receive from state and local governments. If they need to cut back on water use, on police services, on trash collection, then they ought to do so. The argument “we’re tax exempt so we get these services for free” is just as silly as the explanations advanced by the mayor of Pittsburgh.

The mayor of Pittsburgh probably got his idea from the mayor of Providence, Rhode Island. But he should have finished reading the story. The attempt by Providence’s mayor to impose a fixed-dollar fee was rejected, an attempted negotiation for voluntary payments fell through, and when he tried to get the legislature to enact a reduced-rate property tax on non-profit organizations, the state legislature balked. When the Pittsburgh mayor said, “I have an idea,” someone should have saved him by saying, “It’s not a good one.”

Here’s a suggestion for the city of Pittsburgh. Enact user fees set at the value of the services provided by the city. Here’s a suggestion for the non-profit organizations, including institutions of higher learning, operating in Pittsburgh. Don’t treat tax exemption as though it means everything is free. Support the city if it attempts to enact user fees set at fair value, and pay them. It’s an arrangement that has been adopted elsewhere, and it works. Had some research been done before the “good idea” was publicized, a lot of embarrassment, bad publicity, and bad tax policy could have been avoided. It’s not too late to prevent tax-dollar-consuming litigation from impeding progress. That’s my idea, and it is a good one.

More on Tax-Free Beverages: Let Them Drink Chocolate?

Earlier today, Mary O'Keefe reacted to my Tax-Free Beverages: Let Them Drink Chocolate? post with a question. Had I read the article, Nutrition: Chocolate Milk May Reduce Inflammation, in the New York Times? I had not. I am grateful for the tip from Mary.

So there's further proof, assuming the studies aren't fabricated products of dairy industry influenced-focused funding, that chocolate is medicinal. Taxing medicine is a horrific idea, and most, perhaps all, state and local governments choose to refrain from imposing sales taxes on prescription medications. Almost all similarly exempt over-the-counter medicines. So, if white milk isn't taxed, and chocolate gets the medicine exemption, chocolate milk should survive the taxation attempt, just as strawberry-flavored milk would escape because of the fruit exception.

Here's the catch. Red wine does a better job of reducing inflammation. Most children who drink chocolate milk probably graduate to soda, coffee, and beer. Perhaps the health care bill should be amended to include a tax credit for people who engage in healthy dietary habits, such as eating fruit, say, strawberries, chocolate, say, covering the strawberries, and drinking red wine. Maybe any chocolate-covered fruit would qualify. Now I'm off to think up a fancy name for this credit, one that is catchy and also generates a fun acronym.

Tax-Free Beverages: Let Them Drink Chocolate?

Amidst the furor over children’s access to sugar, particularly sugar-laden beverages, in schools, and proposals to impose a tax on sugary drinks, another front has opened up in the battle for children’s taste buds and dietary intake. For my earlier thoughts on this tax idea, see What Sort of Tax? and The Return of the Sugar Tax Proposal. According to an article with an informative title, Industry Pushes Chocolate Milk in Schools, the dairy industry is starting a campaign to encourage more children to drink milk while at school by touting the allure of chocolate milk. People are quickly taking sides.

It appears that the dairy industry thinks that adding chocolate to milk will encourage students who wouldn’t otherwise drink milk to reach for it at mealtime. Some educators and health-care professionals, particularly those concerned about childhood obesity, prefer to keep chocolate milk out of the schools, and claim that if the only available milk is the usual white milk, students will drink it. These folks see chocolate milk as a sugar-delivery vehicle in the same “food group” as soda and candy. The dairy industry thinks otherwise, and one of its campaign’s goals is to cause people to see chocolate milk as in a separate category because of the nutrients it provides. Opponents of chocolate milk sales in schools claim that there are no signs of calcium deficiency in children attending schools that don’t offer chocolate milk. They also claim, pointing to anecdotal evidence, that children will drink white milk if it’s the only thing available. While the debate picks up steam, no one has yet to calculate the number of schools that offer chocolate milk, the number of those schools thinking about pulling it off their shelves, and the number of schools that don’t offer chocolate milk but that are considering adding it to replace soda and other beverages removed from the menu.

What would help would be a gathering of facts rather than anecdotes, isolated studies, and theoretically-based conjectures. For example, there’s no debating the value of milk as a substance delivering essential nutrients to its consumers. Using information from this nutrition site, I created a table to compare the various characteristics, including sugar content, of four types of milk – there are dozens but I went with the most common:

Type	Chocolate Milk	Reduced Fat Chocolate Milk	Whole Milk	2% Milk
Calories	208	190	146	122
Fat (grams)	8.48	4.75	7.93	4.81
Cholesterol (mg)	30.00	20.00	24.40	19.52
Carbohydrates (grams)	25.85	30.33	11.03	11.42
…sugars (grams)	23.85	23.88	12.83	12.35
Protein (grams)	7.93	7.47	7.86	8.05
Calcium (mg)	280.00	272.50	275.72	285.48
Iron(mg)	0.60	0.60	0.07	0.07
Potassium (mg)	417.5	422.5	348.92	366.00
Vitamin A (Int’l Units)	237.5	567.5	248.88	461.16
Vitamin C (mg)	2.25	trace	trace	0.49

Nutritionally, chocolate milk provides more calories, more sugar, slightly more fat, and slightly more cholesterol than does white milk. It also provides Vitamin C and iron, whereas white milk pales in comparison, and chocolate milk also provides somewhat more potassium. The question therefore becomes one of whether the increased caloric and sugar intake is a price worth paying to get children to drink milk instead of something else. Despite the anecdotal evidence, and the assertion by one chocolate milk elimination advocate that children will not go on a “thirst strike,” it isn’t unlikely that children have turned, and would turn, to water instead of white milk. Water had the advantage of providing nothing much in the way of calories, sugar, or fat, but it also provides nothing much in the way of vitamins, calcium, other minerals, and anything other than thirst quenching qualities.

For teachers, the disadvantage of chocolate milk is that chocolate wires students at least as much as do sugar-containing foods and beverages. What is it like to teach the first class after lunch? Once upon a time, students were sent out to “recess” after lunch, presumably to burn off the energy generated from their meal, to give teachers a chance to eat their own lunch, and to pump fresh air into the youngsters’ lungs. Does recess still exist? It does, in some places, but where it persists, it has been eroded both in terms of time and in terms of permissible activities. So although sugar ingestion and caloric intake deserve attention, and although a good argument can be made that chocolate milk encourages at least some children to drink milk, the chief concern is the challenge of dealing with the consequences of children filled up on chocolate.

At one school, according to the article, a school superintendent reacted to a student petition in favor of flavored milk, and decided that the school would have “flavored milk Fridays.” On that day, students can select not only white milk, but chocolate milk and strawberry milk. Perhaps strawberry milk counts as a fruit serving? I remember some of my elementary school classmates drinking pink milk. Sorry, the color didn’t work for me. It still doesn’t. I wanted my chocolate. Of course, it was white milk for me. My parents and my teachers knew well enough that the last thing they or the school wanted or needed was school-age Jim Maule on chocolate.

Ultimately, several big decisions loom if a tax on sugar-laden foods moves forward. If chocolate milk is subjected to such a tax because it contains sugar, ought not white milk also be taxed? Granted, many fruits contain sugar, but I expect a “fruit exception” to be drafted into “sugar tax” legislation. If an exception is made for white milk, logic would dictate that combining exempt white milk with exempt strawberries should create tax-free pink milk. As for the chocolate milk, full use should be made of the vegetable exception. Chocolate is a vegetable, is it not?

Taxes and Benefits: Territorial Mismatch

One of the tax policy ongoing debates that tends to get little attention in mainstream media is the question of how the United States should tax income that its citizens and corporations derive from activities abroad. Part of the reason for the inattention is the complexity of the issue. Trying to explain the current system in anything short of a book is difficult and trying to explain the options requires almost as much textual space.

The current debate focuses on the advantages and disadvantages of shifting federal income taxation to a territorial system. Under a territorial system, a nation taxes income generated within its borders and ignores income derived elsewhere. Most countries use a territorial system. It is claimed that only the United States, Vietnam, Eritrea, and North Korea do not use a territorial system. According to this report, Oman is moving away from the territorial system. The alternative to the territorial system is the world-wide system, under which a nation taxes its citizens and corporations on income from all geographical sources. Because this approach can cause its citizens and corporations to find themselves paying tax both to the United States and the country in which the income is generated, the United States uses a hybrid system, under which it permits its citizens and corporations to claim a credit for the taxes paid to foreign countries. In practice, it’s far more complicated, because tax treaties between the United States and foreign countries tweak this arrangement, and if corporations use foreign subsidiaries to generate the income, that income isn’t taxed until and unless it is distributed by the subsidiary to its parent United States corporation, but even this description oversimplifies the tax law. Furthermore, the United States exempts from taxation some or all of the wages earned abroad by United States citizens. This, too, is an attempt to provide a simple yet technically accurate description of section 911.

Although the current Administration has delivered proposals that would move the United States closer to the world-wide system, there is a growing chorus of voices clamoring for adoption of a territorial system. For example, in this post, Keith Hennessey explains how the world-wide system disadvantages United States corporations. Support for shifting to a territorial system comes from, to give a few examples, the Heritage Foundation, the Tax Foundation, the National Foreign Trade Council, and the Peterson Institute for International Economics. So, too, did the President’s Advisory Panel on Federal Tax Reform, but its web site seems to have disappeared. It isn’t difficult to find many more advocates of the territorial system.

Though I understand the arguments that suggest a territorial system makes United States corporations more competitive because it reduces their overall tax burden, I don’t understand how that necessarily translates into good tax policy. I suppose the underlying premise is that if it is good for a United States corporation, it is good for the United States. That’s the “If it’s good for GM, it’s good for America” mindset that has demonstrated its own shortcomings. Yes, I understand that, in theory, if a United States corporation is more competitive, it supposedly creates more jobs, but there’s nothing to guarantee that those jobs are created in the United States. Nor is there a guarantee that the presumed increas in profits generated by increased competitiveness would go anywhere but into the pockets of the corporate officers and shareholders, who are not necessarily United States taxpayers.

But there’s an even deeper question that I must ask, that reflects the difficulty I have in accepting territorial taxation as the best approach, particularly when coupled with the notion that at least some element taxation should reflect payment for services afforded by the government and its citizens. Permit me to be a law professor and to pose a hypothetical. A group of citizens of nation A are living abroad in nation B, paying taxes to nation B but not to nation A, because nation A's tax system is territorial. An uprising occurs in nation B. The citizens of nation A want to be rescued. They would gladly accept the assistance of the nation A military. Yet we are told they are unwilling to pay taxes to fund the cost of nation A keeping a military in place to provide rescue services. Is this simply another instances of “I want it, I want it all, I want it now, and I don’t want to pay for it”? Or is it expected that nation A will rescue these citizens and then send them an invoice, much the same way the town ambulance sends a bill after its services have been used?

I posted this inquiry to a listserv frequented by tax practitioners. Off-list, I received replies suggesting the same reaction as was encapsulated in an on-list response, “Good point.” Of course, everyone could see through the hypothetical because the nation whose military most frequently comes to the rescue of people in trouble during uprisings is that of the United States. Occasionally, a few other countries step in, but most do not and cannot do so. The United States even comes to the aid of people who are not its citizens. Perhaps the thinking is that if the United States is willing to help non-citizens without sending an invoice, it also should come to the aid of its own citizens who are abroad without sending an invoice or imposing a tax. That reasoning breaks down when one realizes that citizens living within the territory of the United States have no less a claim for assistance without invoices or taxes. Doesn’t this put things on the road to elimination of taxes? Or is it again a matter of a particular group finding ways to demonstrate that the disadvantages of its members paying taxes outweigh whatever justification exists for subjecting them to taxation, with the hope that no other group, or few other groups, will jump on the “don’t tax us” bandwagon, knowing that if everyone found a way to make the same sort of arguments there would be no one left to tax? Proponents of territorial taxation respond that citizens and corporations living and doing business abroad pay taxes to the nations in which they are resident, but many qualify for relief from most, if not all, taxation under laws and programs enacted by these nations to attract business to their shores. The price that is paid is diminution in services provided by those governments to its own citizens, thus causing them, and even their governments, to appeal to the international community for aid in a variety of forms. Much of that aid is funded by United States taxpayers. And even where citizens and United States corporations resident abroad pay meaningful taxes to foreign countries, how many of these citizens and corporations decline to look to the United States for rescue services when an uprising or other civil unrest threatens them? Would they still support territorial taxation if it came with a price tag, namely, no one answering the phone when they call for help?

Perhaps a territorial system would work if it were accompanied by a special services fee. How should this fee be calculated? Because corporations measure themselves through a combination of income and asset value, a percentage of the income and asset values that are “insured” by the United States military, and its judicial system, would make for a sensible tax. The rate need not be very high, if imposed across the board, to pay for the cost of that protection. For individuals, a percentage of asset values is much more difficult to administer, because individuals do not file the sort of financial statements that corporations are required to provide, so a small percentage of income, or perhaps a flat fee, would be appropriate. What would not work is self-insurance, because there’s no feasible way to separate those who have “waived” any benefits provided by the United States from those who are chipping in for the costs imposed on this country of protecting its citizens abroad.

Imposing some sort of user fee as an offset to a shift from global-wide to territorial taxation makes sense. Whether others, including the Congress, see it that way remains to be seen.

New Jersey to Follow in California’s Tax Footsteps?

So the “lower taxes” candidate won the governor’s race in New Jersey. That doesn’t mean taxes will be reduced, because the New Jersey legislature will have something to say about that. And the governor-elect may discover that reducing taxes isn’t necessarily the best choice.

If the governor-elect succeeds in lowering taxes, what will happen? It’s not as though there’s no precedent for this sort of thing. The anti-tax crowd has done well in California. Proposition 13 has been described as the opening salvo in the attempt to reduce and even eliminate taxes and to derail tax increases. Many are of the opinion that its requirements, and those of follow-up restrictions, are a major factor in the budget crises that have tormented California during the past decade. Recently, California was ordered to release 27% of prisoners from its prisons, because the prisons are too crowded and lack sufficient health care services for inmates. Over-crowding occurs when the state’s population increases, criminal offenses increase, arrests increase, and convictions increase, but the state lacks funds to build or expand prisons and has insufficient resources to maintain the prisons that do exist. Though some claim that there are 40,000 prisoners who can be released without threat to the public safety, the steady stream of news stories about ex-prisoners continuing their crime sprees when released, particularly when released before serving their full sentences, isn’t going to calm a jittery public. Nor are prisons the only problem in California. One-day-a-week furloughs for state employees have caused traffic snarls, and the full cost of cutting funding for education won’t be seen for at least a decade even though the immediate price is more than sufficiently worrisome to those who understand the role of good education in the development of an informed citizenry. Essential infrastructure projects are left unfinished, bridges are falling apart, cuts have been scheduled for in-home services to the elderly and disabled, income tax refund checks no longer are being issued, and useless IOU notes are being issued to those owed money by California. To make matters worse, some of the cuts in service proposed by the California governor and legislator have been blocked by federal judicial orders. Simply put, California is falling apart. And not because of earthquakes.

When asked to approve tax increases, Californians voted no. They also rejected caps on state spending. Hello? Is the “don’t tax me, but spend money on me” outlook on life sweeping through California as a precursor to sweeping through the nation? It is said that trends begin in California. This is a bad one. A very bad one.

Now New Jersey gets a chance to see what happens when tax revenues are reduced but demand for government spending continues unabated. Is no one taught the skills required to balance budgets? Are fiscal discipline and common sense lost abilities? Are there any political leaders still standing who have the courage to explain the true cost, tax-wise and otherwise, of the things that the people demand? Is the nation paying the price for too many years of too many people refusing to say “no” to the demands of those who are unable to comprehend that money does not grow on trees?

Perhaps New Jersey residents will get to experience the latest California budget solution trick, and a trick it is. According to this story, California is increasing income tax withholding on wages. It’s not a tax increase, but it’s a compelled interest-free loan to a government that isn’t issuing income tax refunds. Taxpayers who understand how withholding works, and most don’t, will file amended withholding certificates with their employers, claiming more exemptions, and thus offsetting the impact of this “get cash now” stunt that some wizard in Sacramento conjured up while trying to figure out how to rescue the state from its self-imposed budgetary mess. The best reaction comes from Christopher Thornberg, a principal with Beacon Economics in Los Angeles, who explains that the withholding and similar ploys don’t solve the problem, "they just more or less hid it. I call it a fraud." Indeed.

The question that hasn’t been asked enough times, and for which meaningful answers haven’t been forthcoming, is this: how much spending will be cut from each New Jersey program on account of the governor-elect’s planned spending cuts? Will there be a decrease in highway repairs? A reduction of assistance to the disabled? Pink slips handed to half of the K-12 teachers in the state? Closing all prisons and releasing all prisoners? Firing all of the state police?

The standard response from the anti-tax crowd is that cutting taxes increases government revenue. Tax-cut advocates rely on the disproven “trickle down” theory, a theory to which some die-hards cling as tightly as flat-earthers embrace their belief that all of us should fear boarding ocean-going ships because they will falling off the edge of the earth. Here’s some news. The earth isn’t flat, and trickle-down is yet more proof that a theory isn’t worth much until it is proven to work. And this one doesn’t.

Hopefully, New Jersey residents and taxpayers will be glued to their television sets, iPhones, and computers to learn which of their favorite state programs or state-provided services will be axed so that their taxes can be cut. Then, I suppose, they will go shopping with those tax cuts in hand, trying to buy themselves some plowed highways, police protection, disaster assistance, beach cleanups, and similar items no longer provided by the state. Or perhaps they’ll use the tax cuts to offset the impact of increased wage withholding that will generate IOUs the following spring. They, and we, will discover what tax cuts can buy.

Tax Illiteracy as a Threat

Friday’s post, Unmasking the Deductibility of Halloween Costumes got the sort of attention that wild costumes attract at off-the-wall Halloween parties. A quick google search picked up these mentions:

• Tax Prof Blog: Deductibility of Halloween Costumes
  
• The Wandering Tax Pro: What’s the Buzz? Tell Me What’s A Happennin’ (“* Since today is Halloween I must include at least one holiday-specific tax post. Prof Jim Maule’s as usual scholarly and well-documented “Unmasking the Deductibility of Halloween Costumes” at MAULED AGAIN certainly fits the bill.”)
  
• Wall Street Journal Popular Tax Stories from Around the Web: Unmasking the Deductibility of Halloween Costumes
  
• Trigeia: Deductibility of Halloween Costumes
  
• Twitter: Deductibility of Halloween Costumes: Jim Maule, Unmasking the Deductibility of Halloween Costumes
  
• Megite: Deductibility of Halloween Costumes

The post also brought an email from Jamal Razavian, who wrote:

I agree with your analysis in your October 30, 2009 post regarding the fact that a Halloween costume, though it may be unsuitable for everyday use, is almost certainly insufficiently related to the taxpayer’s trade or business activities to be deductible. It is quite problematic that Ms. Walker (who provided the advice) fails to discuss the nuances that are relevant to the deductibility of Halloween costumes. Even more problematic, based on a casual review of that website and her own professional site, I noticed that the Ms. Walker generally does not discuss the difficult nuances present in the tax law, instead choosing to focus on blanket statements (which may or may not be inaccurate depending on the advisee’s particular circumstances). My fear is that tax laymen will read advice of this type and (i) mistakenly come to believe that there are more easy answers in tax than there truly are, or (ii) follow such advice blindly and misreport their own income. I worry about the Service’s ability to administer the revenue system when individuals like Ms. Walker are out there providing inaccurate and misleading advice, and I wish there was more the Service could do to prevent such abuses.

My response to Mr. Razavian:

Absolutely. There is, as you point out, a broader “text” to the question, but I chose – in an unusual attempt at being diplomatic – to focus on the Halloween costume issue (topical!!) rather than the entire site. The internet is replete with sites operated by tax protesters, people who lack expertise, and a variety of people who mean well but don’t quite understand tax law. The problem reaches beyond tax law to other areas of law and other professions and trades. Would it make sense to have the IRS “certify” web sites as providing accurate information? Would that be feasible? Would it be easy to circumvent? Would it require constant “re-accreditation” by the IRS? Your comments raise some good questions. Perhaps the more I think about them the more I’ll discover another post. If I do that I can give you attribution if you wish, or leave you as an anonymous reader, whichever you like.

Mr. Razavian chose attribution, and I have decided to expand on my comments concerning the flood of incorrect, misleading, inaccurate, and over-simplified information drowning those who travel the information highway.

The internet simply magnifies and disseminates more widely the same sort of misguided advice and information that inhabited, and still inhabits, newspapers, journals, magazines, radio, and television. Too many people, particularly those whose entire lives have been accompanied by internet access, think that “if it’s on the internet, it’s true.” The modern cultural affinity for sound-bites that impose little or no burden on the use of brain cells compounds the problem. Some years ago, before internet use became pervasive, a student in one of my basic tax courses came up to me after class and commented, almost in these words, “I notice you expressed amazement that many of us could not follow the multiple-step analysis you took us through. You should understand that you lose us after three steps. We’re the MTV Generation and we can’t hang on to more than a few things at once.” He appeared to be several years older than most of his classmates, and perhaps that was why he had taken the time to sit back and think about his, and his classmates’, thinking. What I learned from him, yet another student who taught me something specific about teaching, was that it would take a concentrated, transparent, and deliberate effort on my part to break students of the bad academic habit that they had acquired, a habit that discouraged them from focusing and working through things more complicated than three-item soundbites. Pressure for the “quick and easy” tempts teachers, writers, and media commentators to keep it “short and simple,” but the danger is that “simple things for the simple-minded” will transform the country into something lacking viability. Accurate and complete analyses of questions such as the deductibility of Halloween costumes require more paragraphs than what most people are willing to read. “Better wrong than well read” might yet become a rallying cry for the self-appointed guardians of postmodern culture.

What can be done to protect people from the incorrect, misleading, inaccurate, and over-simplified information available on the internet, particularly with respect to tax law? Is it enough for the IRS to certify a web site? I don’t think so. First, the IRS does not have the resources to survey the internet and identify all sites providing tax information. Because the internet is an evolving world, the task faced by the IRS would be a continuing one, and could easily swamp the agency. Second, assuming it had the resources, the IRS would be reluctant to certify sites that were providing accurate analyses with respect to issues on which the IRS and taxpayers held inapposite positions pending judicial or legislative resolution of the issue. For example, would the IRS certify a site that explained why taxpayers should follow the Bolton decision when computing section 280A limitations on vacation home deductions? Third, within minutes of an announcement that the IRS would be engaging in a “tax web site certification” project, the scammers and hackers would get to work trying to pin certifications on sites deserving of nothing more than a thumbs-down logo. Unfortunately, the state of technology is such that these malfeasants would succeed. Fourth, it is unlikely that certification would mean much to some, perhaps many, of the people who are drawn to, and rely on, misinformation sites. It is unlikely that they are visiting the IRS web site where, though deficient in providing taxpayer perspectives on debatable issues, the agency does provide a significant amount of quality tax information.

The answer, it seems to me, is tax education of the citizenry at an early age, with some sort of transitional catch-up for all the people who have made it through 12, 16, 19, or even 22 years of education without learning basic tax principles and concepts, without getting good advice on where to look and where not to look for tax information, without being given the opportunity to learn how tax law is enacted and developed, and without a glimpse into what the IRS and state revenue departments really do. That’s why I want to bring to everyone’s attention Prof. Marjorie Kornhauser’s Tax Literacy Project. In her own words, it is designed to “use popular media to informally educate young adults about basic aspects of taxation.” A brief write-up of the project appears in Law prof's mission is to make tax policy interesting, and it deserves reading by every person concerned about the dangers that tax illiteracy poses to the republic. In other words, it deserves reading by everyone over the age of twelve.

I’ll Show You My Taxes if You Show Me Yours?

In How Can Asking Questions Improve Tax and Spending Policies?, I considered what would happen if the Norwegian practice of disclosing taxpayers’ incomes and tax liabilities were adopted in the United States. After suggesting some of the consequences that would follow, I predicted that it would not happen. Well, perhaps it won’t happen, but it did, once, a long time ago. A former Commissioner of the Internal Revenue Service pointed out to me that in the Income Tax Act of 1862, provision was made for disclosure of tax returns to the public.

So there is precedent in this country for doing what Norway does. Those who enjoy reading 19th century tax legislation, and perhaps those who don’t, will find this instructive. In the Act of July 1, 1862, ch. 119, 12 Stat. 432, Congress provided, in sections 8 and 93, the latter specifically dealing with the “duty” on incomes, that taxpayers were required to make lists of items subject to taxation and that if the taxpayer did not do so, the assessor would create the list. In section 15, the statute provided:

And be it further enacted, That the assessors for each collection district shall, by advertisement in some public newspaper published in each county within said district, if any such there be, and by written or printed notifications, to be posted up in at least four public places within each assessment district, advertise all persons concerned of the time and place within said county when and where the lists, valuations, and enumerations made and taken within said county may be examined; and said lists shall remain open for examination for the space of fifteen days after notice shall have been given as aforesaid….

The goal of the legislation was to encourage tax compliance. Perhaps in those days people had more shame about understating tax liability.

Thereafter, disclosure of tax return information followed a choppy path. As Paul M. Schwartz points out in The Future of Tax Privacy, the Treasury Department subsequently “prohibited newspaper publication of annual tax assessments, but permitted public inspection.” More than twenty years later, legislation adopted Treasury’s approach and required additional legal authorization for publication of returns. Thirty years after that enactment, Congress required Treasury to make lists of taxpayers’ names, addresses, and income taxes paid, and to let the public inspect them. Needless to say, opponents of this legislation reacted to it and a Supreme Court decision upholding the legislation by pushing through an amendment that removed income taxes paid from the list. A subsequent attempt to disclose not only names and addresses but also gross income, deductions, and other items was enacted but repealed before it went into effect. Only in 1966 did Congress specifically ban newspaper publication, and ten years after that incorporated a tax privacy concept in the tax law. The history of tax information disclosure is much more complicated than my simple overview suggests, and those who are interested should take a few minutes to read Schwartz’s article. He not only explores the various arguments advocating and opposing tax information disclosure, which have been advanced for as long as there has been an income tax, but also shares stories of what happened when the Italian government posted on its web site a list of all taxpayers and their earnings and taxes, what happened when technical problems permitted H&R Block clients to see other taxpayers’ information instead of just their own, and how several Presidents accessed tax information with respect to specific individuals for political purposes.

Suppose the question were put to a national referendum. How would you vote? Disclosure of names, gross incomes, and reported income tax liabilities and payments? Or protection of that information from all but a very few within the IRS?

Unmasking the Deductibility of Halloween Costumes

Ah, yes, Halloween again looms, and once again it’s time to make MauledAgain particularly frightening. In years past, I have focused on sugar, candy, and, yes, pumpkins:

In 2004, I looked at the idea of Taxing "Snack" or "Junk" Food. In 2005, I had some fun with Halloween and Tax: Scared Yet?. For 2006, in Happy Halloween: Chocolate Math and Tax Arithmetic, I simply lamented my inability to find four-pack versions of Reese's Peanut Butter Cups. In 2007, I added Tricky Treating: Teaching Tax Trumps Tasty Tidbit Transfers, while also noting that Halloween Brings Out the Lunacy. Finally, 2008 brought us A Truly Frightening Halloween Candy Bar.

A few weeks ago, an email came my way that opened with this question: “Can you deduct the cost of your Halloween costume as a business expense?” It then answered the question:

No, if you bought it to go trick-or-treating with your kids.

Yes, if you bought it to attend a client's Halloween party.

For both? Then proportion the cost based on % of use.

You can find this question and answer on the web at Ways Through the Maze: A Tax Guide for Indies.

Though I agree with the first part of the response, I recoil in horror at the second. Unquestionably there is no deduction if the costume is purchased for a Halloween outing with the children. But if the purchase is for a client’s party, the answer depends on whether the cost of attending the party is an ordinary and necessary expense of carrying on a trade or business. And that means that the third part of the response, dealing with percentage of use, requires a more sophisticated determination than simply hours at a party compared to hours with the children, but rather a comparison of deductible use versus non-deductible use.

The rule with respect to clothing that gets everyone’s attention is the rule that precludes a deduction if the clothing can be worn for everyday purposes. Many people think that if the clothing cannot be worn for everyday purposes that the deduction is allowable. But in so thinking they trick themselves. They miss the position of the rule in the larger scheme of things. The non-deductibility rule doesn’t become relevant until it is determined that the clothing can otherwise be deducted. Thus, before getting to the question of whether a costume can be used for everyday wear, one must determine if the cost of attending the party is deductible. Those costs include not only the apparel that one wears, but the transportation expenses of getting to and from the party. And even if the cost of attending a Halloween party can somehow turn out to be deductible, the cost of the costume might still be non-deductible because it is suitable for ordinary wear. Think about the lazy law professor who shows up in a flannel shirt and jeans, passing himself off as a lumberjack.

So is it possible to deduct the cost of attending a Halloween party, even assuming the costume is not useful for ordinary wear? A look at some authorities is instructive.

In Starrett v. Comr., T.C. Memo 1990-183, the Tax Court looked at the expenses paid by the host of a Fourth of July party and a “Christmas open house” that the taxpayer characterized as “business promotions.” The court concluded that the taxpayer had not demonstrated that the party expenses were ordinary and necessary. That’s not to say that party expenses never are deductible, but it points out the trap of assuming party expenses always are deductible. The court also pointed out that entertainment expenses must meet the requirements of section 274. Thus, they must be directly related to, or at least associated with, the active conduct of the taxpayer’s trade or business. For the “directly” requirement to be satisfied, the taxpayer must demonstrate that the taxpayer has more than a general expectation of deriving a specific business benefit at some future time and that the taxpayer actively engages in business during the period of entertainment. Though the latter may occur at some parties, one must wonder what sort of business goes on at Halloween parties. For the “associated” requirement to be satisfied, the taxpayer must demonstrate that the entertainment directly precedes or follows a substantial and bona fide business discussion. So even if the taxpayer had worn bizarre clothing to the party that was inappropriate for ordinary use, there would have been no deduction permitted to the taxpayer.

It is extremely unlikely that the deduction requirements can be satisfied by a taxpayer hosting or attending a Halloween costume party. In Gardner v. Comr., T.C. Memo 1983-171, the Tax Court considered the deduction claim of a dentist who hosted 200 guests at a cocktail party during which attempts were made to foster business relationships. The court rejected the taxpayer’s claim that the party was “directly related” to the active conduct of the dental practice, and noted that the regulations describe cocktail parties as examples of entertainment situations which generally are considered not directly related to the active conduct of a trade or business. The rationale provided in Regs. Section 1.274-2(c)(7)(ii) is that the party is “essentially a social gathering and there is little or no possibility of engaging in the active conduct of a trade or business because of the substantial distractions inherent in such form of entertainment.” The court explained, “Clearly a large party such as was given by petitioners in this case does not lend itself to substantial business discussions. . . . Indeed, the very size of the party dooms the claimed deduction to failure. Surely petitioner could not have expected to have had substantial business discussions with all or even most of those attending. Rather, the party has every appearance of a social gathering intended for the purpose of renewing acquaintances and enjoying a pleasant evening.” When put in the context of a Halloween party, how can one possibly argue with a straight face that discussion, particularly when masked, with another person who if not masked most likely is face-painted or otherwise circulating incognito, can reach the level of serious business dialogue?

Theme parties take a serious hit when it comes to deductibility. In Steinberg v. Comr., T.C. Memo 1995-116, the Tax Court held that the cost of a birthday party for a physician’s one-year-old son was not deductible. Anyone who has been at a child’s birthday party would find it very difficult to swallow an argument that serious business discussions were underway during the event. In this regard, Halloween parties are no less chaotic and perhaps even more out-of-control than birthday parties for children.

Though these cases focus on the cost of throwing a party, the same analysis should apply to the cost of attending a party. In Preston v. Comr., T.C. Memo 1961-250, the Court lumped the cost of “attending parties” with other expenses that it categorized as “entertainment expenses” and then proceeded to hold those expenses non-deductible.

The only mention I could find of Halloween parties involved the deduction, as a charitable contribution, of the cost of tickets to a Halloween Ball held to raise funds for a charity. The cost of costumes or other apparel acquired for the event is not mentioned. So the IRS has not treated us to a specific analysis in this context.

So if a costume is purchased for use at a Halloween party, the taxpayer doesn’t have a ghost of a chance when it comes to deducting the cost. Hopefully, people aren’t goblin up the advice being shared by those who claim that the cost of a Halloween costume purchased for use at a client’s party is deductible.