Tax Law and Rodents Afire

At first it appeared that a flaming mouse, trying to escape from being tossed onto a pile of burning leaves, ran back all afire into the house where it had been caught, triggering a fire that caused it to burn down. What a great story to use as the framework for discussing casualty loss deductions and public policy.

Then came news that the mouse was dead when cast into the flames, and wind carried sparks into the house. The casualty loss deduction issues remain, but the story just isn't as interesting or attention-getting.

To the rescue comes Mark Cochran, who teaches tax at St. Mary's University School of Law. He reminds us of a famous torts case, United Novelty Co. v. Daniels, 42 So. 2d 395 (Miss. 1949). Quoting the facts as summarized by the Supreme Court of Mississippi:

Appellees include the members of the family of William Daniels, a minor aged nineteen years, who was fatally burned while cleaning coin-operated machines as an employee of appellant.

The work was being performed in a room eight by ten feet in area, in which there was a gas heater then lighted with an open flame. The cleaning was being done with gasolene. The testimony yields the unique circumstance that the immediate activating cause of a resultant explosion was the escape of a rat from the machine, and its disappointing attempt to seek sanctuary beneath the heater whereat it overexposed itself and its impregnated coat, and returned in haste and flames to its original hideout. Even though such be a fact, it is not a controlling fact, and serves chiefly to ratify the conclusion that the room was permeated with gasolene vapors. Negligence would be predicated of the juxtaposition of the gasolene and the open flame. Under similar circumstances, the particular detonating agency, whether, as here, an animate version of the classic lighted squib, or as in Johnson v. Kosmos Portland Cement Co., 6 Cir., 64 F.2d 193, a bolt of lightning, was incidental except as illustrating the range of foreseeability.

And so into the law, more than a half century ago, entered the flaming rat. Yes, though the court was addressing a torts issue, casualty loss deduction issues lurk under the surface, assuming, of course, that there was no or inadequate insurance coverage for the damage.

These "animal afire" stories reach back centuries. Consider the fifteenth chapter of Judges, verses 4-6:

And Samson went and caught three hundred foxes, and took firebrands, and turned tail to tail, and put a firebrand in the midst between every two tails. And when he had set the brands on fire, he let them go into the standing grain of the Philistines, and burnt up both the shocks and the standing grain, and also the oliveyards. Then the Philistines said, Who hath done this? And they said, Samson, the son-in-law of the Timnite, because he hath taken his wife, and given her to his companion. And the Philistines came up, and burnt her and her father with fire.

Someday, when I have time (ha ha), I might sit down and see how many Bible stories can generate tax issues. For the moment, though, I'm content with warning folks not to let their pets play with matches.

Follow-Up Report Extinguishes Blazing Mouse Tale (but not the tax issues)

Yesterday, I analyzed the tax issues arising from the survival attempts of a mouse tossed into a pile of burning leaves. Fleeing the flames, the mouse ran back into the house in which the owner had caught it, and somehow set the place ablaze, destroying the residence and all its contents. But now the extinguisher of exaggeration has come to smother the fun.

Drat. It was such a great story. But it turns out that the house fire in New Mexico was NOT caused by a fleeing, flaming mouse. According to a WSB television report, the mouse was killed before it was tossed into the burning leaf pile. The fire apparently was caused by high winds spreading the embers. WSB has initially reported the story along with many other news services, and initiated further investigations after the news had spread world-wide. I guess people were questioning what they thought was an account just a wee bit on the other side of totally bizarre.

According to the most recent report, the homeowner has no insurance. So, despite throwing cold water on the supposed antics of an allegedly blazing mouse, the story keeps the flame of the hypothetical alive. How? The issue of gross negligence remains, continuing to present the question of whether leaf burning at the time violated any local laws, and adding the question of whether it is grossly negligent to burn leaves close enough to a home such that winds could carry burning embers into the structure. The area has been afflicted with unseasonably dry and windy conditions for at least several weeks. We still don't know if a casualty loss deduction is allowable.

So where did the tale of the flaming mouse come from? The local fire department captain explained that the rumor "probably got started because there was 'a little too much excitement' at the time of the fire." A little too much excitement? Sounds like tax class to me, even if the students aren't all fired up.

I feel bad for Paul Caron. Yesterday, in a post nicely titled, "Of Mice and Casualty Loss Deductions," he picked up on my analysis of the story. He stated, "Jim Maule has enlivened my income tax class for years to come by posting a wonderful Associated Press story that ran in newspapers across the country today, Blazing Mouse Torches House." Now, I guess he's back to a less-enlivened pedagogical prospect. OK, I'll keep my eye out for a similarly discussion sparking news item.

And thanks to Mark Morin for the tip.

Why Tax Law Can Fire Us Up

Classes begin today. I should be fired up. But I have good reason to hesitate, when it comes to fire.

First, the background. The Internal Revenue Code permits a deduction for casualty losses, in excess of certain limits, that are caused by fire, storm, shipwreck, or other casualty. Section 165(a) and (c)(3), to be more precise. Generally, despite the tax law being replete with cases dealing with whether something, such as termite damage or massive Southern pine beetle attacks, constitutes a casualty, fire pretty much is self-defined.

But there is another limitation. It arises from the public policy doctrine, which has been applied by courts to limit all sorts of deductions, not just casualty losses. A fascinating case that nicely explains the law, and life, not only to the taxpayer but to students of tax (and not just those enrolled in a tax course), is Blackman v. Commissioner, 88 T.C. 677 (1987). I cannot do justice to the facts through paraphrase, and because they are set forth by the court in three paragraphs, here they are:

The petitioner's employer transferred him from Baltimore, Maryland, to South Carolina. The petitioner relocated his wife and children to South Carolina. Mrs. Blackman was dissatisfied with South Carolina and returned, with the couple's five children, to Baltimore. During the 1980 Labor Day weekend, the petitioner returned to Baltimore, hoping to persuade his wife to give South Carolina another chance. When he arrived at his Baltimore home, he discovered that another man was living there with his wife. The neighbors told the petitioner that such man had been there on other occasions when the petitioner had been out of town on business.

On September 1, 1980, the petitioner returned to his former home to speak to his wife. However, Mrs. Blackman was having a party; her guests refused to leave despite the petitioner's request that they do so. He returned to the house several times, repeating his request, and emphasizing it by breaking windows. Mrs. Blackman's guests did not leave the house until about 3 a.m., September 2, 1980.

Later, on September 2, 1980, the petitioner again went to his former home. He wanted to ask his wife whether she wanted a divorce. They quarreled, and Mrs. Blackman left the house. After she left, the petitioner gathered some of Mrs. Blackman's clothes, put them on the stove, and set them on fire. The petitioner claims that he then "took pots of water to dowse the fire, put the fire totally out" and left the house. The fire spread, and the fire department was called. When the firefighters arrived, they found some of the clothing still on the stove. The house and its contents were destroyed.

Mr. Blackman was arrested, charged with arson, and sentenced to probation without verdict. The homeowners insurance company refused to pay. And, Mr. Blackman claimed a casualty loss deduction on his tax return. The relevant portions of the court's opinion are worth reading:

* * * * *the Commissioner argues that the petitioner intentionally set the fire which destroyed his home in violation of Maryland's public policy, that allowing the deduction would frustrate that public policy, and that, therefore, under the doctrine of Commissioner v. Heininger, 320 U.S. 467 (1943), and subsequent cases, the petitioner is not entitled to a deduction for the damage caused by his fire. * * * * *

Moreover, it is well settled that the negligence of the taxpayer is not a bar to the allowance of the casualty loss deduction. * * * * * On the other hand, gross negligence on the part of the taxpayer will bar a casualty loss deduction. * * * * * "Needless to say, the taxpayer may not knowingly or willfully sit back and allow himself to be damaged in his property or willfully damage the property himself."

In our judgment, the petitioner's conduct was grossly negligent, or worse. He admitted that he started the fire. He claims that he attempted to extinguish it by putting water on it. Yet, the firemen found clothing still on the stove, and there is no evidence to corroborate the petitioner's claim that he attempted to dowse the flame. The fact is that the fire spread to the entire house, and we have only vague and not very persuasive evidence concerning the petitioner's attempt to extinguish the fire. Once a person starts a fire, he has an obligation to make extraordinary efforts to be sure that the fire is safely extinguished. This petitioner has failed to demonstrate that he made such extraordinary efforts. The house fire was a foreseeable consequence of the setting of the clothes fire, and a consequence made more likely if the petitioner failed to take adequate precautions to prevent it. We hold that the petitioner's conduct was grossly negligent and that his grossly negligent conduct bars him from deducting the loss claimed by him under section 165(a) and (c)(3).

In addition, allowing the petitioner a deduction would severely and immediately frustrate the articulated public policy of Maryland against arson and burning. Maryland's policy is clearly expressed. Article 27, section 11, of the Maryland Annotated Code (Repl. vol. 1982), makes it a felony to burn a residence while perpetrating a crime. * * * * * We are mindful, also, that Maryland has an articulated public policy against domestic violence. We refuse to encourage couples to settle their disputes with fire. We hold that allowing a loss deduction, in this factual setting, would severely and immediately frustrate the articulated public policies of Maryland against arson and burning, and against domestic violence.

So now, having been brought up to speed to the point where a student in a tax course should be when entering the classroom on the day casualty loss deductions are discussed, everyone is ready for the professor's hypothetical. Except it is not a hypothetical. It is a story reported in this morning's Philadelphia Inquirer (free subscription site). The headline is almost priceless: "Blazing Mouse Torches House." When I saw this, I wondered, "What is a blazing mouse?" The story answered the question:

A man in Fort Sumner, New Mexico, caught a mouse inside his house. To dispose of it, he threw it on a pile of leaves that he was burning outside the house. The mouse, on fire, escaped from its hellish environment and ran back into the man's house. And somehow set it on fire. The firefighters, who claimed this was a first for them, determined that the mouse had run to a point underneath a window. Though the story doesn't explain what happened, I'm guessing that there were curtains on the window. The house, and everything in it, was destroyed.

Can this man claim a casualty loss deduction?

More facts are needed. When I point that out to students, they often groan. More facts? Yes. If, for example, the man has homeowners insurance and it fully covers the loss, then there is no casualty loss deduction, because there is no loss. Nothing in the story tells us if there is insurance. Of course, to get an education from this "hypothetical" we need to assume that there is no insurance.

Where does that take us?

Was the man grossly negligent? Was the house fire a "foreseeable consequence" of tossing of a captured mouse into a pile of burning leaves? Would it matter if outdoor leaf burning was illegal? Ah, this question means that there is more information that is required. Some towns have permanent bans on outdoor leaf burning, and others impose temporary bans during droughts or periods of high fire risk. Considering the number of wildfires that pop up in New Mexico, this is more than a theoretical possibility. Is it against public policy to throw living mice into burning leaf policies? Did the man have a chance to extinguish the fire at the window? Did he try? Oh, if it matters, the man was 81 years of age. Maybe that matters. Maybe not.

I'm not going to determine if a casualty loss deduction would be permitted. I don't know. I don't have the necessary facts. Nor do I want to devalue this story's utility as a future examination or semester exercise question.

So this morning, as I head off to class, I'm going to be careful about getting the students fired up about their new courses. They may have a burning interest in the subject matter, but I'd rather they not flame me.

OK, that's enough. I'm running the risk of extinguishing my readership.

A New Year's Resolution for Congress: Help Stop Inmate Tax Fraud

One of my colleagues, Steve Chanenson, passed along a link to a story about prisoners and tax fraud. Steve, who teaches, among other courses, corporate and white collar crime and the sentencing workshop, is a member of the Pennsylvania Commission on Sentencing, an editor of the Federal Sentencing Reporter, and involved in other activities related to improvement of the criminal justice system. So Steve's much more tuned in than I am to some of the things going on behind prison walls, and I thank him for pointing me in the direction of this article.

What some prisoners have been doing is easily described, and it doesn't take an LL.M. in Taxation to understand how it works or why it's bad. A prisoner with access to the Internet or a prison library prints out or makes copies of IRS forms. The prisoner, or others in the scheme, prepare fraudulent documents showing fictitious withheld taxes on fictitious income. Using these forms, the prisoners then file tax returns seeking refunds of the supposedly overpaid taxes. That's the basic pattern, though there are many variations. It is not my intent to provide a guidebook on how to imitate these practices, so I'm not going into the details. In most instances, there are confederates on the outside who do the mailing and receive the refund checks, usually taking a percentage of the check as a fee for mailing the forms and cashing the checks.

The blueprint for the scheme passes from prisoner to prisoner, and from prison to prison. It has been described as a "huge" prison enterprise. How they have time for this is something I don't understand. I do understand it's not economically efficient to have prisoners making license plates, but wide open access to the internet, photocopy machines, printers, libraries, and outside contacts seems more the stuff of a resort than of a prison, whether the focus is punitive or remedial.

It's not that the IRS doesn't detect at least some of these fraudulent filings. In 2005, the IRS flagged 18,000 prisoners who filed false refund claims amounting to $68 million. According to Congressional testimony by Nancy Jardini, who heads the IRS criminal investigation unit, tax fraud by prisoners has grown by 700 percent in three years. [I digress: Nancy is a graduate of Villanova's Law School, who cut her tax teeth in my basic tax course. When I explain to my students that there's no way of knowing when they'll come to appreciate having been introduced to tax law even though they plan a career in a very different area, I describe Nancy's journey from law school, through a few years as a criminal defense attorney, additional years as a federal prosecutor, and an appointment as Chief of Criminal Investigation for the IRS. I warn students that the tax world never misses a chance to pull a good attorney into its realm. We here at Villanova are proud of Nancy's accomplishments, including the fact that she is the first woman appointed to head IRS Criminal Investigation in its 85-year history.]

But even though the fraudulent filings are flooding the IRS, and even though the IRS detects a significant number of them, few inmates are prosecuted. Insufficient resources push these cases onto the back burner, and prisoners know it. During a two year period, only one prisoner in Arizona was prosecuted, despite the fact that inmates in that state generated about half of the false returns filed in Arizona, and that most likely happened because the prisoner in question managed to file false returns claiming more than $200,000 in false refunds. The prize goes to an anonymous inmate who also testified in front of a Congressional subcommittee. He filed 700 returns claiming $3.5 million in fraudulent refunds.

In addition to insufficient resources to prosecute these crimes, the IRS and prison officials are hampered by privacy laws that prohibit the IRS from disclosing taxpayer information. Thus, after prison officials alert the IRS to their discovery of a fraudulent return operation in their prisons, turning over seized items such as lists of social security numbers, the IRS cannot coordinate efforts with those officials or even tell those officials if their tips led to a successful outcome.

Finally, a practical concern encourages prosecutors to let the matter slide. The people filing the false returns are already imprisoned, if successfully prosecuted they'll get no more than two dozen months added to their term, many of the witnesses lack credibility, and it's difficult to figure out which prisoners are active members of the plot and which ones are innocent identify theft victims.

The IRS and prison officials cannot fix this problem without help from Congress. The IRS cannot unilaterally ignore privacy laws enacted by the Congress and having the effect of shielding prisoners from prosecution. The IRS cannot print money to fund the additional staffing and support personnel required to save taxpayers the tens of millions, or hundreds of millions, of dollars ending up in prisons where it can be used to finance trade in illegal drugs, other contraband, and illicit activities. Congress has held hearings on the matter. The IRS has proposed changes to the language of privacy statutes that would permit cooperation with prison officials. It remains to be seen if Congress can muster up the courage to invest $10 or $20 million to prevent the payment to prisoners of five or ten times that amount in falsely claimed refunds. I am sure Nancy Jardini and her charges would make good use of those funds to patch up an embarrassing glitch in the federal income tax collection and refund procedure. For a Congress in need of some New Year's Resolutions, I suggest putting this on the list.

Corruption Highlights a Preview of This Year's Top Ten Tax Stories

Yesterday, Paul Caron published the Top Ten tax stories of 2005 on TaxProf Blog. Actually, it was a top ten and ten runners-up. As challenging as it was to select ten, especially because I sent him so many nominees, it would be even more challenging to publish the Predicted Top Ten Tax Stories of 2006. Although I won't try to do that, I will offer several can't-miss predictions. One is like the free spot in bingo, namely, Congress will let 2006 go by without enacting any sort of meaningful tax reform. Another prediction is that we will hear confirmation that the legislative process, including the process that brings us tax law, is not only inefficient but also corrupt. OK, so that's not a risky prediction either.

Yesterday, lobbyist Jack Abramoff pleaded guilty to a variety of charges. Not only was conspiracy and fraud on the list, he went for the trifecta with tax evasion. Why is it that criminals never learn to stay clean with the tax returns? Perhaps because the attitude that they should be unfettered by civilized rules pervades their life, making the filing of a proper tax return a compulsive impossibility. So does a lobbyist without due regard for the tax law, evidenced by tax evasion, work the halls of Congress in ways that respect the integrity of legislative development? I doubt it. It remains to be seen whether, and to what extent, the corruption affected decisions on tax law changes. According to the linkedCNN report, among Abramoff's longtime associates is Grover Norquist, director of Americans for Tax Reform. It's not my sort of tax reform. Masked behind the calls for lower tax rates are proposals whose impact would make tax law worse. For example, the so-called "National Taxpayer Protection Pledge" includes a promise to "oppose any net reduction or elimination of deductions and credits, unless matched dollar for dollar by further reducing tax rates." In other words, the organization refuses to support removing from the tax law badly designed and poorly implemented deductions and credits unless the inappropriate tax savings produced by those deductions and credits is preserved. Norquist's organization supported H.R. 2895, which would extend the multi-layered, unduly complex, policy questionable section 168(k) of the Internal Revenue Code, which added yet more computational nonsense to the depreciation deduction. Even if the goal of encouraging business investment is one that should be addressed through depreciation deductions, it makes no sense to add layers of complexity rather than reform the core provisions of section 168. Just last month, Americans for Tax Reform issued a statement supporting the extension of the special rates for capital gains and selected dividends, one of the most dreadful and complicated elements of the current federal income tax law. Abramoff's guilty plea was accompanied by a promise to come forward with information about his activities. We should watch for future developments very carefully. Why? Consider that CNN was told that "Abramoff may have thousands of e-mails in which he describes influence-peddling and explains what lawmakers were doing in exchange for the money he was putting into their campaign coffers."

Although the specifics of Abramoff's guilty plea, and the information he is expected to provide, may be news, the general tenor of the situation is not. Yesterday, CNN released the results of a poll indicating that roughly half of American adults believe "most members of Congress are corrupt." Wow. Talk about a lack of confidence. People claim I am a cynical critic. Well, perhaps I am, but I am not alone. This is roughly half of the adults in this country thinking that MOST, not some, or a few, but MOST members of Congress are corrupt. CNN notes that the poll "makes it clear that the perception of congressional politicians is largely negative." Maybe the public is too harsh. Maybe my expectations are too high. I doubt it. After all, what am I, or the public, to think when a source close to the Abramoff probe explains that it "involves about two dozen lawmakers and staffers."

Members of Congress, and their staff, are public servants. They have an obligation to serve the public, not themselves. They must be held to the standards applicable to trustees because they are entrusted with the public welfare. In a theological sense, they are stewards, because they must be held to the protection not only of public funds, but the defense of the nation and the guardianship of citizens' rights, including the right to be represented openly and fairly in a democratic process free of the taint of dirty money. Let's not overlook the likelihood that the corruption dollars flowing into private pockets on Capitol Hill, or into campaign funds, were not coming from the poor or the middle class. Those who have been using their wealth improperly, regardless of how they obtained the wealth, have become bolder and more disrespectful of the nation and its citizens as each day passed.

The culture of corruption, of bribery, of putting one's own selfish interests above those of the public one is required to serve will also trigger yet another easy-to-predict Top Ten tax story of 2006. At least one politician, one celebrity, and one lawyer will run afoul of the tax law by failing to file a tax return or by failing to pay income taxes. The year 2005 closed with a case involving an attorney who failed to pay income tax, but escaped being disbarred from practice before the United States District Court because the state law treated failure to pay as insufficient to warrant the disciplinary action that would come from failure to file a return. Nonetheless, the attorney was convicted of a misdemeanor. I tell my students that if they, or a client, are unable to pay income taxes, file the return and ask for a payment arrangement. The IRS and the Department of Justice are not going to pursue criminal charges against someone who acknowledges a tax liability and seeks to pay it, unless the person fraudulently hides his or her assets, fails to disclose the problem, or otherwise acts in a manner inconsistent with a responsible attitude toward the tax debt.

It is a challenge getting across to law students the point that when they enter the profession, and even as law students, they are subject to a higher set of integrity standards than those that apply generally to citizens of the nation. Holding to those standards by being open and honest would do much to curtail the low level of esteem in which attorneys are held. Likewise, members of Congress and state legislatures, many of whom, not surprisingly, are attorneys, would do much to enhance public respect for legislatures if they went about their duties openly and honestly. Getting this point across to politicians is no less frustrating than getting it across to law students. Many hear, but only some listen and abide.

When coupled with the consequences of corporate greed and corruption, accounting misdeeds, lawyer noncompliance, and lobbyist bribery, the exposure of significant legislative malfeasance may trigger more than a momentary backlash. In its wake, I hope, will come a sweeping away of the detritus of special interest legislation, including the tax law provisions that benefit a privileged few at the expense of the unrepresented many. One way or another, though, this mess probably will make for some sort of top ten tax story a year from now.

New Tax Year....Same Old Congressional Tax Nonsense

Officially, tax filing season begins on January 23. That's when the IRS shifts into a higher level of providing taxpayer assistance. For most taxpayers, tax filing cannot begin until after January 31, because Forms W-2 and 1099 need not be sent until that date. For some taxpayers, filing is impossible until much later in the year, because Schedules K-1 from partnerships aren't due until April 15. That design flaw, however, is not the subject of today's post.

This story is all about how a tax law provision can be found in a Defense Department Appropriations bill. Section 5021 of H.R. 2863, which was presented to the President on December 28 for signature, contains the following provision:

SEC. 5021. For purposes of compliance with section 205 of Public Law 109–115, a reduction in taxpayer service shall include, but not be limited to, any reduction in available hours of telephone taxpayer assistance on a daily, weekly and monthly basis below the levels in existence during the month of October 2005.

So what does THIS mean?

Let's go back a few months. When Congress enacted the Transportation-Treasury Appropriations bill, it allotted $11.7 billion to the IRS for fiscal year 2006. This is a $400 million increase over the fiscal year 2005 budget. However, in order to provide more funding for other IRS functions, Congress mandated a DECREASE in the IRS customer service budget of $100 million. This bill directed the IRS to continue improving its telephone hot-line service and to allocate resources necessary to increase the number of phone lines and staff available for the hot-line.

The IRS had announced plans to close 68 of its walk-in assistance centers, intending that its web site and toll-free telephone hot line would provide adequate replacements for the closed locations. By doing this, the IRS would save $50 million. Congress, however, put a stop to these plans, enacting legislation that required the Treasury Department's Inspector General for Tax Administration to study the impact of the proposed closings, with the first report due on April 14, 2006 and the second on October 1, 2006. This legislation prohibited reduction or termination of any taxpayer services by the IRS until 60 days after the reports are submitted, and then only after consultation by the IRS with those affected by any changes.

Faced with this obstacle to dealing with the $100 million cut-back in its customer service budget, the IRS then announced that it would reduce the hours during which its toll-free taxpayer assistance hot-line would operate from 15 hours a day to 12 hours a day. It explained that 93 percent of the calls received by the hot-line come in during the 12 hours from 8 a.m. until 8 p.m. Almost immediately, the president of the National Treasury Employees Union called the planned cutback in telephone assistance "outrageous" and claimed that the reduction would "push" some taxpayers into noncompliance. Another report claims she called it "an outrage." Yet another report claims she called it "an absolute outrage." The NTEU president also characterized the planned cutback as a serious mistake in emphasis and resource allocation by the IRS.

In response, the Congress inserted the quoted language into the Defense Department Appropriations Bill. The purpose was to clarify that the prohibition on cutting back customer service also applies to the toll-free telephone assistance program. An IRS official has stated that the IRS would continue to meet customer demand by providing the same level of service as in previous years, but that it would not hire the 400 seasonal workers it usually hires. This news makes it easier to understand why the NTEU had no loss for words in conveying its anger at the IRS plans.

But let's see if I understand this. The Congress cuts the IRS customer service budget by $100 million. At the same time it tells the IRS not to cut customer service, and when the IRS tries to wiggle around the definition by cutting telephone hot line hours, Congress smacks the IRS wrist. Huh? The ONLY logical message from these actions is that the IRS must find a way to provide the same service for less money. What are the possibilities? Negotiate lower rates for the phone lines from the telephone companies? Hardly. Hire fewer seasonal workers and shift the workload onto existing workers? Perhaps, but then union officials and members will howl. Cut back telephone hours that would have been covered by the seasonal workers? No, that also brought howls from the union, perhaps because it figured that the calls that would have come in during the eliminated hours would come in during the remaining hours, thus increasing the work load for existing workers whose numbers aren't supplemented this year by seasonal hires.

It seems to me that if the Congress has some specific ideas on how to run the IRS and its taxpayer services, it ought to say so. The actions of the Congress remind me of those all-too-familiar folks who are quick to criticize but when pushed for an alternative, stare blankly and mumble, "I don't know." My response is that the admitted lack of knowledge makes the criticism a reflection of nothing more than ignorance.

Did it ever occur to the geniuses who cobbled together this nonsense that the easiest way to reduce the need for customer service by the IRS is to SIMPLIFY THE TAX LAW? Is it remotely possible that nonsense such as the multiple-rate schedule arrangement for umpteen categories of capital gains and certain dividends contributes to taxpayer need for IRS assistance? Or perhaps that the confusing array of mutually inconsistent and definitionally complex provisions encouraging education contribute to taxpayer confusion?

Here's an idea. If Congress doesn't want to spend the money investing in the collection of revenue, then let Congress invest some time. Each member of Congress ought to volunteer to staff the IRS hot-line. The proposed cutbacks, 3 hours a day for the roughly 84 days of the tax filing season, amount to 252 hours. If each member volunteers 5 hours of time, it should provide an average of 10 Senators or Representatives per hour during those 3 hours a day that are so critical. Oh, wait. We want competent advice offered to taxpayers. Scratch that plan.

There's no escaping the fact that it is totally irresponsible of the Congress to demand that the IRS maintain customer service, spend more money on increasing the number of phone lines and staff for its hot line, and yet cut $100 million from the IRS customer service budget. Somewhere, someone is relying on some philosophical theory without having had any experience with practical implementation. So while we wait for reports from the Inspector General for Tax Administration, that cannot hardly be expected to tell us anything we don't already know, the administrators at the IRS must deal with the mess Congress has made. Is it any wonder that so few people care to apply for an IRS administrative position? Is it any wonder that IRS employee morale is something less than wonderful?

New Year. Same old Congress. How happy.

Happy Silver (Teaching) Anniversary to Me

Usually someone remembers my birthday by the time it arrives, although one year everyone conspired to ignore it so that they could engineer a surprise. It worked. And there always are people wishing me Happy New Year, Merry Christmas, Season's Greetings, Happy Father's Day, and Have a Great Thanksgiving. But there's one event for which no one offered any sort of congratulations so I'm going to say it to myself. In public. Here, on this blog.

I will consider today to be the end of the fall semester. I'm not certain when the fall semester ends. Certainly not when classes end, because examinations remain to be taken and graded. Perhaps on the last examination day, even though grades are not due until weeks into the spring semester? For me, because I am finished grading, and immersed in preparation of my spring courses, it suffices to treat today as the end of the fall semester.

So with the fall semester finished, at least as far as I am concerned, that means I have completed twenty-five, yes, 25, years of law school teaching. Or, if it seems more impressive, 50 semesters. I started when Jimmy Carter was serving the last days of his presidential term. I have worked through 191 legislative enactments that amended the Internal Revenue Code. I have taught the basic income tax course, under a variety of names, 28 times. I have taught Partnership Taxation in the Graduate Tax Program 45 times, and in a J.D. Program 12 times. I have taught Introduction to Taxation of Business Entities 13 times. I have taught Decedents' Trusts and Estates 16 times. I have taught some sort of Computers and the Law course 6 times. I have taught a half-dozen other tax courses anywhere from once to 6 times. I have taught Legal Writing and delivered Legal History lectures during law school orientation. The best estimate is that at least 4,000 students have sat in one or more of my courses. It has been a rewarding experience, especially when students who graduated 3, 5, 10 years ago contact me to tell me they finally figured out what it was about, that they've come to appreciate what I was trying to do to their brains, and that it eventually worked.

I'm sure you're wondering, so here's the answer. I had not yet reached the age of 30 when I began teaching law school. That doesn't set me apart, but it's somewhat unusual. I'll continue with my standard, though surprising, reaction of silence when people comment, "Oh, you must have started teaching in your early 20s." Right. The biggest dose of reality is the realization that, with a few exceptions, the law students now in my classes were not alive when I started teaching. That, according to my children (and others), makes me old.

I would be the person most surprised if I teach another 25 years. Theoretically, it could happen. Theoretically, I could be elected President. Theoretically. As a practical matter, since I don't expect to "celebrate" a Gold or Diamond Anniversary of teaching, I figured I'd make the most of this one and pat myself on the back. I'd buy myself a gift but I don't know what to get. :-)

As for professional writing, it is somewhat more likely that I might make it to a Gold Anniversary, depending on which publication counts as the first one. I'll ignore the student writings and start with the 1978 article about the election by nonresident aliens to file joint income tax returns. That puts me at 27 years, with 23 to go. It's possible.

Now let's see if MauledAgain can find its way to a Silver Anniversary of Blogging. Considering how I enjoy writing and talking, it could happen.

MauledAgain Receives Award

Late last evening I learned that MauledAgain has received a DennisKennedy.com 2005 Best of Legal Blogging Award, as the 2005 Best Law Professor Blog. You can read the entire story, but for those impatiently needing to see the specifics, here's the relevant excerpt:

8. Best Law Professor Blog - Jim Maule's Mauled Again

As Professor Maule says, his blog features "more than occasional commentary on tax law, legal education, the First Amendment, religion, and law generally, with sporadic attempts to connect all of this to genealogy, theology, music, model trains, and chocolate chip cookies." His blog also shows that you can write engaging and helpful commentary about the U.S. tax system. Mauled Again is a great read on any topic; I really enjoy the writing. Two other law prof blogs earn an honorable mention from me because I enjoy reading them so much: Paul Caron's TaxProf Blog and Tun Ying's The Yin Blog (among other things, we like some of the same TV shows).

Thanks to Dennis Kennedy and to all the readers and subscribers who make it all worthwhile. To everyone, a happy New Year.

Need a Last-Minute Gift for the Tax Person in Your Life?

Yes, we're talking way-last-minute here. Unless we're discussing a New Year's gift.

So what DO you get that tax practitioner in your life? Well, if he or she does not have a blog, and has hesitated to enter the tax blogosphere because the technical part is daunting, there is an alternative. [redacted], a former student who graduated ten years ago from Villanova's Graduate Tax Program, has come up with a turnkey solution. The tax practitioner does the writing and [his] solution takes care of the rest of it. Visit him at [redacted], which offers [redacted].

Because I find the technical part so easy, I too often forget how intimidating it is, even to tax folks. And I'm still mulling over the fact that Scott graduated ten years ago. An entire decade? Whew.

And, no, don't ask me how to wrap this sort of gift. I'd probably write a note and then get all sorts of comments about my lack of creativity. :-)

[Note: redactions made 12 Aug 2010 at request of former student]

Objections Raised to Elimination of Legislative Tax Deceit

The Center on Budget and Policy Priorities has issued a report in which it advocates repealing or delaying the scheduled elimination of the itemized deduction phaseout and the personal and dependency deduction phaseout. Although the major point made by the Center, that these eliminations have the effect of cutting the taxes of wealthier taxpayers, the Center's proposal is deficient in five serious respects.

Let's start with a little background.

These two phaseouts were enacted in 1990 as part of a Congressional subterfuge, or deceit, foisted upon the American citizenry. When public officials deceive citizens, problems arise. In this particular instance, Congress wanted to raise taxes without raising tax rates, because it concluded that it could tell Americans that it did not raise taxes by pointing to unchanged tax rates. However, "clever" minds figured out that if deductions, in this case itemized deductions and the deduction for personal and dependency exemptions, were reduced, the effect would be an increase in tax revenues. In other words, Congress "discovered" that it could raise taxes without raising tax rates and thus trumpet a self-serving proclamation that it had not raised taxes. The simple word for this is lying.

The mechanics of these hidden tax increases was not so simple. In fact, it added bucketfuls of complexity to the Code. As a taxpayer's adjusted gross income increases above a specified threshold, an increasing percentage of the particular deduction group is reduced. The word for this nonsense is phaseout. The phaseout of the personal and dependency deduction (called PEP) begins at one set of thresholds, but the phaseout of itemized deductions (called Pease after the foolish member of Congress who let his name be forever attached to this travesty of complexity and deception) begins at another set of thresholds. There are four thresholds for the PEP phaseout, depending on filing status, and there are two thresholds for the Pease phaseout. The mechanics of the phaseout differ. The Pease phaseout, which requires an entire Code section, is based on 3 percent of the amount by which adjusted gross income exceeds the applicable threshold. The PEP phaseout, which somehow fits into a mere Code paragraph is based on 2 percentage points for each whole or multiple $2500 contained within the excess of adjusted gross income over the applicable threshold. No, I'm not making this up. Take a look at section 68 and at section 151(d)(3). The Pease phaseout does not apply to certain "protected" itemized deductions, whereas the PEP phaseout applies to all personal and dependency exemption deductions. The Pease phaseout is cut off once 80 percent of unprotected itemized deductions have been denied to the taxpayer, whereas the PEP phaseout can wipe out all of a taxpayer's personal and dependency deductions.

These phaseouts are excellent examples of how the tax law becomes complex. In this instance, the complexity arises not from the nature of the underlying transaction subjected to taxation but from the unwillingness of members of Congress to be honest with the American citizen. Nor was it accidental complexity. Members of Congress were told that the complexity was required in order to mask the tax increases. Nonetheless, Congress went along with these amendments because their political aspirations were more important to them than were the values of truth, integrity and decency. Understand that not all members of Congress at the time bought into this charade, and also understand that Congress finally decided to eliminate the phaseouts as part of an attempt to simplify the Code.

In the interest of disclosure, I have campaigned against these phaseouts from the start. For example, take a look at my letter to the editor, "Author, Don't Phase Out the Phaseouts, Kill Them," 70 Tax Notes 911 (1996). From July of 1996 through July of 1999, I chaired the Phaseout Tax Elimination Project of the American Bar Association's Section of Taxation Committee on Tax Structure and Simplification. The major accomplishment of that Project was the Report of the ABA Tax Section Committee on Tax Structure and Simplification: Phaseout Tax Elimination Project, issued in July 1997. Almost a year later, the elimination proposal found light of day in H.R. 4053, introduced by Mr. Neal, for himself and Mr. Rangel (June 11, 1998), and eventually found its way into enacted legislation through a path too long and tortured to recount in detail.

Let's turn now to why the report of the Center on Budget and Policy Priorities is flawed. There are five major deficiencies in its reasoning.

First, the hidden tax increase does not fall solely on the "wealthy," unless one's definition of wealthy is anyone earning more than $145,950 a year (or even less for married taxpayers filing separate returns). That may sound like a lot of money, especially to those earning $60,000 a year, but people earning $150,000, $200,000 or even $300,000 are in a totally different economic world than those earning $1,000,000, $10,000,000 or $100,000,000 a year. People earning $150,000 a year, who are trying to support a spouse and raise several children, share with those earning $60,000 a year a need to budget their money carefully, whereas those earning in the millions annually rarely if ever count their pennies and dollars. If $150,000 of annual income makes a person "wealthy," then the term "ultrawealthy" gets tagged onto those earning $500,000 or $1,000,000 a year, leaving us at a loss for words to describe the celebrities, athletes, corporate executives and others who pull down tens of millions of dollars a year.

Second, the PEP and Pease phaseouts exacerbate the marriage penalty. Assume two single individuals, each with adjusted gross income under the applicable phaseouts, decide to marry. Their combined adjusted gross income makes them subject to phaseouts that cause their tax liability to increase disproportionately. Of course, this impact also strengthens the marriage bonus, the tax savings that arises when one spouse earns little or no income compared to the other spouse. In fact, one of the several reasons that the PEP and Pease phaseouts were scheduled for elimination was the attempt to eliminate the marriage penalty. There are other contributing factors to the marriage penalty, such as the adjusted gross income limitation on deduction of active management passive rental losses, which have not yet been "repaired," but that's no reason not to fix the mess that the Congress created in 1990.

Third, the PEP and Pease phaseouts contribute significantly to one of the three major "bubbles" in the effective income tax rate array. A "bubble" is a range of taxable incomes that encounter higher effective tax rates than do incomes higher than taxable incomes in that range. For example, if a person earning $120,000 would incur an additional $4 of tax by earning an additional $10 of income but a person earning $1,000,000 would incur an additional $3 of tax by earning an additional $10 of income, there is a "bubble" in the chart mapping the effective tax rates, because the person with the lower income is being taxed at a higher rate than the person with the higher income. This phenomenon is a feature of a regressive tax. The three bubbles incidentally, are those caused by the earned income tax credit phaseout, the phase-in of social security benefit taxation, and the PEP/Pease deduction phaseout. Features of the tax code that cause bubbles are regressive and need to be repealed. Ironically, the Center on Budget and Policy Priorities report claims that the scheduled elimination of the PEP and Pease phaseouts is regressive, but the flaw in that argument is that the Center on Budget and Policy Priorities report begins its analysis with PEP and Pease phaseouts as status quo, rather than using a baseline that reflects undistorted taxable income computation. The truth of the matter is that the PEP and Pease phaseouts are tax increases on those in the middle of the effective tax rate array and not on those in the upper reaches of income, because those taxpayers encounter lower effective tax rates on marginal income thanks to the "completion" of the phase-out.

Fourth, PEP and Pease add boatloads of complexity to the tax law. Not only are the phaseouts themselves complicated, one requiring a full Code section and the other generating a long and byzantine Code paragraph, the interaction of the phaseouts with other areas of the tax law generate all sorts of issues. For example, application of the tax benefit rule to refunds of state and local taxes, or similar returns of itemized deductions, stymied the IRS and commentators until, finally, a "workable" solution was ascertained. When the Center on Budget and Policy Priorities report claims " In fact, complying with Pease and PEP involves a few simple arithmetic calculations," it honors the tradition of deceptiveness associated with the enactment of the two phaseouts. The complexity is much, much more than "simple arithmetic" and this sort of thinking is what happens when a tax law provision is analyzed in isolation rather than in the context of the entire tax law. In all fairness, there are few people left on the planet who can grasp the entire tax law, let alone analyze one provision in the context of the entire array. Worse, the Center on Budget and Policy Priorities report claims " Moreover, to the extent that the provisions do create complexity, they impose it on those households that are typically best able to cope with it: high-income taxpayers who most often have professionals calculate their taxes or use a software package that would automatically handle the Pease and PEP calculations." This perspective, that complexity is acceptable because there are people who can be paid to cut through the thicket, is thoroughly unacceptable as a matter of public policy, not only on the basis of efficiency and utilitarian choice, but also on the basis of moral integrity.

Fifth, the PEP and Pease phaseouts are the offspring of deceit. Even though the deceit was no secret at the time Congress engaged in it, it is deceit nonetheless. Those who justifiably complain about surreptitious behavior by public officials surely must include the supporters of PEP and Pease phaseouts among those whom they criticize. And unlike some of the secretive and deceptive behavior that is the target of the critics, PEP and Pease do not involve national security. There is no justification at all for PEP and Pease other than the desire of Congress to raise taxes in a manner that permitted it to claim that the untouched section 1 tax rates meant that it had not raised taxes even though it had raised taxes.

Here's the solution. If Congress chooses to impose progressively higher taxes on persons with progressively higher incomes, do so in the tax rate schedules. Using phaseouts injects regressivity ("bubbles") into the effective tax rate array. A truly progressive tax requires that the rates be in the progressive tax rate array. Once this is understood, it is easy to see why the phaseout elimination proposal found support among members of Congress who genuinely support progressive tax rate structures.

It may well have been that in 1990 a majority of the members of Congress figured they could fool most of the people most of the time when it comes to gaming the tax code, but unfortunately there are a few of us around who have seen through the deception from the start. Here's hoping that this short commentary will add to the list of those who understand what's going on. As for the Center on Budget and Policy Priorities report, my guess is that it reflects good intentions framed in a bona fide misunderstanding of what the Pease and PEP phaseouts do. The Center on Budget and Policy Priorities report appears to support progressivity, and hopefully the Center will re-think its position rather than continue to be sucked into the whirlpool of clever deceit that causes the super-duper-ultra-pick-a-big-word-wealthy to get away with lower effective marginal tax rates than do those with far less income than those on the top of the income array. It would be a shame if the Center on Budget and Policy Priorities continued to be duped, especially now that the PEP and Pease phaseout scam has been exposed and is on its way to a well-deserved but unfortunately slow-in-coming death.

Tax Gap Becoming a Tax Chasm

As the New Year approaches, and people start thinking about resolutions, I have an idea for all those who contribute to the tax gap. Resolve to stop contributing. Being a contributor is fine when the beneficiary is a charity, or some other worthy cause. Being a contributor to the tax gap is like being a contributor to pollution, crime, or a New Year's Party mess. It's not something of which anyone should be proud.

Last month the Bureau of Economic Analysis (BEA) issued its annual report on the tax gap. Yes, this is another one of those posts that has been waiting in line to get some attention. To be fair (to myself), although it carries a November date it actually was made available in early December and came to my attention just a little more than a week ago.

The tax gap, for those unfamiliar with the term, is the difference between income that is reported to the IRS and income that should have been reported to the IRS. The BEA uses economic data from other sources, such as payroll information provided to state and federal agencies, to determine how much income of a particular sort was derived by taxpayers. It then uses IRS data to determine how much of that income was reported.

The tax gap for calendar year 2003, the latest year for which sufficient statistical information is currently available, is $1.0417 trillion. Yes, more than $1 trillion. Compute the tax on that amount, pay it to the Treasury, and re-determine the budget deficit. Of course, if the tax on $1 trillion is paid to the Treasury and not on consumer purchases and business investments, the economy might shrink and reduce the amount of income earned by those who are reporting properly to the IRS. On the other hand, perhaps much of the tax on the $1 trillion that hasn't been paid to the Treasury instead has been sunk into off-shore investments or otherwise removed from the economy. The reality most likely is some combination of the two extremes I've just described.

It's interesting to ponder the BEA's breakdown of the gap. According to the report, the largest gap, $407.7 billion, is non-farm sole proprietorships. The second largest gap, $346.9 billion, is wages, followed by $145.7 billion of interest and dividends, and $102.9 billion of taxable pensions and annuities. The rest is distributed among farm income ($20.3 billion), taxable unemployment compensation ($9.8 billion), and taxable social security benefits ($8.4 billion). The surprise is the gap for wage income. What ever happened to withholding, and could it be that the high compliance rate for wages is no longer valid? I'm not surprised that huge amounts of sole proprietor income or even interest and dividend income goes unreported.

One must wonder what motivates noncompliance. Perhaps some psychologists will conduct surveys to determine if it simply greed, or a growing rebellion in which people are "voting with their feet" by appropriating unto themselves their own special tax break that they cannot get through the Congress because they lack the clout of the lobbyists who have managed to reduce the tax on capital gains to extremely low levels. How much of the noncompliance is simple ignorance, stupidity, carelessness, or confusion? How much of the gap arises from people trying to hide information about the activities generating the income?

Some people may not realize they are contributing to the tax gap, because they are making good faith efforts to comply with an absurdly and unjustifiably complex income tax system. Others know full well what they are doing when they engage in "pay cash, pay less" schemes, launder money, or simply fail to file. I suppose this reflects our culture, for surely it resembles what one finds on our highways: drivers who try to comply and succeed, drivers who are ignorant, stupid, careless and confused, and drivers who think they are so much more important than or better than everyone else that they flaunt whatever rules get in the way of their own self-centered approach to life.

A fun calculation is to determine how much tax has not been paid on the tax gaps for 2002, 2001, 2000, and earlier years, add interest and penalties, and imagine what happens if Treasury had the ability to collect the total amount due. The shock to the world economy might be staggering. We'll never know, because Treasury lacks the ability to collect even a minute fraction of this amount. Why? Because Congress has not implemented a system that ensures all taxpayers pay their fair shares.

Until Congress does two things, the tax gap will continue to grow, and the ultimate outcome might be far worse than the impact of quadrupled prices for oil and gas, shortages of concrete, or devastating hurricanes. Congress must reform the income tax system so that it is easy to understand, inviting of compliance, and difficult to evade. Congress must also put in place safeguards that prevent noncompliance and punish tax evaders. Ideally, a well-designed system that prevents tax evasion will reduce the number of tax evaders and thus reduce the need for prosecution of tax evaders. Law enforcement could then redirect more resources to the prevention of, and prosecution of, other crimes.

Oh, yes, the tax gap as a percentage of what should have been reported? 14.4 percent. That means one of every seven taxable income dollars in the economy during 2003 went unreported and untaxed. I'll venture a guess that when the 2004 analysis is reported next year, the gap will be at least 15 percent.

One last way to think about the tax gap. Of every dollar in taxes that a compliant taxpayer sends to the Treasury, approximately 15 cents is to cover the taxes not paid by someone who is deliberately or accidentally not paying tax. At what point will the outcry of disapproval motivate Congress to act, and act sensibly?

The Tax Side of New Year's Eve Weddings

One reason I don't get through the backlog of planned posts is because new items are added to the list faster than I can get through it. For example, this morning I open the Philadelphia Inquirer and see headline that reads: "Nuptials and noisemakers: More couples are exchanging vows on New Year's Eve, the better to entertain their guests." This is news? For years, when I teach law students about how the tax law is structured to provide marriage penalties and marriage bonuses, I point out that it has not been unknown for people facing marriage penalties to postpone their weddings beyond December 31, and perhaps indefinitely, and for people facing marriage bonuses to accelerate their weddings. Just as a child born on December 31 is worth, in the tax economy, a full year's worth of dependency exemption in contrast to the child born on the following day, so, too, a marriage on December 31 counts the same as a marriage on January 1 of the same year when it comes to the marriage penalty and marriage bonus.

There is nothing in the article about taxes. It's all about entertainment, and things such as "welcome baskets in their hotel rooms, multiple parties, tours of the city, and post-wedding brunches." If the right location is chosen, guests can be treated to a fine view of the midnight fireworks, the New Year's Day Mummers Parade, and an elimination of worries about not having a date for New Year's Eve. The New Year's Eve wedding business, according to the establishments hosting them, is booming. Topping it off is this sentiment, "And the symbolism of starting a new life together in the new year is sooo romantic."

I suppose that folks in a position to handle the additional cost, reflecting markups as high as 20 percent, might not be too concerned about marriage penalties and marriage bonuses. Love, I guess, is so blind. Ha. So few people talk with their tax advisors BEFORE doing things like getting married, starting businesses, buying out shareholders, or engaging in transactions accompanied by serious tax planning issues.

The article, by the way, doesn't mention if the folks who are booking New Year's Eve wedding dates at what no longer are open public admission celebration venues are tax practitioners. Nor does it mention if these are weddings between people one of whom is in a much higher income bracket than is the other, thus accelerating the potential marriage bonus and demonstrating good tax planning. I wonder how many of these couples face marriage penalties, and will get a rude shock a few months later when they discover that the withholding and estimated tax payments done at unmarried rates are very inadequate for joint returns. Oh, who cares? Love conquers all, right?

The kicker is this quote from one of the grooms mentioned in the story: "I'll never forget my anniversary." The best anniversary remembrance story in a tax context I ever heard was from a fellow who married on April 15. That, he explained, was a date that had been etched in his mind for years. He is NOT a tax practitioner and never had been. He's a very successful business entrepreneur. And he says he never forgot his wedding anniversary. His wife agreed.

Hint to all wedding planners: become friends with a tax type. It may be worth it in the long run. And you'll discover that tax types can make good friends, once you get past the stereotype. And then you can give back all these New Year's Eve party locations to the general public. And if you still need a holiday for a wedding, as if the wedding itself is insufficient reason to celebrate, I suggest that if Valentine's Day is too cliched and too booked, try Thanksgiving or Labor Day (pun intended). And steer clear of Independence Day (pun also intended and I'll duck for cover on this one, ha ha).

A View from Down Under

As the year rushes to a close at what seems to be breakneck speed, I will try to catch up on a backlog of posts I want to share. We'll start today with some comments from Philip John of Perth, Australia. Yes, folks, MauledAgain is being read on the other side of the world (in a country I want to visit for many reasons, including the chance to take the famous cross-continent train, because seeing it on a TV documentary isn't the same as experiencing it in person).

Trains aside, Philip John was responding to a comment made by Nakul Krishnakumar as part of that long exchange he and I had a few weeks ago, reported in its entirety back on December 14 of this year. Nakul had explained:

My argument is simply this: In the long run, private industry will better be able to provide services such as highways (even snow plowing), education, etc and will do so in more cost effective manner - because they have more of an incentive to do so.

Philip John shared these thoughts:

Being an Australian and having visited America a number of times (my girlfriend is currently doing her doctorate at Ball State, Indiana), I would like to add a point of view. Comparing Australia to the USA, I would have to say those free market forces have not served the USA well and have created a more highly stratified society. In Australia, the rich are not as rich (perhaps with the exception of Rupert Murdoch). However, the poor are nowhere near as poor. The last time I was in the USA (4 months ago) was the first time I have ever been really shocked by poverty.

While I would agree that the private sector does provide a better service in some instances, it generally fails abysmally in those areas where profit competes with the good of society. For example, on average I believe Americans spend more on health care but receive very poor service compared to Australia's government Medicare service. The cost of private health insurance here is also much lower. While Australia has waiting times for elective surgery, emergency cases are seen immediately and at an essentially no-charge basis. My father has recently received two hip replacements under private health insurance and the total cost for his coverage would be in the order of AU$1000/year. This is only possible because private health is subsidised (i.e. supported) by the government / public sector.

As a second example, the proliferation of expensive private universities in the USA is a situation where free market forces provide, at best, a range of service levels. I have never seen an advert by an Australian university for an online degree for $x. The motivation of a private market university is to make money. The motivation of a government funded university is to teach students. I attended public primary schools, high schools and universities and received a world standard level of education. The evidence I have seen suggests the private sector charges more and delivers less. There is less focus on the quality of delivery when compared to the brand / marketing of the university, the profit per student and the drive for growth. Under the private sector, there would be no allowance for research universities. There is no profit in providing scholarships to PhD students, waiving fees and then paying for equipment, supplies and supervisors.

As a third example, private companies have little understanding of environmental impact. Mining companies in Australia do not rehabilitate the land out of a sense of civic duty, but rather because they are required by law and overseen by a governmental body. Without government regulation and control, intangible benefits to society are not included in the private sector profit equation. Australia is presently facing big salinity and water problems due to deforestation at the hands of the private sector. Government regulation has slowly forced the establishment of a renewable timber industry.

As a last example, I believe the deregulation of the electricity market in California resulted in price hikes from $40 to $1000. As this demonstrates, the profit motive is much stronger than the desire to provide a high quality service to society. I previously worked at a public run electricity plant during my university breaks. Prior to its preparation for privatisation, 'preventative' maintenance was carried out - fix it before it breaks. As privatisation is occurring, repairs are carried out as items fail. While this is more efficient / cheaper / lowers costs, the result has been a larger number of blackouts and business losses due to an irregular power supply (I have learned it is hard for bakeries to bake bread without electricity).

While I understand the importance of the free market, I believe essential services required by the vast majority of members of society must be overseen and regulated by the government. At the very least, privatisation must occur with regulation by the government which specifies maximum price and/or minimum service delivery levels. Key infrastructure (roads, railways, air space) must be controlled by the government and access provided to all. Unfortunately, I believe many in America cite 'free market forces' as dogma, yet fail to realise we do not live in a society with perfect competitive forces.

In closing, my belief is that the focus should not be "how do we privatise the public sector", but rather "how do we ensure the public sector functions efficiently while delivering quality services to society".

Getting a focus on these issues through the lens of someone from another nation is helpful, and I appreciate Philip John's comments. There's something to be said for injecting into the teaching of just about any subject the perspective of people who live in nations, states, and cities other than our own.

It was not news to me that in Australia the distribution of income and wealth is different from what it is here in the States. What fascinated me, though, was understanding the reaction of someone accustomed to a different situation than exists in our nation and who encounters the reality of that difference. What is it about the application of free market capitalism in Australia and in the United States that generates such different outcomes? When it comes to healthcare, could the difference be the litigious nature of American society? Could it be that Americans have been raised, during the past half century, with such an expectation of "paradise on earth" that the least little problem, which people in most other cultures would take in stride, triggers the "sue 'em all" mentality? What is the impact on the a free market health care system of having the risk of litigation hovering over one's shoulder waiting for the least little error? This is something worth investigating, and perhaps someone already has.

Philip John's comments about education deserve some clarification. He separates education providers into government and for-profit sectors. I see a third group, namely, non-profit non-governmental institutions. There is much to be said about the impact on the quality of education when the institution has profit as its primary goal. This sort of arrangement easily leads to the creation and operation of a "learning factory" in which large quantities of "educated people" are cranked out at a low per-unit cost. Ironically, though, most of the large factory educational institutions in this nation are the huge state-funded schools, where size alone defeats quality in many instances. The other day someone mentioned having taken a course at a state university, in which there were hundreds of enrolled students and the professor, who wrote the book, appeared once, on the first day, leaving the teaching to a group of graduate students only a year or two older than the undergraduates supposedly getting the advantage of low-cost taxpayer-funded education. The issue here is accountability, which does not corroborate uniformly across the great expanses of a free market. In contrast, non-governmental non-profit schools have as their primary focus educational goals tied to the philosophy of the institution's larger affiliation. For example, at least in the United States, a substantial number of private schools are associated with, and usually funded by, religious organizations. The quality of the education varies widely. At the K-12 level, there are many places where parents prefer to enroll their students in private, religious schools, even though they are not members of the denomination in question, and even though they need to fork over some money, because the quality is so superior to the local publicly-funded government school. Why? Again, it is a matter of accountability. Even though I advocate government as a more efficient provider of certain services, for the reasons I explained in my discussions with Nakul, and for some of the reasons Philip John articulates, I also advocate infusing government bureaucracies with some semblance of accountability as found in the free market system. My concern is that influence has been flowing the other way, as the sort of entrenched, safe-from-dismissal public employee mindset has infiltrated the management levels of some private enterprises operating in a so-called free market that no longer is truly free. At least it's not free of incompetence, greed, cronyism, politics, and excuse manufacturing.

As for Philip John's last point about environmental concerns, he makes a good point. Private enterprise had several centuries to demonstrate what it thinks about fouling its own nest. It demonstrated that it cannot be trusted to nurture the golden goose that lays the dollar egg. Yes, the planet needs to be in good health for the free market to flourish. Who wants to go shopping in a cesspool? His point about utilities deserves one further comment. What we have with most utilities, especially cable, is a deregulated, and thus supposedly free-market industry, operating with a monopoly license. In other words, the worst of both worlds.

As best as I can tell, the cross-country train in Australia, unlike most of the train service in this country, continues to operate. When I get there, I want to ride that train. And I'll stop by to see Philip John in Perth. I'll have a chance to see how things are, and will share the impressions made on this visitor. I'll let you know about it. Someday.

Legislatures Take a Holiday From Taxes

They may not have invented the phrase, but the Rolling Stones made sure everyone knows that "You can't always get what you want." Whether a warning or a simple statement of reality, it is an omnipresent thought. Even when it is holiday time. So try this remake of a holiday classic: "All I want for Christmas is some genuine tax reform." Yes, I know there is no Santa to bring this to me. But did the grinches in the legislatures really need to have said resoundingly, "NO!"? And not once. Or twice. But thrice.

First, the United States Congress whiffs on reform of the alternative minimum tax that would prevent 15 million more taxpayers, mostly from the middle class, coming within its reach for the first time in 2006, even though the tax was designed to prevent the wealthy and ultrawealthy from using deductions to lower their tax liabilities below a specified minimum. According to Senate Majority Leader Bill Frist, as reported by a number of sources, including this Los Angeles Times story, earlier this week asserted that Congress "had run out of time" to finish work on the proposed legislation fixing the problem.

Strike One.

Second, as reported by the Philadelphia Inquirer, the Pennsylvania legislature failed to finish work on local property tax reform. Both the House and the Senate approved separate bills by overwhelming votes, but the two plans are very different. Despite the efforts of the governor, who called House and Senate leaders to a meeting, a problem that the Pennsylvania legislature has been trying to solve for three decades (yes, you read that right, three decades) will continue to vex taxpayers, particularly those on fixed incomes. Yesterday, legislators announced that nothing more would happen this year. The Senate wants to fund property tax reduction with gambling revenue and increases in local income taxes. The House wants to fund property tax reduction with gambling revenue, an expansion of items subject to the state sales tax, and an increase in the state income tax.

Strike Two.

Third, as also reported by the Philadelphia Inquirer, even though Philadelphia City Council voted 9-6 to cut the business-privilege tax from 6.5% to 6.3% over five years, in an attempt to stem the exodus of business from the city, the mayor has promised to veto the legislation. Considering that he has vetoed similar legislation several times in the past, it's safe to conclude that this is one promise by a politician that will be kept. There are insufficient votes in Council to override the veto. An illustration of the insanity that has gripped tax reform in the city is evident from the vote against the tax reduction plan by a member of council allied with the mayor. This member of council then introduced a plan to cut taxes by almost 10 times the plan that the mayor promises to veto.

Strike Three.

They're out. Actually, we're out. Out of luck. Out of patience. Maybe even out of chances.

The Congress claims it ran out of time. The Pennsylvania legislature ran out of time. City Council has run out of time. It's the clock's fault. Or the calendar's fault.

No, it isn't.

Back in March, everyone knew that December 16 would follow December 15. It's not as though December 15 was followed by December 23, and whoa, time disappeared. Good planning, good project management, good time budgeting, and common sense tells everyone that if something is to be finished by December 23, it needs to be started sooner. Much sooner if the issues are complicated, controversial, and time-consuming. These are elected public officials, who owe it to their constituents to do their jobs. It's not enough to issue platitudes about tax reform and then to go home because time ran out. They let time run out. And if someone said they did so deliberately, I would not argue.

Good time management is not some elusive goal such as time travel. As I tell law students who fall into that end-of-semester trap, where they have far more to do before a final examination than they have time to do it (because they wasted time earlier in the semester), time is like money. There are 168 hours in the week. Decide beforehand how they will be used, and allow some cushion for the unexpected emergencies. I see the same lack of time sensitivity when I sit in meetings that are scheduled for two hours, with 10 items on the agenda, and participants devote 80 minutes to the first item. Simple math tells us that instead of 12 minutes per item, the remaining 11 items now must share 40 minutes. That's less than 4 minutes. And, in most instances, the first item was trivial compared to those either tabled or rushed through without appropriate thought.

At the beginning of each semester, I warn my students about the need to budget their time. I explain that through all their years in the profession, the requirement that they account for their efforts in 3 or 5 or 6 minute intervals on billable hour software (or, horrors, "time sheets") will be an unescapable reality that shadows them without respite. Most of us, not just students, lawyers, law professors, and tax practitioners, would like to suspend time, turn back the clock, or even to pull the Congressional stunt of "deeming" it to be one minute before midnight until as long as it takes to finish work on legislation. We can't. We may want it, but we won't get it. But compared to tax reform, sometimes it seems as though there's a better chance we'll learn to suspend time before we learn how to compel legislators to act in the best interest of their constituents.

Can we get what we want? The phrase of warning and reality, at least as sung by the Stones, continued, "You can't always get what you want but if you try sometimes well you just might find you get what you need." We want tax reform. We need tax reform. We have tried. We are still waiting. Like Charlie Brown's baseball team, and like the child who discovers that no one lives or works at the North Pole, we are in danger of becoming so accustomed to legislative tax reform disappointment that we might end up thinking it is impossible.

But so long as there is a chance, I will keep asking. And writing. And proposing ideas. And criticizing. And insisting. I hope you do, too.

Using the Tax Law to Impose "Morality"

Congress finally enacted and sent to the White House for the President's signature the Gulf Opportunity Zone Act of 2005. I suspect it will be known as GOZA.

This legislation creates a Gulf Opportunity Zone not unlike the New York Liberty Zone that was created after the September 11, 2001 terror attacks. Individuals and businesses in the zone are eligible for a variety of tax benefits, including more favorable depreciation, expanded eligibility for tax credits arising from hiring employees, and greater availability of tax-exempt bond financing. GOZA includes an increase in the amount of low-income housing credit available in the zone, a deduction for certain clean-up expenses, and other tax benefits.

A group of legislators, however, were appalled at the thought that tax benefits would be available to certain businesses. "Horror!" they cried. Led by Representative Frank Wolf from Virginia, 65 members of Congress wrote letter to the President, opposing the extension of GOZA benefits to the gaming industry. These legislators argued four points. First, denying special tax breaks to casinos "has been routine." Second, the casinos in Mississippi are planning to rebuild and thus do not require any incentives to rebuild. Third, casinos in Mississippi were excluded from previous state economic development incentive programs. Fourth, high budget deficits demand that tax dollars go "to those who truly need the government's help," namely, "the poor, the needy, and the vulnerable," which does not include the gaming industry.

These legislators prevailed. New section 1400N(p) of the Code will deny GOZA tax benefits to any property that is "used in connection with any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises," and it also denies the benefits to "any gambling or animal racing property."

It is true that golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, liquor stores, race tracks, and casinos have "routinely" been set apart and treated differently for income tax purposes. These restrictions apply to business deductions, depreciation, empowerment and enterprise zone benefits, and other provisions. This policy reflects an attitude not mentioned in the letter written by the 65 legislators.

Let's look first at that letter. It justifies excluding casinos from GOZA benefits because the casinos plan to rebuild even without tax incentives. I like that as a test. The statute should read, "Any business that plans to rebuild even in the absence of tax benefits is barred from these benefits." Why is that language not acceptable? Theoretically, it simply would encourage businesses to claim they don't plan to rebuild. The casino industry, being honest, admitted that it was planning to rebuild, and was rewarded for that honesty. Practically, it would deny tax benefits to businesses such as Walmart, Exxon-Mobil, and hotel chains, which also would rebuild in the absence of tax benefits. So why not deny the tax benefits to Walmart, Exxon-Mobil, hotel chains, and all the other businesses that would have rebuilt even without tax incentives? So this aspect of the letter is nothing more than a smokescreen.

The letter then takes the position that because the state of Mississippi did not assist casinos with economic development monies in years past, it is acceptable and even essential that the casinos not be assisted this time around. The difference is that this time around, it's a matter of destruction by a hurricane with the force of dozens of megaton nuclear weapons. It's a different ball game. Let's face it. This, too, is a smokescreen.

Then comes the clincher. Casinos don't deserve the tax breaks because they are not "the poor, the needy, and the vulnerable." That's true. Again, though, if other businesses qualify for the tax breaks even if they are in fine financial shape, for example, Walmart and Exxon-Mobil, why not deny tax benefits to businesses with taxable incomes exceeding some dollar amount separating the needy and vulnerable from the wealthy? Again, it's a smokescreen.

The reality is revealed by the list of businesses that are targeted for benefits denial. It's not just casinos and race tracks. It includes other businesses. Liquor stores. Hot tub establishments. Oh, my, massage parlors. And even suntan salons. Wow. I guess the owners of those places were planning to rebuild even without tax incentives. I guess they were omitted from previous state economic redevelopment programs. And I'm sure they're not needy or vulnerable. Their owners are rolling in the cash just like casinos, oil companies, and, of course, Walmart.

Right.

This is nothing more than imposition of a particular moral code on America through use of the income tax law. Now, I understand the theological arguments that some make against drinking alcoholic beverages and gambling. But hot tubbing and massages? Oh, perhaps Congress thinks these are fronts for some other activities? Hogwash. I understand that absent careful use, artificial tanning and hot tubs can cause health problems. But that can't be the justification because I don't see denial of GOZA benefits for establishments selling cigarettes. No, it's not about physical health. It's imposition of a particular moral code.

It certainly is acceptable for the voters of a state or county to decide that gambling will be prohibited. Or that it will be permitted. Why should the federal government use its income tax club to punish states and localities that haven't conformed to the moral principles of these 65 legislators? Why should a member of Congress from Virginia get to second-guess the voters of Mississippi? Casinos brought business to Mississippi. They brought tax revenue. They created jobs. There are good arguments for and against legalizing gambling. Ditto for massage parlors, hot tub facilities, and liquor stores. But once the voters of Mississippi spoke, what gives Washington the right to make it more difficult for these enterprises to do business?

Worse, these legislators don't have the courage to try to enact legislation that imposes fines and penalties on voter-approved casinos. That would be too obvious, too blatant, and too risky. Voters might figure out what these members of Congress are doing, and replace them when they go to the polls. Instead, they put this provision, and for years have been putting provisions like this, into the tax law. It's the equivalent of a fine or penalty, because it economically disadvantages these businesses as contrasted with other businesses. These are stealth fines and stealth penalties. After all, how many people have read section 1400N(p) or its counterparts throughout the Code?

I can understand, and even support, a restriction of GOZA benefits based on taxable income, that excludes the wealthy from participation. I can understand a limitation of GOZA benefits to businesses that otherwise would not rebuild although I am unlikely to support it in such a form because the practical logistics of making that sort of limitation work are almost impossible. I can understand the denial of deductions to illegal businesses even though I think it's sad that the government must use the tax law in its efforts to enforce criminal law. But singling out particular industries, that are legal and acceptable to the citizens of a state or locality, and denying them tax benefits simply because they engage in activities that violate some particular moral code to which those citizens have not subscribed is nothing short of federal tyranny.

Let's take this New Prohibition out of the tax code. Let's leave it to the voters in our states and localities. Their votes on matters of state and local concern should not be diminished in effect by the Congress in Washington. After all, for these 65 legislators, and their philosophical predecessors, it's casinos, suntan salons, and liquor stores. For others, it could be cigarette retailers and video games. For still others, it could be rock 'n roll or rap music vendors. Perhaps stores that sell meat should be denied these benefits, for surely there are folks who consider the eating of meat to be at least as horrific as gambling or the drinking of alcoholic beverages. Or, goodness, getting a suntan or sitting in a hot tub.

Wealth Charts

One of this blog's readers sent along a link to some wealth inequality charts. When tax reform is debated, these charts should inform the discussion. Of course, the charts tell us what IS, but are truly meaningful only when compared to what SHOULD BE. And what should that SHOULD BE be? Most things in nature are distributed on a natural bell curve. Give a tax exam to 200 students, and no matter what techniques are used in teaching and tutoring the students, there will be a bell curve outcome, or, in some instances, two intersecting bell curves, one for the students who plugged away and one for those who coasted. Is there something different about how wealth accumulates and to whom it accrues? To the extent income contributes to the growth of wealth, the answers to these questions are relevant to the tax reform debate.

Have Yourself a Very Merry Tax Time.....

A day after I express hopes that Little Tax Drummer Boys hired by the IRS don't start showing up in our neighborhoods in an attempt to drum taxes out of our reluctant neighbors, I pick up on another holiday tax delight. This one, too, worries me. A wee bit.

Paul Caron reports in TaxProfBlog that Argentinian tax inspectors are dressing up in Santa Claus outfits as part of a campaign to increase tax compliance. People are being stopped on the street and presented with reasons to pay overdue taxes. They call it "Holidays without Debt."

Don't they know that the end of December is a principal reason so many people are IN debt? Do they understand that in many places dressing up as Santa Claus and stopping a perfect stranger on the street is unwise, dangerous, and perhaps stupid? Now perhaps if they had a reindeer or two in tow..... Perhaps the one named Vixen. Or the one named Cupid? Ha.

What's next? Frosty the Levyman? Rudolph the Pencil-Nosed Taxhound? The Deduction Elf?

Of course, there's nothing new under the sun. Years ago, someone came up with a name to describe what Congress does to tax legislation when it tacks on all sorts of goodies for favored constituents, special interest groups, and heavy-handed lobbyists. It's called a Christmas Tree Bill. Don't believe me? Check out this story.

Snaring Tax Delinquents with Drumbeats

Somehow in this information age, some news takes its time finding its way to me. This weekend I noticed a story in Parade Magazine, which is bundled with Philadelphia's major newspaper. When I went on-line to find the original story, I discovered that Paul Caron had reported the story on TaxProfBlog last March! For some reason, I hadn't noticed it. Yet, it doesn't seem to have attracted any commentary, but I couldn't let an opportunity, especially the chance to toss in puns once I fell into the right rhythm, go by. Plus, it's the time of the year when we hear some music that nicely fits.

The story is short. According to the MSNBC account, tax authorities in Rajahmundry, a city in India's Andhra Pradesh state, send groups of 20 drummers to play outside the homes of tax delinquents who ignore demands to pay overdue property taxes. They play continuously until the taxpayer drums up the money. The revenue officials resorted to this tactic after it failed to make a dent in the $1.15 million tax backlog by waiving interest and penalties. The incessant drumming has had an effect, clearing 18% of the delinquencies after one week.

I suppose the theory is that if you can't beat the taxes out of them, you beat the message into them. Literally.

But in practice, it has to be uncomfortable for the delinquent's neighbors. Imagine this drum corps showing up next door because the next-door neighbor hasn't paid her taxes. Do they manage to keep the sound from pounding into the eardrums of the innocent residents? HOW? Perhaps what has happened is that the rest of the people living on the block passed a high hat around to raise funds that could be used to pay the delinquent tax bill. Then the collector could stuff that into the pocket.

This is the time of the year when "Little Drummer Boy" gets airplay. If the tax folks in India sent along a chorus, would it sound like this?

Come they told me
Pa rum pum pum pum
A new tax cheat to see
Pa rum pum pum pum

Our finest noise we bring
Pa rum pum pum pum
To pound around the house
Pa rum pum pum pum,
rum pum pum pum,
rum pum pum pum

So to annoy Him
Pa rum pum pum pum
When we come
Little scofflaw
Pa rum pum pum pum

I am a poor boy too
Pa rum pum pum pum
I have no other way
Pa rum pum pum pum

That's fit to get the tax
Pa rum pum pum pum,
rum pum pum pum,
rum pum pum pum

Shall I play for you
Pa rum pum pum pum
On my drum
Neighbors cried no
Pa rum pum pum pum

The government paid us
Pa rum pum pum pum
I beat my drum all day
Pa rum pum pum pum

I played all night as well
Pa rum pum pum pum,
rum pum pum pum,
rum pum pum pum

Then he handed me cash
Pa rum pum pum pum
Me and my drum

This is one of my mother's favorite Christmas carols. She will not be amused. Oh, well. I think it's clever. See what living in a tax world can do?

So, please, my wish for the season is two-fold. One, don't let anyone in the IRS or state revenue departments get any bongo ideas about collecting taxes. Two, please, folks, if you're not going to pay your taxes, don't live next door to those of us who do.

Red Pens, Crossword Puzzles, and Some Tax Exams

It's grading time again. So if you see fewer posts or shorter posts, don't worry, I will soon be back with the usual frequent and extensive analyses of tax law issues of every sort. And other topics, too. Of course, if the idea of fewer and shorter posts brightens your day, hey, rejoice in it. While it lasts, ha ha.

When I first started teaching I was told that by grading exams, law professors learned not so much whether their students understood, or did not understand, the material, but how much the students had learned that wasn't there to be learned. Principles of black letter law never before articulated on the planet show up as settled doctrine. Facts are invented that conflict with the facts presented. Indecision is evident on examinations where crossed out answers are in turn crossed out and then circled with an arrow pointing to the word "keep." Fortunately, as the years passed, I learned how to identify which students had any bad test taking habits before the examination, and I've had some success persuading some students to break those bad habits. The exams are a much more pleasant experience to read.

Some students, particularly accountants in both the Graduate Tax Program and in the J.D. program insist on setting forth tax law principles without appropriate citations to authority. Most leave out any citation, as though the fact they wrote it should somehow earn credit for creativity. Sometimes, though, students will cite me, or a statement I made in class, as the authority. Thanks, but I'm not the authority on the matters tested by the exam. If I read a portion of a Code section in class to emphasize a particular drafting concern, or a semantic twist, that does not make me the authority. The Code section is the authority. The impression I have is that some students deluded themselves, in college or perhaps high school, into thinking that tossing flattery at the person grading the exam would somehow better their grade. I'm guessing that this approach has worked once or twice for some students, giving them incentive to try it yet again. No, it doesn't work. Not with me.

Many law faculty claim that the least enjoyable part of their academic responsibilities, setting aside administrative and committee tasks, is grading examinations. It can be depressing to read examination answers that tempt responsible faculty into thinking that their teaching somehow caused the problem. Yet in the same batch of examinations one can find brilliant answers, as close to the model answer as students get, and that is, at least for me, a most joyous occasion. It confirms that the course was packaged and delivered well, for in the hands of a diligent, responsible, and interested student, the exam provides the opportunity to generate an answer that is exciting and satisfying to read.

The most difficult part of this process is finished. Creating an examination, or a semester exercise or in-class quiz, is far more challenging than taking the examination. I speak from experience. As difficult as it may be to do a crossword puzzle, it's even more difficult to create one. Again, I speak from experience. Curious? It's what parents and teachers do with a young child who needs to be kept busy so he stops talking and doesn't wander into other trouble. Yes, I speak from experience.

Now let me go find a red pen.