Blasted Partnership Taxation

Several days ago, someone posted an inquiry to the ABA-TAX listserve concerning the tax consequences of a sale of a partnership interest. The inquirer wanted to know if the proposed analysis was correct, and if so, whether some other arrangement could be structured to avoid the undesirable tax outcome. The proposed analysis appropriately included the parsing of at least four major partnership taxation Code provisions. It was no surprise to me that the inquiry carried the subjecte heading of "D#$% Partnerships!"

Shortly after I replied to the question, someone else provided a terse but telling response: "My head hurts too much to even read your email, I don't have an answer (sorry) I just wanted to chime in re: #$%%** Partnerships! Hate em."

I could not resist. I tried to cast the responsibility for the mess where it belongs:

It's not the fault of partnerships. They've been around for several centuries.

It's the fault of the complex legislation that includes overlaps, lack of clarity, overkill, and gaps in coverage (e.g, sec 465 and 469 as applied to partnerships, sec 752 with no definition of share of liability, sec 721 not mentioning services one way or the other, sec 751 with two definitions of inventory depending on the transaction, sec 736(b) with different rules for general partners in services-type partnerships, sec 743(b) somewhat elective but at times mandatory, sec 732(d) which is elective and mandatory and wouldn't be required if sec 743 were mandatory, sec 724 and sec 735 being asymmetrical, a different set of rules for large partnerships in sec 771, etc). It's the fault of regulations that attempt to set rules for every possible situation, thus generating more complexity, but that also are imbued with vagueness, and gaps in coverage (regs under sec 704(b) and 752 take the prize, with the regs under sec 704(c) coming in closely behind, whereas the regs under sec 706(d) are yet to be issued, and so on and so on).

It's the fault of taxpayers who try to use partnerships to end run flat-out unquestionable rules, which entices the Congress and the IRS to enact or issue so-called "anti-abuse" provisions (e.g. sec 704(c)(1)(a), 737, 706(d), 751(f), 721(c), 731(c), 732(c), and others, the anti-abuse regs, etc etc). Though some of the complexity comes from the entity v aggregate disparity, far more comes from responses to taxpayers gaming the system, trying to find ways to turn OI into CG, to turn transactions not qualifying for like-kind exchanges into ones that appear to qualify, etc.

Years ago, at an ABA-TAX meeting, I proposed simplification that would treat partnerships as S corporations. I could smell the tar being heated and hear the chickens squawking as their feathers were being removed.

As my students know, I do not hold in high esteem the various maneuvers, the billowing smoke, the polished mirrors, and the other machinations that are designed solely for the purposes of avoiding, or even evading, a tax liability that Congress certainly intends to be paid. Some examples might help.

Section 731(c) is a long provision, most of which consists of a definition of "marketable securities." It exists because some clever folks found a way to get around the basic rule that a distribution of cash to a partner in excess of the partner's adjusted basis in the partnership constitutes gain. Because a distribution of property does not generate gain, some partnerships obtained and distributed marketable securities so that the partner would not be taxed. For all intents and purposes, marketable securities are so much like cash that their distribution accomplished the same objectives as did a distribution of cash. Although the IRS could have prevailed on the argument that the partnership was acting as the partner's agent in buying securities with cash that could be deemed distributed to the partner, the IRS did not take that route because some partnerships purchased the securities ahead of time. So to put a stop to this end-run around the basic rule, Congress added several pages of text to the Code.

Sections 704(c)(1)(B), 704(c)(2), and 737 exist because several practitioners decided they could use partnerships to circumvent the limitations on the section 1031 like-kind exchange nonrecognition rules. Under section 1031, exchanges of like-kind property are not taxed except to the extent property not of a like-kind is transferred. Thus, an exchange of two properties not of like-kind one to the other is taxed. Because there is nonrecognition on the contribution of property to a partnership and on the distribution of property from a partnership, taxpayers wanting nonrecognition on the exchange of properties not of a like-kind, a goal denied by Congress in section 1031, would contribute both properties to a partnership and then distribute each property to the other exchange partner. In other words, although Congress clearly intended to limit nonrecognition on property exchanges to like-kind property, cagey planners used partnership provisions intended to deal with other types of transactions to circumvent Congress' intent. Add another four pages of text to the Code to deal with this one.

It's not my purpose to defend Congress. Surely there are enough ambiguities, unaddressed issues, and inconsistencies in the partnership tax provisions to generate all sorts of angst for tax practitioners who are trying to help their clients comply with the tax law. When the IRS comes along to fill in the gaps, it adds to the complexity. The simple phrase "share of partnership liabilities" in section 752 spawned page after page of regulations. The phrase "substantial economic effect" generated dozens of regulation pages. Neither phrase is defined in the Code.

Partnership taxation probably is the epitome of what's wrong with the tax system. It is almost a farcical exaggeration. Yet it is very real, and very challenging to tax practitioners. It could be simplified, but attempts to do so would bring howls of objection from those who find in its complexities little folds and wrinkles in which they can hide yet another scheme to circumvent the general purpose of subchapter K. Simplification attempts would also be opposed by those who have advantages under the current system that they would lose if the partnership provisions were simplified. The same, unfortunately, can be said about most other areas of the tax law, though perhaps not quite to the extreme level as afflicts partnerships.

For the moment, all one can do is to find a way to learn partnership taxation. It's an endeavor that should be approached with a willingness to dig in and work with overwhelming effort, probably a level effort unlike anything previously experienced. It isn't easy, but partnership taxation is so pervasive that it's difficult to practice tax law or to be a tax practitioner without understanding it. The few students in my Graduate Tax partnership course who have tried to prove they could practice without getting involved in partnership taxation issues eventually, sooner or later, came around to realizing, glumly in some instances, that it was inescapable. That it is, and frustrating, too.

Does It Make Sense to Overload the IRS and the Tax Code?

Earlier this month, in Using Taxation for Non-Tax Purposes, I criticized the use of the tax code to compel, entice, or discourage activities not related to taxation:

There is a problem with using taxation to control behavior. For example, the Internal Revenue Code is overloaded with credits and other provisions dealing with energy conservation, energy production, adoption of children, and other issues better handled more directly. Everyone complains about the complexity of tax laws, yet too many people jump on the bandwagon of proposals that contribute to that complexity.

One of Senator Barack Obama's proposals illustrates how a great idea can become tainted by inserting it into the Internal Revenue Code rather than where it belongs.

Obama is a strong believer in the value of citizen service. One of his many ideas for encouraging service and volunteer activities is the American Opportunity Tax Credit. Obama's website describes the proposal as one that would "Require 100 Hours of Service in College," one that would "establish a new American Opportunity Tax Credit that is worth $4,000 a year in exchange for 100 hours of public service a year." His speech in which he outlined the idea puts it differently: "For college students, I have proposed an annual American Opportunity Tax Credit of $4,000 to make tuition affordable. To receive this credit, we'll require 100 hours of public service."

Two aspects of this proposal concern me. One involves tax, and the other involves civics.

Turning to the question of what citizenship means, is volunteer service truly volunteer if the person providing the service is compensated? Whether the reward comes in the form of wages or tax credits, a monetary return for performing services removes it from the category of volunteer activity. Obama may be correct that providing economic compensation for service would encourage college students to engage in helpful activities, but let's not call it volunteer work.

Turning to the tax question, does it make sense to add yet another credit to a tax code already stuffed with tax credits and other provisions? If the goal is to reward college students for providing services, why not simply issue a check to the student? If there is concern that the money would not be used for tuition, then why not simply issue a voucher? If there is concern that the student would somehow not get the voucher to where it should go, why not simply issue a check to the student's college? Ought this not be administered by the Department of Education? Why bring the IRS into the picture? Could it be that Congress, elected officials, and candidates have far more faith in the IRS to get the job done properly than they do in some other agency? If that is the answer, then why do we tolerate the existence of agencies that cannot do what they ought to be doing and that need to be bailed out by the IRS?

Peacetime Tax Policy While Waging War = Economic Mess

The Congress appears to be on its way to approving a budget that contemplates a repeal of at least some of the tax cuts enacted at the urging of the Bush Administration during the past eight years. According to this report, the Senate approved a budget that "would torpedo hundreds of billions of dollars in tax cuts won by President Bush." Some Republican Senators criticized the decision, claiming that letting the tax cuts expire as they are set to do under the law that enacted them will amount to a massive tax increase that will choke the economy.

Though the budget resolution is non-binding, and though even Democrats in Congress suggest that ultimately they will preserve some of the tax cuts, especially the few targeted at the middle class, barring unexpected election results later this year, it is likely that by 2011, tax increases for at least some taxpayers will be the order of the day. Is this outcome as bad as its critics assert?

At present, the economy is a mess. It very well could get worse. The list of problems begins with the credit crisis and doesn't end with high gasoline prices. It includes rising unemployment, fading home sales, drops in housing starts, federal budget deficits, trade deficits, spot shortages of commodities, a very unhappy stock market, reduced incomes for retirees on fixed incomes, the continuing decline in the value of the dollar, and the ugly cloud of inflation. That's not an exclusive list, but simply a series of examples to support the contention that the economy is a mess.

Why is the economy a mess? Commentators offer all sorts of ideas, but I think that the economy is a mess because of the factors underlying the decline in the value of the dollar. The dollar's value represents what the markets think of the economy. On the edges, that value is affected by the issues of the day, but the longer term value reflects the opinion of investors, traders, and others on the health of American enterprise and the national economic system.

So why has the dollar shrunk in value? Why is it not worth as much in the world market? The dollar represents the worth of the nation, and the nation been on a headlong rush into serious debtor status. China, Saudi Arabia, and other foreign nations and investors are beginning to drown in dollars. Things tend to lose value when there are so many of them that a person or nation can drown in them. Why are there so many dollars held abroad? In part it is because American consumers are sending dollars overseas in order to acquire goods and services produced overseas. In larger part, it is because the United States Treasury continues to borrow money to finance the federal deficit.

Why is there a federal deficit? There is a federal deficit because federal expenditures exceed federal revenue. Why has that happened? It has happened because at the same time federal revenues were trimmed through tax cuts, chiefly benefitting the wealthy, federal expenditures soared on account of the war in Iraq. As I asserted in War Taxes: Even A Discussion Can Teach Lessons:

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

The advocates of keeping taxes as they are claim that deficits can be eliminated by reducing federal spending. When asked, they claim that there is enough "fat" in the budget to account for sufficient cuts. Yet when one adds up the expenditures that are not "fat," one tallies up an amount larger than federal revenue. Unless cuts are made in social security, medicare, or defense spending, cutting expenditures alone will not accomplish what needs to be done. A significant, and increasing, portion of federal expenditures is interest on the national debt, and so the failure to balance the budget during the past decade means that it will be even more difficult to do so in the future. When individuals go through life spending more than they earn, they end up in bankruptcy and even if they avoid bankruptcy, lose many of their possessions, including their homes. Why would it be any different with the nation? The answer, that a government can print money whereas we mere mortals cannot do so, at least not legally, is no answer, because the printing of money devalues its worth. And that brings the analysis back to the declining dollar.

Change is necessary. If someone needs a phrase to describe it, that person can borrow this one: our elected officials need to act responsibly and put aside their irresponsible ways. Unfortunately, when the legislation that permits the tax cuts to expire came up for a vote, the Senate overwhelmingly defeated a proposal to do away with earmarks. The moral of that story is that if change is to occur, it must occur in more than one office on Pennsylvania Avenue. That office is only one part of the problem and only one part of the solution.

Why Some Politicians Fear the IRS?

In the flurry of news reports, editorials, commentaries, and blog posts dealing with the latest adventures of New York's now ex-governor, so much attention has been given to the sensational aspects of the story that almost lost in the buzz is the role of the IRS as the triggering actor in the entire affair. Yes, the story begins with the IRS.

According to the New York Times, the story began when several banks discovered "unusual movements of cash" in accounts connected with the governor. The banks reported these transactions to the IRS. I suppose one could argue that the story begins with the banks, but if there were no IRS, then the story very well may not have been a story. The IRS determined that the governor seemed to be trying to disguise the "source, destination, or purpose" of the cash transactions. When the investigators discovered that the cash was moving into shell companies, they suspected financial crimes. They were thinking about bribes, corruption, illegal campaign contributions, and similar wrong-doing. So the IRS called in the FBI, asking for agents expertised in political corruption. After a little digging, the FBI discovered that the transactions were being hidden to "conceal" Spitzer's transactions with the escort service employees. After establishing a contact with a former employee, the agents obtained a warrant for cell phone wiretaps of individuals involved in the business. It turned out that the payments made to the escort service were funneled into those shell corporations. Why? According to a former employee of the escort service, this was done so that the payments would look "like a business transaction." I wonder if the customers have tried to deduct the payments.

Many people, even those not practicing tax, know the story of how Al Capone was brought down. Of all the government agencies and law enforcement officials trying to deal with him, it was the IRS -- technically, its predecessor -- that triggered his downfall. The IRS is powerful. Why? Because the IRS administers the tax law. The tax law touches almost every aspect of human life. The IRS also does more than administer the tax law. It is, for example, the agency to which cash transactions exceeding $10,000 must be reported. Why? Because the Congress knows that if it wants something involving money done thoroughly, the IRS is the agency to use. That's why there are dozens of tax credits involving energy, adoption, housing, transportation, employment, and other social policies that should be administered by agencies dealing with those issues.

So it's no wonder that the IRS, having been given power over the administration of tax laws, which reach into all sorts of transactions, is in a position to examine the transactions of every citizen. After this latest episode, it would not be surprising to see a resurgence of "anti-IRS" sound bites from candidates and office holders. It's been said that the "anti-IRS" politicians hate the IRS. Perhaps it's not a matter of hate. It may be that they fear the IRS.

Are State Gasoline Taxes the Best Source of Highway Revenue?

According to a recent Philadelphia Inquirer report, the controversy in Pennsylvania over how to fund highway and other infrastructure repairs has narrowed down to a choice between raising tolls, including imposing them on Interstate 80 which currently is toll-free, or leasing the turnpike. Apparently whatever plans there were to increase the gasoline tax have fallen by the wayside.

The gasoline tax has lost its appeal in part because new information released by several state and federal agencies suggests that the revenue flow from state gasoline taxes will not keep up with needs, even if the proposed increases that have been floating around were to be enacted. The Pennsylvania Department of Revenue reported that taxable gallons of gasoline had fallen by 4 percent, from 5.2 billion gallons in fiscal year end 2005 to 5 billion gallons in fiscal year end 2007. Revenues from the gasoline tax, though technically it is a liquid fuels tax because it also applies to fuels other than gasoline, grew by only 25 percent from 1997 through 2007, whereas other taxes revenues grew by 50 percent. The Pennsylvania Department of Transportation has reported a 0.13 percent decline in vehicular traffic at 59 counting points, and the Federal Highway Administration indicates, in preliminary reports, that nationally, miles driven in December 2007 were only 99.6 percent of those driven a year earlier.

Other information also suggests that gasoline, or liquid fuels, usage will decline, or at least not grow at a rate that would generate sufficient revenue. Sales of hybrid and electric vehicles is increasing as a proportion of new vehicle sales. New federal mileage standards almost certainly will reduce, or at least significantly slow the growth in, gasoline consumption as the next decade unfolds. The population of Pennsylvania is not growing.

For these reasons, advocates of toll increases and advocates of leasing the turnpike join forces to push aside increases in the gasoline tax. One legislator predicted that even a two-penny increase would fail miserably in the legislature. Unfortunately, the advocates of toll increases and the advocates of leasing the turnpike fail to see the fatal flaws in their own favorite fund-raising fiascos. Toll increases are fine, when it comes to taking care of the toll road, but it isn't feasible to impose tolls on roads other than limited access highways. It makes no sense to require drivers using the turnpike or I-80 to subsidize repairs to Routes 1, 3, 320, 252, or 202, to name but a few highways in the southeastern part of the state where I live. Imposing tolls on the Schuylkill Expressway, which is a limited access highway, would be a difficult logistical maneuver, all opposition aside. I explored the toll increase proposals in Raising Revenue Through Tolls Isn't Simple, and in User Fees and Costs, to name but two of my several posts on the topic. When it comes to leasing the turnpike, all that needs to be said at this point is that it is a terrible idea, at best a short-term solution with a excessive long-term cost, as I explored in Selling Off Government Revenue Streams: Good Idea or Bad? and in Selling Government Revenue Streams: A Bad Idea That Won't Go Away.

It's easy, of course, to pan all three proposals. It's more difficult to provide a constructive suggestion. Yet in this instance it is easy. As I discussed in Mileage-Based Road Fees, Yet Again, the answer is the mileage-based road fee. As I previously explained in Tax Meets Technology on the Road and in Mileage-Based Road Fees, Again, this fee is not restricted to limited-access highways, does not require the building of toll gates and toll booths, is not dependent on the level of liquid fuels use, can be adjusted for the degree of wear and tear inflicted by the vehicle on roads and bridges, and is easy to administer. It already is being used in other jurisdictions.

The Pennsylvania legislature needs to look beyond the present and consider implementing ideas that are ready to be put in place for the future. Gasoline taxes, tolls, and selling public goods to profit-hungry private enterprises are, or at least should be, strategies of the past. They are being eclipsed by newer, better ideas, and Pennsylvania needs to get on board. It doesn't help when a leading state legislator describes tolls as the "wave of the future," because in doing so, what he demonstrates is a surprising ignorance about the actual wave of the future that already is in the present, namely, mileage-based road fees. With a $1.7 billion annual shortfall in road and bridge maintenance requirements, the Pennsylvania legislature cannot afford to continue functioning in ways that account, at least in part, for the stagnation in the state's population and economic growth.

Finding Humor in a Bad User Fee Deal

Yesterday's post, Bridge Motorists Easy Mark for Inflated User Fees, in which I criticized the DRPA's decision to use bridge tolls to fund infrastructure improvements for a professional soccer franchise, has brought a humorous, though certainly serious, response from a reader, who remains anonymous:

Was it 35 years ago that Philadelphia Magazine ... ran a much praised piece titled "The River Pirates" about the DRPA of that time?

My sister thinks any soccer team that plays in Chester should carry that moniker.

The more things change......

Indeed. I think the reader's sister should enter the team naming contest, which according to this story is soon to be underway. The Chester River Pirates. How appropriate!

Bridge Motorists Easy Mark for Inflated User Fees

A week ago, in Soccer Franchise Socks It to Bridge Users, I noted the decision by the Delaware River Port Authority to divert some of its funds to financing the construction of a soccer stadium complex in the city of Chester, and explained why I objected to the use of bridge tolls for purposes other than the maintenance, repair, upgrading, or construction of the bridge or projects designed to alleviate the impact of the bridge on surrounding areas. The incongruity of the decision is exacerbated by the DRPA's announcement that it needs to raise bridge tolls in order to finance bridge repairs. It seems rather absurd to be asking motorists for what could be 66% toll increases while dishing out allegedly surplus funds to a major league sports franchise.

On Saturday, a spokesperson for New Jersey's governor Corzine announced that Corzine would not use his veto power to block the DRPA plan to funnel toll revenue to a sports franchise. According to this Philadelphia Inquirer report, Corzine had been thinking about doing so, explaining that using bridge tolls for that purpose was not his "first choice on where to put money." Under the terms of the law that established the DRPA, which oversees bridges that connect two states, the governors of Pennsylvania and New Jersey have the power to veto DRPA decisions.

What changed the governor's mind? The governor's attorney revealed that Corzine perceived the $10 million hand-out to developers of restaurants and businesses to be "a legitimate alternative use." Hah. The reason is implicit in the next part of the attorney's explanation. Corzine expects that the members of the DRPA from Pennsylvania to support "New Jersey projects" and thus he would not veto the money for the Pennsylvania project. So, folks, in the not too near future, expect to see the DRPA raise tolls yet again, to finance perhaps a private shopping mall in New Jersey, there being such a shortage of them, he says sarcastically, or some other private venture whose owners think it's a legitimate business plan to get taxpayers to pay for their enterprises. Surely this will be the payback to prevent the governor and his political party from losing votes in the next relevant election, when the residents of south Jersey who pay bridge tolls consider that their objections to the use of tolls for private projects might affect their choice for the state's next governor. If this is the way a democratic government should function, we ought not be so eager to export it as a high quality alternative to civic order. Members of the DRPA are appointed and do not run for their positions, so they simply are not accountable to the people on whom they impose bridge tolls. One would think that the DRPA's charter should limit its expenditures to repair, maintenance, and reconstruction of bridges and other infrastructure under its control, but apparently there is nothing to prevent the DRPA from handing out money to unrelated private endeavors and then making up for the politicians' support by dishing out more money for more unrelated private endeavors. Where's the democracy in this system?

In fact, the DRPA has been handing out so much money to unrelated development projects that it has racked up more than a billion dollars in debt. To service this debt, almost half of the tolls that it collects is used to pay interest and principal on these loans. Does it seem as though some banks are doing well with this system? Why did the DRPA put money into Lincoln Financial Field, the Kimmel Center, the New Jersey Aquarium, and dozens of other projects that surely are not bridges? I can imagine the excuses but there aren't any viable worthwhile justifications.

It comes down to one thing. Motorists who need to use the DRPA bridges have no other choice. They do not have a say in who gets appointed to the DRPA. At best, they have a vote for the people who appoint the DRPA, or in some instances, a vote for the people who select the people who appoint DRPA members. In other words, the bridge-using motorists are easy marks for those who want to divert public money to the benefit of private entrepreneurs. That's no way to run a tax system, and it's no way to run a user fee system.

Using Taxation for Non-Tax Purposes

The editors at Blawg Review directed my attention to a post on Leesburg Tomorrow that suggested copyrights be taxed. The editors asked me if I cared to respond. Yes, I will.

Understanding the question is easier if the analysis begins at the beginning. In an editorial addressing the arguments by the owners of copywritten material and by those who defend sharing that material through peer-to-peer and other means, the Los Angeles Times noted that attempts to compare intellectual property to real and tangible personal property fall short. A poster on Slashdot noted that someone responding to the L.A. Times editorial had asked "If Intellectual Property is actually property, why isn't it covered by a property tax?" To that inquiry, Leesburg Tomorrow asked why copyrights aren't taxed. The post noted that taxing copyrights would raise revenue, and also have the effect of causing copyright owners to release their rights into the public domain sooner and more frequently.

The Leesburg Tomorrow post quoted the Los Angeles Times editorial: "The present system treats these copyrighted works as a funny kind of real property with no carrying costs, taxes or significant fees."

There are two issues to consider. One is the assumption that copyrights are not taxed. The other is whether copyrights should be taxed.

It may come as a surprise to many people, but in most states that do have intangibles taxes, copyrights, patents, and other intellectual property is included in the list of intangible property subject to the tax. For example, property subject to taxation under the Arizona Intangibles Tax of 1933 included "copyrights, patents, trade-marks or other intangible property not otherwise specifically taxed used in the conduct of a trade or business." Georgia Code section 48-1-2(13) defines intangible personal property as "the capital stock of all corporations; money, notes, bonds, accounts, or other credits, secured or unsecured; patent rights, copyrights, franchises, and any other classes and kinds of property defined by law as intangible personal property." I haven't tried to research all of the states. I will leave that effort to others. Some states tax intangibles, and some don't. The intangibles tax is a property tax on intangible property, and although it is not as widespread as the more familiar real property tax, it exists. Compliance with the intangibles tax may be spotty, but to claim that copyrights are not subject to a property tax as is real property isn't correct as a universal principle.

Should copyrights be taxed, in some sort of universal way? It depends on the purpose of the taxation. If one accepts the wisdom of a tax imposed on property, there should be no distinction between real property and personal property, or between tangible property and intangible property. Putting aside questions of exemptions for the first so many dollars of property, and putting aside rates, it does make sense to treat property as property. On the other hand, if one digs more deeply, the underlying question is why should a tax be imposed on property. The answer might suggest treating different types of property differently. For example, a property tax imposed on owners of real property the proceeds of which are used to plow snow on streets accessing the property and to collect leaves raked from the property makes sense. A property tax imposed on the value of real property and the tangible property thereon, the proceeds of which are used to fund fire and police protection makes sense. Of course, in many states, real property taxes are used to fund public education, and serious arguments can be made that this is not the most appropriate nor efficient means of funding public education. So the question is what does the owner of intellectual property obtain from a tax imposed on that property? A fee used to administer some sort of copyright protection system is easily justified. A fee or tax used to finance public education can be criticized in the same manner as is the taxation of real property to fund public education.

Should intellectual property be taxed in order to persuade its owners to release it into the public domain more readily and more quickly? There is a problem with using taxation to control behavior. For example, the Internal Revenue Code is overloaded with credits and other provisions dealing with energy conservation, energy production, adoption of children, and other issues better handled more directly. Everyone complains about the complexity of tax laws, yet too many people jump on the bandwagon of proposals that contribute to that complexity. If society thinks that intellectual property should be released into the public domain more quickly than presently occurs, the solution is a change in the period for which the law provides a monopoly with respect to intellectual property. Trying to accomplish this objective through taxation obscures the debate that would occur if the proposal to shorten the periods of monopoly were addressed up front.

Supreme Court Gets Tax Issue Right, Ninth Circuit Didn't

On Monday, the Supreme Court issued its opinion in Boulware v. United States. Though the outcome was good news to the taxpayer, for the Court reversed and remanded a criminal tax fraud conviction, the case is of much wider importance because the Court pretty much chided the lower courts for making a mess of what is pretty much a simple and straight-forward tax analysis.

The government had charged Boulware with criminal tax evasion and filing a false income tax return because, according to the government, Boulware did not report funds distributed to him by his wholly-owned corporation. Boulware tried to argue that the funds were a return of capital, and thus not gross income, and that there could be no tax fraud for failure to report something that is not income. The district court, relying on the Ninth Circuit opinion in United States v. Miller, 545 F. 2d 1204 (1976), refused to permit Boulware to introduce evidence that the distribution was a return of capital. The Ninth Circuit, relying on its decision in Miller, affirmed. The Supreme Court granted certiorari. Its opinion is instructive, not only with respect to the tax law, but with respect to a deeper issue of federal judicial competence.

To understand why the Supreme Court reversed the lower courts, a short lesson in several aspects of taxation are required. One involves criminal tax fraud and the other involves the determination of gross income.

To convicted a taxpayer of criminal tax evasion, the government must prove that the taxpayer not only evaded tax but also that the taxpayer did so wilfully. To convict a taxpayer of filing a false return, the government must prove that the taxpayer filed a false return and that the taxpayer did so wilfully.

There cannot be tax evasion if what the taxpayer allegedly fails to report is not gross income. There cannot be a false return if what the taxpayer received is not gross income. When a corporation makes a distribution to a shareholder, the applicable principles are very clear. They are set forth in section 301. To the extent the corporation has earnings and profits, the distribution is a dividend that must be included in gross income. Any portion of the distribution exceeding earnings and profits is treated as a return of capital, reducing the shareholder's adjusted basis in the shareholder's stock. If, after adjusted basis is reduced to zero, there remains a portion of the distribution not accounted for, it is treated as gain from the sale of the stock. Thus, if a corporation makes a distribution when it has no earnings and profits, and the distribution does not exceed the shareholder's adjusted basis in the stock, there is no gross income.

In Boulware, the taxpayer wanted to offer evidence that the corporation had no earnings and profits. The district court refused to permit the taxpayer to do so. It relied on the Miller decision, in which the Ninth Circuit held that the receipt of funds in a criminal tax evasion case may be treated as a return of capital only if the taxpayer or corporation demonstrates that the distribution was intended to be such a return. It doesn't take too much effort to figure out that the intention issue ought not be conflated with the "is there unreported income" issue, but that is what the Ninth Circuit did. To the defense of the district court, it had no choice but to follow the Ninth Circuit, so the responsibility for the confusion rests with the Ninth Circuit.

Not many pages into its opinion, the Supreme Court took the Ninth Circuit to task:

Miller’s view that a criminal defendant may not treat a distribution as a return of capital without evidence of a corresponding contemporaneous intent sits uncomfortably not only with the tax law’s economic realism, but with the particular wording of §§301 and 316(a), as well. As those sections are written, the tax consequences of a “distribution by a corporation with respect to its stock” depend, not on anyone’s purpose to return capital or to get it back, but on facts wholly independent of intent: whether the corporation had earnings and profits, and the amount of the taxpayer’s basis for his stock. ... When the Miller court went the other way, needless to say, it could claim no textual hook for the contemporaneous intent requirement, but argued for it as the way to avoid two supposed anomalies.

The Supreme Court then explained why the two anomalies that the Ninth Circuit thought it had to fix did not exist. First, the Ninth Circuit wanted to refrain from applying section 301 in criminal cases because it considered that provision to emphasize exact amounts of a tax deficiency while ignoring the wilfulness element. The Supreme Court noted the Ninth Circuit's "analytical mistake" by focusing attention on the difference between wilfulness as one element of the crime and the deficiency as another:

Those two sections [sections 301 and 316] as written simply address a different element of criminal evasion, the existence of a tax deficiency, and both deficiency and willfulness can be addressed straightforwardly (in jury instructions or bench findings) without tacking an intent requirement onto the rule distinguishing dividends from capital returns.

In other words, as I often tell my students, don't conflate things. The Supreme Court also dismissed the Ninth Circuit's other supposed anomaly, namely, that if a taxpayer "could claim capital treatment without showing a corresponding and contemporaneous intent, '[a] taxpayer who diverted funds from his close corporation when it was in the midst of a financial difficulty and had no earnings and profits would be immune from punishment (to the extent of his basis in the stock) for failure to report such sums as income; while that very same taxpayer would be convicted if the corporation had experienced a successful year and had earnings and profits.'" The Supreme Court noted that in such an instance there is no tax deficiency and if there is no tax deficiency there cannot be a tax evasion crime.

But the Supreme Court was not finished. It continued: "Not only is Miller devoid of the support claimed for it, but it suffers the demerit of some anomalies of its own." What were those anomalies?

First, section 301 is applied at the end of the year, after earnings and profits have been computed. Accordingly, even if there was intent that a taxable distribution made during the year be taxable because the corporation expected to have earnings and profits, it could turn out that a turn-around in business fortunes would cause the corporation to have zero earnings and profits at the end of the year. Thus, according to the Supreme Court, "And since intent to make a distribution a taxable one cannot control, it would be odd to condition nontaxable return-of-capital treatment on contemporaneous intent, when the statute says nothing about intent at all."

Second, the Ninth Circuit's analysis takes section 301, which provides for "all variations of tax treatment of distributions" and turns it into a section "of merely partial coverage" that leaves distributions "in a tax status limbo" when a criminal case arises. The Court explained that section 61 did not serve as a backstop to salvage the Ninth Circuit's coverage gap, because section 61 does not apply if another section provides otherwise, which is precisely what section 301 does. What the Ninth Circuit tried to do was characterized by the Supreme Court as "yet another eccentricity."

Finally, the Supreme Court turned the Miller opinion on its head:

The implausibility of a statutory reading that either creates a tax limbo or forces resort to an atextual stopgap is all the clearer from the Ninth Circuit’s discussion in this case of its own understanding of the consequences of Miller’s rule: the court openly acknowledged that “imposing an intent requirement creates a disconnect between civil and criminal liability,” 470 F. 3d, at 934. In construing distribution rules that draw no distinction in terms of criminal or civil consequences, the disparity of treatment assumed by the Court of Appeals counts heavily against its contemporaneous intent construction (quite apart from the Circuit’s understanding that its interpretation entails criminal liability for evasion without any showing of a tax deficiency).

And thus the Supreme Court concluded that the Miller case was erroneous, and that in relying on it, the Ninth Circuit in Boulware reached a similarly erroneous conclusion.

The narrow consequences of the Supreme Court's decision is that Boulware's conviction is reversed. The case was remanded to deal with a related issue, but I think it would be a surprise if the conviction is reinstated. The bigger question is, what happened?

I think two things aligned to generate the bad results. Each raises totally different concerns.

First, in both Miller and Boulware, the shareholder was taking funds out of the corporation to the detriment of at least one other shareholder. That very well could be wrong, but it is not a federal tax crime if those funds are tax-free funds. It is a state corporate law issue, and the federal government needs to leave the matter to the state. If the state chooses not to pursue the matter, the federal government has no role in trying to make a federal tax case out of a state corporate law issue. Even if the state concludes there is no state criminal law violation, the other shareholders have recourse to civil law remedies and, if they had planned properly, to escrows, insurance, and other safeguards that ought to have been in place to prevent the sort of diversions of which Boulware was accused.

Second, the tax law that applied in Miller and Boulware is not unduly complicated. It is not replete with extensive computations. The concepts are foundational. It is disappointing and aggravating that of all the judges and law clerks involved in the cases, no one could figure out something that is taught in basic corporate tax classes, and that can be understood by someone who has not been in a basic corporate tax class but who has learned basic federal income tax principles, because the taxpayer's brief would educate everyone on that point. What is more disturbing is that the federal government argued the case despite the clarity of section 301. Surely the Ninth Circuit's error in Miller, which is easy to detect, ought not have been interpreted as an invitation to perpetuate the mistake by bringing more federal tax prosecutions for what was, at most, a state corporate law issue.

When people ask why I think basic tax should be a required course, I now have another example to add to one of the reasons. Enough law students will become federal judges and federal law clerks that they should be compelled to take a course that they otherwise might avoid. Though avoiding a challenging subject might be good for the GPA that is dangled in front of employers, it isn't good for the taxpayers who show up in the court and expect the judges and law clerks to get it right. And in any event, with appropriate diligence and focus, the outcome in a basic tax course can improve a GPA. That has happened, far more often that students realize.

Soccer Franchise Socks It to Bridge Users

So now that Chester, a small town southwest of Philadelphia, has been awarded a major league soccer franchise, the people who aren't dancing for joy might want to consider why the proponents of getting the franchise are so exuberant. Yes, soccer fans and promoters are happy that major league soccer has re-appeared in the Philadelphia area. But there is something else bringing them smiles. What is that?

The stadium in which the Chester team will play is being financed in part with contributions from the Delaware River Port Authority. The DRPA collects tolls from motorists who use the bridges spanning the Delaware River between Philadelphia or its suburbs and southern New Jersey. The DRPA claims that its $10 million contribution is for development of the area surrounding the stadium and not for the stadium. As if that matters. Why are bridge tolls being used for development of the neighborhood in which the stadium will be located? Why are they being used for construction of the stadium? Either way, the tolls should be used for repair of the bridges. Here is where the issue gets more interesting.

In December, the DRPA announced that the current $3 toll would need to be increased, perhaps to $5, to pay for repairs to the bridges it operates. According to this story, one of the DRPA commissioners alleged, "We have to maintain and secure the bridges." According to this commentary, the vice chair of the DRPA explained, "The deck of the Walt Whitman [Bridge] had a 50-year life span. We're at 50 years, two months."

Yet another member of the DRPA, according to the same report, justifies the spending of money by claiming that "Federal tax laws say you have to spend the money. You can't just leave it in the bank." Fine. Spend it on bridge repairs, bridge maintenance, and improving security for the bridges. There's simply no acceptable justification for plowing user fees into a private soccer enterprise, however masked, while also planning to increase bridge tolls.

The question of how user fees should be spent previously received some attention in When User Fees Exceed Costs: What to Do? and in User Fees and Costs. So it should not be a surprise that I find it indefensible that motorists paying to cross a bridge are charged more than it costs to operate the bridge because some of the toll that they pay is being funneled into a major league soccer franchise.

Perhaps, though, I would change my mind if the DRPA send several million dollars my way to franchise MauledAgain. I'm sure I could figure out some rationale for soaking bridge users for the money. Not.

Medical Expense Deductions for Embryo and Cord Blood Storage

Every once in a while, a tax question comes along that isn't easily answered. Nothing in the Internal Revenue Code, the Treasury Regulations, the case law, or the administrative rulings deals directly with the question. Though these situations are welcome as yet more proof tax practice isn't simply "just numbers" or "not really law," they can be frustrating to the client, who must be told that there is no definitive authority. The practitioner's fee increases because more time is required to analyze the matter and provide an opinion.

Recently, a practitioner on the ABA-TAX listserve asked about the deductibility, as medical expenses, of the costs for storing "cord blood" from a newborn baby and the costs of embryo storage. The practitioner correctly noted that there was nothing directly on point. To reach an opinion with respect to the two questions, a tax practitioner must engage in legal analysis that includes comparative analogy and policy considerations.

Embryo storage is one aspect of medical science's attempts to solve problems of infertility. In Publication 502, Medical and Dental Expenses, the IRS explains that medical expenses include the costs of "Procedures such as in vitro fertilization (including temporary storage of eggs or sperm)." Embryos are not mentioned. Comparative analogy instructs us that the cost of storing embryos should be treated in the same manner, because they, too, are no less a part of fertility treatment than are eggs and sperm. Logic tells us that because embryos are the product of combining eggs and sperm, the cost of storing them should be treated in the same manner as the cost of storing eggs and sperm. Policy dictates that whatever considerations bring the cost of storing eggs and sperm within the definition of medical expenses should also bring in the cost of storing embryos. Though not specifically addressing the cost of storing embryos, in The Implications of Using the Medical Expense Deduction of IRC 213 to Subsidize Assisted Reproductive Technology, 79 Notre Dame L. Rev. 1117 (2004), Anna L. Benjamin explains, "Both the language of the statute [section 213 of the Internal Revenue Code] and Publication 502 support the claim that a taxpayer may deduct medical expenses for fertility enhancement, and this deduction appears to include all methods of assisted reproductive technology." It seems reasonable to treat the cost of storing embryos as a method of assisted reproductive technology.

The storing of cord blood is a more difficult expense to characterize. Cord blood is stored with the expectation that it could be used at a later date to ameliorate a disease or adverse medical condition. The Wikipedia article on cord blood is a good place to start, and perhaps finish, a self-study on the topic. Cord blood could be considered a medicine or drug because it is a substance that will be injected into the body when necessary. Is cord blood more like a prescription drug, the cost of which is deductible? Or is it more like an over-the-counter drug, the cost of which is not deductible (aside from insulin), because no prescription is issued for use of the cord blood? Is the cost of storing cord blood a cost of medical care to be provided substantially after the end of the year, in which case it is not deductible? Or is the cost of storing cord blood a current expense? Comparative analogy doesn't tell us much other than that good arguments exist for both outcomes. Policy considerations, though, seem to support allowance of the deduction, because the cost of storing cord blood isn't unlike the cost of providing stand-by electrical power generation for a refrigerator used to store medicines that require refrigeration.

Though back in 2005 some predicted imminent release of an IRS ruling on the deductibility of cord blood, no such ruling has been issued. No empirical or other research appears to exist that discloses whether taxpayers who have paid for cord blood storage are deducting the cost. Clients, like law students, don't want to hear the tax practitioner or professor say, "There is no definitive answer" but sometimes that is all we have. It is then time to explain the arguments for and against claiming the deduction, to describe the benefits and risks, and to let the client decide how adventurous the client wants to be.

The Artificiality of Mandatory Grading Curves

Last fall, in Yet More Reasons to Dislike Grading Curves, I explained why I do not think grading curves are appropriate. The discussion arose in the context of litigation brought by a student who objected to a teaching assistant assigning grades on a basis other than what had been explained to the students. In defense, the teaching assistant claimed that he had applied a grading curve to determine the student's grade.

The menace posed by grading curves has surfaced again, this time in connection with the demand by law students at Hastings that the law school's grading curve be adjusted so that their grades match those earned or assigned to law students at UCLA and Boalt Hall. According the Hastings Law Students Look to Stay Ahead of the Grading Curve, students are unhappy with a curve that restricts the A grade to 20% of the class, the B grade to 60% of the class, and the C grade to 20% of the class. Students claim that they are at a disadvantage when seeking jobs, because they perceive that even a single C grade severely harms their employment prospects.

Administrators at Hastings, who suggest changes will be made, don't think that the problem is one of employment opportunities. Instead, they express concern that there is an "overall competitive tension" on campus which harms student morale. They point out that employers are capable of figuring out that someone is in the bottom or top half or quarter or whatever of the class, no matter the grade point average. Lawyers who were interviewed for the story explain that they understand that each school has a different grading system, that they take those differences into account, and that they remind their recruiters to avoid "comparing apples and oranges."

Other schools that impose grading curves have started to eliminate them, relax them, or narrow their scope. One school reduced the number of mandatory C grades. In some instances, there is no mandatory C grade for upper-year courses. Some schools have no curves, and others have curves for first-year courses but not upper-year courses.

One administrator at Hastings suggested that the curve should be "relaxed" because it is "the right thing to do" and because "students become stressed about grades." An administrator at another school explained that a reason for relaxing the curve was to respond to faculty concerns that they felt "they were having to arbitrarily push people down to a grade they didn't deserve."

Justifications for having curves include the need to avoid inequity in grading and the desire to encourage faculty to develop a "collective sense" of what constitutes work deserving an A or B grade. Advocates also claim that curves protect students from faculty who are "too harsh" in their grading. Others claim that rigorous grading curves identify students less likely to pass the bar exam and bring their dismissal from school.

Some of the comments made in support of grading curves cannot go unanswered. Nor should the reasons for changing them be accepted without a closer analysis.

The existence of mandatory grading curves does nothing to give faculty a collective sense of what constitutes work deserving a particular grade. Mandatory grading curves simply tell faculty that the students whose exam or other scores are among the top x% earn an A, the next y% earn a B+, and so on. There is nothing to ensure that the various evaluative devices, including examinations and other graded work, are of comparable quality, are well designed to measure achievement, or are structured in ways to generate natural performance curves. The top students in one section of a course might not do so well on the exam for another section of the course, perhaps in part because they weren't pushed as hard, introduced to as much material, or faced with as difficult a set of questions. Grading cannot begin with curves. It needs to begin with a definition of course goals, the design of a syllabus, and a conscious determination of coverage both in terms of breadth and depth, it needs to continue with the design of evaluative devices that include relatively easy, moderate, and difficult questions or problems, and it needs to conclude with a measurement of a student's performance against the standards required for the practice of law. This ensures not only some fairly good consistency between sections of a course but also consistency from year-to-year offerings of that course.

The existence of mandatory grading curves does discourage the awarding of excessive numbers of low grades, but that accomplishment presupposes that it is always wrong to have more than a certain number of low grades. If students earn low grades, then they have earned low grades. If many students earn low grades, the answer isn't to pretend they earned higher grades, but to explore why they earned low grades. Was the course poorly taught? Did the course attract a disproportionate number of slackers and burned-out or discouraged upper year students? Were the students suffering from the effects of inadequate preparation in prerequisite and precursor courses? Was the course badly designed? The solution should be to identify and fix the problem, and not to mask it with some grade shuffling maneuvers.

The existence of mandatory grading curves has very little correlation with the identification of bar exam pass rates. Quite to the contrary, grading against a standard is much more likely to identify the student whose chances of passing the bar exam are rather low. There is a minimum level of competence that must be demonstrated to earn a passing grade, and that standard should apply both to bar examinations and law school courses. Sadly, law school concern with bar exam pass rates is more a matter of the rankings game than it is anything else. Some mandatory grading curves would prevent faculty from entering on a student transcript a low grade earned by the student if doing so would cause the number of low grades to exceed the limit. Recall that grading curve advocates also express a concern about "too many" low grades. Well, what is it? Avoid too many low grades or make certain that those who aren't succeeding don't earn high grades? It is troubling, but not surprising, that two of the arguments in support of mandatory grading curves conflict with each other.

When it comes to a solution, my preference, of course, is to abolish grading curves. Instead, I would require law faculty to take courses in a school of education to learn about course design, feedback strategies, evaluative device design, grading theory, and other teaching skills rarely found among law faculty. Is it any wonder that I'm not a law school dean?

Instead, most schools with mandatory grading curves have tinkered with them, as though fiddling with a buggy whip is going to do much to reduce air pollution. Worse, the reasons given for doing so are quite suspect.

It's the right thing to do? Who says that the right thing to do is to relax, rather than abolish, a mandatory grading curve?

It should be done because students are stressed about grades? Students will always be stressed about grades, no matter the process for earning them. The best way to reduce student grade stress is to give each student a fair opportunity to do well. Tell the students what they are expected to learn. Explain how their work product will be evaluated. Disclose how performance relates to specific grades. Be consistent, and don't change the rules in the middle of the game. Grade students against the array of requirements demanded of them by law practice. Then they can worry about what they are doing, and push aside concerns that some other students will perform so much more capably that they are precluded from demonstrating that they, too, are quite capable. A football player who runs a 40-yard dash in 4.4 seconds isn't quite as good as one who runs it in 4.2 seconds, but they're both high quality athletes in this regard. Putting an "A" label on one and a "B" label on the other because there are insufficient "A" labels is silly. Similarly, if in a particular year the best performance is 5.1 seconds, labeling it an "A" because it is the best that year is no less silly.

Relaxing the grading curve should be done because faculty feel they are being required "to arbitrarily push people down to a grade they didn't deserve"? Is it no less harmful to push people arbitrarily to push people up to grades they don't deserve? Does it make sense to have curves that require most grades to be "B" or higher? Are practitioners jumping for joy that almost everyone they hire out of law school is performing at an "A" or "B" level in practice? Rarely do I hear a practitioner tell me that a student with C and C- grades suddenly emerged as a top-notch lawyer. But far too often I hear practitioners wonder how students with high GPAs reflecting mostly A and B grades got through law school with those grades, when they demonstrate deficiencies in core competencies such as spelling, research, grammar, and analytical thinking. On the other hand, I'm more than willing to assign mostly "A" and "B" grades, and thus I give students every opportunity to earn them, but in the process I push the students to a level close to what one finds in practice. It is intense, it is demanding, it is broad in scope, and deep in specific topics, and it is realistic. It is troubling that students figure they can earn high grades much more easily in some other course. It dilutes the value of the hard-earned high grade. Ultimately, and fortunately, it does get sorted out in practice. I know, because I get those phone calls. But that's another post for another day.

In sum, law schools need to become more imaginative and demanding of themselves when it comes to grading. Mandatory grading curves are quick and easy masks for a much deeper set of problems. Law schools, working with practitioners, need to set standards, in terms of course coverage, demonstrated achievement, identified skill sets, and quality. Then law schools need to test their students against those standards. Perhaps law schools should examine each other's students. Perhaps faculty ought to examine the performance of students in other sections of the courses that they teach. There needs to be something more than simply some general consensus that a mandatory grading curve, whatever its specific numbers, adequately tells anyone how they have performed and how well they have learned.

Another Public Official Convicted of Failure to File Tax Returns

Late Friday evening, a federal jury returned a verdict convicting Milton Street, brother of Philadelphia's former mayor, John Street, of failure to file income tax returns for 2002 through 2004. The jury could not reach a verdict on charges Street assisted in the filing of false income tax returns for 2000 and 2001, and acquitted him of a variety of fraud charges brought in connection with sales of contracts that Street knew did not exist.

Street formerly served in the Pennsylvania State Senate. His explanation for the failure to file returns, that the federal income tax is unconstitutional, did not persuade the jury. Nor does it persuade me, or anyone who understands the tax law. During the trial, Street challenged the prosecutor to show him the statutes requiring him to file federal income tax returns. The judge admonished Street to answer questions and not give tasks to the prosecutor.

Street expressed relief that he had been acquitted of the corruption and fraud charges. He claimed that despite being convicted of crimes that could bring up to three years in prison, he was "happy" that he had been acquitted of the other charges. According to this Philadelphia Inquirer story, Street admitted trading on the family name after his brother was elected mayor of Philadelphia. The attorney for Street's co-defendant argued, ""It's not illegal. It may be unsavory, but that is the way business is done." Indeed, in Philadelphia, it is, and has been for a long time. That's too bad.

Tax and Other Courses Ought Not Be Easy

When I read Paul Caron's post on the publication of Attractiveness, Easiness and Other Issues: Student Evaluations of Professors on Ratemyprofessors.com, 33 Assessment & Evaluation in Higher Education, No. 1, pp. 45-61 (Feb. 2008), in his nicely titled Students Prefer Easy Courses and "Hot" Professors, I laughed. This is news? Actually, the three authors took their inquiry further, going to a larger and improved database. What did they discover? Quoting their abstract, "Results indicate even stronger relationships than previously reported. In addition, this study demonstrates significant cultural differences by institution and discipline in the relationships between Quality, Easiness, and 'Hotness' in web-based SET."

Humans prefer all sorts of things. Sometimes, what is preferred isn't what gets the job done. Many people would prefer to sleep than exercise, to vacation rather than work, and to be served rather than serve. So it's no surprise that students prefer easy courses. But are easy courses going to provide what needs to be accomplished in an educational program?

For what sorts of things do easy courses prepare students? Do they prepare students for careers that are demanding in terms of intellectual challenge? Do they prepare students for the realities of the jobs that they will obtain? In the law school context, do they prepare students for the difficult cases that clients will bring to the attorney? Though it once annoyed me, it now mostly amuses me that students complain that my courses are "too hard." I've even been told by other faculty that my courses are "too hard." Are they? No. How do I know that? My friends in law practice tell me my courses are too easy, that I'm not tough enough on the students, and that I really should bring even more of the practice world into my courses. The disconnect between student expectations and preferences, and the realities of the employment world, is huge, and it's getting bigger by the day.

Student preference for easy courses, standing alone, is informative but has no more impact than a four-year-old child's preference for a fifth candy bar. Simply because someone expresses a preference is no reason to cater to it. Would it be so easy. Oops, sorry. Too many faculty, across the nation and throughout most institutions and academic departments, respond to the student demand for easy courses by watering down coverage, reducing reading load, lowering performance expectations, tolerating low quality writing, giving credit for flimsy thinking, and reducing the difficulty of examinations. Those who hold students to standards matching the demands of the employment and practice worlds are appreciated by some students, but castigated by many others when it comes to sharing course selection advice or filling out course evaluations. The other day I read a comment on an evaluation that drives home the unreasonableness of some, perhaps many, students' perspectives. The evaluation was for a course that requires intense study because the material is difficult, and for which I recommend at least 6, and preferably 8, hours of work outside the classroom each week to prepare for, or assimilate, what is covered in the 2-hour weekly class session. My approach was criticized because by requiring more than two hours outside of class, I was ignoring the impact of the requirement on students who have full-time jobs and who have families. I simply don't get it. Whether someone has a full-time job or a family doesn't reduce the number of Code provisions enacted by the Congress and that are relevant to preventing and solving the problems brought by clients, doesn't change the complexity of the regulations, and doesn't reduce the intellectual difficulty of the material that must be understood by tax professionals.

The temptation to "dumb down" courses, one to which more than a few professors have succumbed, is strong. What happens when courses are made "easier" by leaving out material, covering issues superficially, and ignoring important exceptions? When the students enter the next course, they struggle because they are not up to speed for what the next course requires. And when they enter their employment position, they do not perform at the level required by the needs of the employer and the employer's clients and customers. Most employers no longer can afford to invest in remedial education, because there is too much economic competition and pressure from clients and customers to keep fees and prices down.

Who would advocate that someone training to run a marathon not prepare by running long distances before the marathon? Who would advocate that someone intending to give a piano recital not take time before the recital to practice the difficult pieces that are to be performed? Yet caving in to preferences and demands for easy courses is akin to telling a piano student that learning how to play "Mary Had a Little Lamb" is sufficient preparation for a concert in which the student will be playing Chopin. I understand how students come to think in these terms. They watch television shows where people perform in all sorts of contests and shows, making it look easy, but they don't get to see all of the hard work that goes into hitting .320, getting to the quarterback, reaching the high G sharp, or bench-pressing 350 pounds. What I don't understand is how faculty can think there's legitimacy to softening courses to the point they are characterized as "easy" by the students.

Though the preference for easy courses can be attributed to that nemesis of progress, entropy, the preference for "hot" professors is nothing more than proof that many students are in class for some reason other than learning the material. A preference for a teacher who knows and understands the material makes sense, and says much about the student's goal. Similarly, a preference for a teacher who is willing to take questions outside of class, who responds within a reasonable period of time, who tries several ways of explaining something in an effort to get the point across to the student, and who is willing to review an examination to help a student understand what the student did correctly and incorrectly also makes sense, and also says much about the student's goal.

One role of the educational institution is to prepare students for the profession, career, or employment field into which the students will go when they graduate. Another role of the educational institution is to refrain from certifying as accomplished those students who are not adequately prepared for that profession, career, or employment field. Though educational institutions can't do much about the "hotness" of their instructors without running into legal difficulties, they certainly can ensure that there are no "easy" courses available to students. Whether faculty and administrators are willing to take that step remains to be seen.

Do the Tax Rebates Cheer You Up?

Last week, in Can Tax Rebates Help Prove Malthus Wrong?, I responded to Joe Kristan's reaction, in GOOD MORNING! WE'RE ALL DOOMED!, to my inquiry, Can a Tax Rebate Band-Aid Stop the Economic Bleeding?, in which I note that the economic problem at which the tax rebate is directed is only going to worsen because of increasing world population and diminishing supplies of essential materials. Now, in CHEER UP, PROFESSOR MAULE!, Joe tries to get me out of what he calls a funk by directing my, and our, attention to several websites that paint a rosy picture of the future because the past didn't turn out to be as bad as predicted by the so-called doomsayers.

Let me assure Joe, and others, that I am not in a funk. I would be in a funk if I thought there was no alternative outcome. As I wrote, I worry and I wonder. I continue to urge the use of tax revenues to solve the deeper problems rather than to mask symptoms and buy votes. If the government is going to spend money, even money that it doesn't have, then it ought to spend it productively. There are serious problems that are going to get worse unless something is done quickly, effectively, and sensibly. I don't see signs of that happening. That's not to say it won't happen, but it surely isn't going to happen so long as apologists for the present system try to minimize the threats that the world faces.

My argument that the so-called stimulus payments, formerly known as rebates, are a temporary palliative that distracts voters until after the election reflects a view that does not require a dismal view of future trends. Those future trends only exacerbate the lack of wisdom in tossing around money borrowed from foreign nations. The recent upsurge in oil and commodity prices are consistent with a future trend of inadequate resource supply. If, however, there is no underlying long-term resource problem, then the advocates of stimulus payments would argue that those payments solve the temporary "glitch" in the economy. So it comes down to whether the problems in the economy are temporary glitches or symptoms of an intrinsic resource sufficiency flaw.

The projections made by the optimists to whose pages Joe links make claims that sound good but that side-step the question. For example, Ronald Bailey claims that "In addition, fossil fuels will not run out in the 21st century." That suggests we need not worry. Though the statement is true, what matters is that fossil fuel quantities will decline to the point where there is insufficient fuel to meet the needs of the world's population. Thinking that there always will be a miracle cure because most things have worked out in the past ignores the reality of tens of millions, perhaps hundreds of millions dying from influenza shortly after the First World War because no one had yet to step up and provide a cure or vaccination. If there were a way to use tax revenues and tax policy to focus attention on the problem, it arguably would make some sense to borrow money from foreign countries. Why not use the stimulus payments to stimulate the manufacture of artificial oil that burns without polluting the atmosphere?

Bailey notes that over-fishing is a problem, and then suggests that privatization and expansion of aquaculture will solve the problem. Privatization? Is that so a few huge corporations can own all of the world's sea life resources? Expansion of aquaculture? Where will that industry obtain the requisite water, fuel, and transportation resources?

Bailey also puts much faith in the growth of food produced per acre during the past few decades. Much of that increase can be attributed to heavy use of fertilizers, which are manufactured using natural gas, and the use of mechanized farming techniques, which consumes fuel. One study suggests that of the $22 billion increase in food costs incurred by Americans from 2005 through 2007, $15 billion has been caused by the increase in cropland and crops dedicated to biofuel production. Biofuel production is just beginning to ramp up. Perhaps people will use their stimulus payments to pay their food bills. But then who writes the checks to pay the creditors who are lending the federal government the money to make those payments? And what happens next year? Will there be more stimulus payments to assist people to purchase food? Should we not consider the ecological impact of the farming methods that are touted for increasing per-acreage yield? How much more fertilizer run-off can the world's fresh water systems absorb? I doubt the folks facing the sort of food price increases described in The Growing Pain of the Middle Class, serendipitously published on the same day Joe posted his latest comments, will find much solace in the arguments Bailey makes.

Bailey reports that "Americans are using less water per capita too." The question, though, is a global one. Yet, even looking at the United States, ought there not be concerned about the serious drop in fresh water levels in the Colorado River system? What happens when the levels in Lake Mead and Lake Powell, currently at their lowest levels in more than 100 years, go even lower? What happens if the hydroelectric dams cannot function? Or if, in order to keep them functioning, no water for domestic or industrial uses can be drawn from the system. An official with the Department of the Interior predicts "tough times ... ahead."

It would take pages to go through the claims that Bailey makes. His assertion that "There is no likely future shortage of construction materials" must come as good news to those who watched the cost of lumber, steel, and concrete jump as demand in China and other nations soared. Bailey admits that "As the poor in the developing world become wealthier, they will want better housing, transport, and modern energy supplies." Somehow he thinks that all of these things will be produced from what remains on the planet. Bailey thinks that "China's notoriously bad air pollution may be decreasing" but recent reports from Beijing aren't all that promising as that nation goes through all sorts of gymnastics to prevent athletes and visitors from suffering ill effects of the perpetual brown haze in that city. This report uses the delicate word "struggles" to explain the challenge.

Joe answers one of my questions by explaining, "Yes, the supply-demand curve and human ingenuity have prevented the death by starvation of millions in developing nations." Yet somehow those who died in the 1970-1985 famine in Africa, which caused more than a million deaths, didn't get much help from the economists. Some scientists think that the drought can be attributed to pollution. Whether or not that is the case, the supply and demand curve did not end the drought. Far more people have died in famines caused by wars and civil unrest, most of which arise, at least in part, as people vie for power and control of resources.

Joe also suggested that the supply and demand curve and human ingenuity "have prevented 'the riots that have broken out in various places when supplies of drinking water, gasoline, food, or other essential items become exhausted,' because I'm not aware of any such riots actually occurring outside of a failed state, war zone or disaster location." By definition, when there are shortages or a total lack of essential items, people sometimes get out of control. Yes, it happens in failed states and war zones, but it civil unrest and violence have also appeared when gasoline shortages cropped up. I don't live far from the riots noted in this report from the late 1970s. In Indonesia, Mexico, Italy, and Senegal, hardly countries that can be called failed states, disaster locations, or war zones, tens of thousands have taken to the street to protest steep food price increases, as reported in The Growing Pain of the Middle Class.

Joe didn't try to answer my other question:

Have the supply-demand curve and human ingenuity eased the spread of new and dangerous diseases throughout the planet? Have the supply-demand curve and human ingenuity lengthened life expectancy in the former Soviet Union? .... Did the supply-demand curve and human ingenuity prevent the massive death and destruction of a world war fought principally over access to land, oil, rubber, and other supplies?

That's ok. I wasn't expecting answers. Not to those questions. The question I'd like to have answered is this one: So what do these tax rebates, excuse me, stimulus payments, do to refill Lake Mead and Lake Powell, to clean the air, to restore fish populations in the ocean, to clean the Mississippi River, and to stave off the next pandemic?

Mileage-Based Road Fees, Yet Again

It appears that America is beginning to pay attention to the dangers posed by highway, bridge, and tunnel degradation that has become increasingly a problem as maintenance costs soar, heavy truck use continues, and age takes its, sorry, toll on our roads and overpasses. The interstate bridge collapse in Minnesota was yet another ringing of the alarm clock, bringing into the spotlight many of the issues I discussed in Funding the Infrastructure: When Free Isn't Free. Suggestions for raising the required funds to repair our highways and put them into better shape to withstand the wear and tear of future use are easy to find. Some advocate increasing tolls on existing toll roads and adding tolls to highways that are presently toll-free, a suggestion I examined in Raising Revenue Through Tolls Isn't Simple, and in User Fees and Costs, to name two of several of my posts on the issue. Others prefer increasing the federal gasoline tax, an idea which I support for reasons discussed in The Return of the Federal Gasoline Tax Increase Proposal and the numerous other posts of mine that are cited therein. Another group has rallied behind the quick-fix tactic of selling state highways to private investors, a proposal that poses a variety of dangers, as I described in Selling Off Government Revenue Streams: Good Idea or Bad? and in Selling Government Revenue Streams: A Bad Idea That Won't Go Away. Now another solution, the mileage-based road fee, first discussed more than three years ago in Tax Meets Technology on the Road, and again revisited a few months ago in Mileage-Based Road Fees, Again, has moved back onto center stage.

Last week, in a Philadelphia Inquirer Commentary, Charles E. Greenawalt, senior fellow at the Susquehanna Valley Center for Public Policy, shared his thoughts in a version of Pennsylvania Must Look Beyond Gas Tax To Fund Transportation Needs. Greenawalt makes some good points, though I must confess that I think some of his points are good because they echo my commentary from three and a half years ago.

Greenawalt points out that as vehicle mileage standards increase and as more and more Americans shift to using vehicles that do not consume gasoline, or consume much less gasoline, the revenues generated by the gasoline tax will tumble if the per-gallon rates are left unchanged. No one can disagree with this conclusion. Unlike me, Greenawalt doesn't tilt at windmills and urge an increase in the gasoline tax. He acknowledges that legislatures just won't bring themselves to voting for such an increase. He's probably right, though I do wonder if legislatures will act differently when the funding system breaks down, as it will unless something is done. On that latter point, the need to do something, Greenawalt and I agree.

Spurred by the Center's dislike of the turnpike lease proposal, another point on which Greenawalt and I agree, he turns our attention to the mileage-based road fee. Known in some circle as the Road User Charge, the fee is computed by tracking mileage through the vehicle's GPS. Greenawalt mentions the experiment underway in six states that I referenced in Mileage-Based Road Fees, Again. Greenawalt notes that state road use fees won't go down each time someone purchases a more fuel efficient vehicle, a point I shared in Tax Meets Technology on the Road. Of course, as total miles driven by Americans decrease, even road user fee revenues will decrease unless the per-mile fee is increased. Though most of us, mired in congestion, probably doubt total miles driven by Americans would decrease, that happened in 2007.

If the road user fee is going to get serious attention, and it should, it makes sense to examine some of its advantages and disadvantages to determine if they matter or if they can be alleviated. Here are a few considerations.

The road use fee can be adjusted so that it is higher for peak use times than for other times. This adjustment would encourage driving patterns that reduce congestion. It is not unlike the off-peak rates charged by electric utilities to encourage the use of hot water heaters and clothes dryers at times other than the peak demand period.

The road user fee, in its present form, does not distinguish among types of vehicles. It makes sense to impose different per-mile fees based on the weight of the vehicle and perhaps other characteristics that measure the costs that the vehicle imposes on the transportation system.

Unless the road user fee is enacted on a national level, there will be issues when someone with a vehicle from a state not imposing the fee drives it into a state that relies on the fee. Technology, I am sure, has the answer, but the implementation could be cumbersome. Would an out-of-state vehicle need to stop at the border and have a temporary unit installed, and then logged onto the state tracking system? Such an approach probably would resemble what happens when someone drives into Switzerland and must stop to purchase the road use sticker for the windshield.

Likewise, would a state that imposes the fee collect for miles driven by residents when they are out of the state? Would that raise constitutional concerns if the other state also imposed a road use fee on all vehicles, including out-of-state vehicles, using its roads? Probably not. But it might require a system to provide a credit for road use fees paid to other states, not unlike the current credit for income taxes paid to other states. Hopefully, states would enter into agreements to prevent the multiple taxation in the same instance.

A tax that relies on information gathered from the GPS in a person's vehicle causes many people to recoil in fear. Some simply don't understand technology. Others dislike change, especially when it involves technology. Still others worry about a government having access to information about driving habits, such as speed limit compliance, and destination identities. Similar concerns were raised when EZ-Pass and similar systems were put into place, and yet those technologies have caught on big-time.

The fun might begin when it is time to identify vehicles exempt from the user fee. It might make sense to impose the fee on fire engines and let fire companies shift the incidence of the fee to those using fire services, but it makes just as much sense to forgo taxing government vehicles. Of course, the fun could be avoided simply by creating exceptions that match those applicable to the gasoline tax, but that presupposes that the gasoline tax exceptions are neither over-inclusive nor under-inclusive.

The road mileage fee is regressive, imposed without regard to income. But, so too, is the gasoline tax, the highway toll, the bridge toll, and the excise tax on various automobile parts. If the fee varied by vehicle weight, it would cause the tax paid by owners of smaller vehicles to be proportionately less, and if lower income individuals tend to purchase smaller vehicles, that would mitigate at least some of the regressivity of the fee.

So, I join Charles E. Greenawalt in concluding that the road user charge, by whatever name known, is something whose time has come. States should establish commissions to explore its implementation, and should do so sooner rather than later, before the current highway infrastructure funding crisis becomes an unmitigated disaster.

Getting Those Tax Rebates Might Not Be So Easy

Across the nation, large numbers of citizens are looking forward to receiving a rebate check from the federal government. I doubt very many of them are giving much thought to the question of whether tax rebates solve the problems they supposedly address or to the concerns I expressed in Can a Tax Rebate Band-Aid Stop the Economic Bleeding?. Most of them probably think that at some point later this year a check will arrive. But it's not going to be so easy.

On Wednesday, the IRS released Stimulus Payments: Instructions for Low-Income Workers and Recipients of Social Security and Certain Veterans’ Benefits, in which it explains what people must do in order to obtain their rebates. According to the IRS, "most" taxpayers need not do anything because they will have filed their 2007 income tax returns by the time the Treasury is ready to process the checks. The IRS computer systems will "know" that these taxpayers exist.

What happens, though, to people who do not file tax returns because their gross income is below the filing threshold? The IRS advises that these people should file a 2007 federal income tax return so that can receive a rebate. To qualify, a person must have at least $3,000 of qualifying income. Qualifying income includes not only gross income such as wages and interest, but also income that is not taxed, such as certain social security benefits, certain railroad retirement benefits, and certain veterans' benefits. In order for the IRS to know that an individual has sufficient qualifying income, the individual must report these non-taxable benefits on the return that the individual would not otherwise be filing. Surely, that is going to confuse people. Individuals who do not receive a Form 1099-SSA for some reason need to estimate their 2007 social security payments, but must be careful not to include supplemental security income because it is not qualifying income. Recipients of veterans' benefits must go through some computations to estimate the amount they received in 2007 unless they have some better record.

What happens if someone receiving non-taxable income that counts as qualifying income already filed a return for 2007 without disclosing these amounts? If those returns do not show $3,000 or more of qualifying income, these folks must file amended returns. Their tax liabilities will not change, because they will be adding to the return amounts that are not taxable. If that seems oxymoronic, so it is.

In a news release, IRS Will Send Stimulus Payments Automatically Starting in May; Eligible Taxpayers Must File a 2007 Tax Return to Receive Rebate, the IRS further explained that no rebate will be sent to taxpayers who lack valid social security numbers, nor will they be sent to married couples who filed joint returns if either spouse lacks a valid social security number. Rebates will not be sent to taxpayers who use an individual taxpayer identification number issued by the IRS or any other number issued by the IRS, such as an adoption taxpayer identification number. Nor will rebates be sent to taxpayers who file forms 1040-NR, 1040-PR, or 1040-SS. The IRS also announced that to accommodate taxpayers who file their returns later in the year, rebate checks will be issued until December 31, 2008.

What about taxpayers who move after filing their returns? The IRS recommends filing a change of address with the Postal Service.

The IRS also alerted taxpayers to be on the watch for scams. This is one time no reasonable person can disagree with the IRS. The IRS will not call or email taxpayers with respect to rebates. Unfortunately, the scammers will continue to work the room, so to speak, because they know there are people who will fall victim to whatever con game these thieves cobble together.

What about taxpayers who owe back taxes? According to Facts about the 2008 Stimulus Payments, another issuance by the IRS, the rebates will be diverted to payment of those liabilities. In that issuance and in the others, the IRS disclosed it will be sending two notices, by regular mail, to taxpayers in order to explain the rebate program and to confirm eligibility.

If it weren't for the fact this is presumably a one-time event, I would propose to the faculty that we add a course to the curriculum called "Income Tax Rebates." Considering the fact this is not the first time that the Congress has used the rebate maneuver to fiddle with the economy, perhaps I should design such a course so that it's ready to be taken "off the shelf" at a moment's notice. No, that's a bad idea. Each rebate is different, and each time one is enacted, it is more complicated.

Although I continue to doubt that the rebate will have much of an effect on the economy or the underlying economic problems facing the nation, I must admit it surely will stimulate the tax return preparation industry. As some wrote to me today put it, it's not difficult finding tax return clients. Perhaps it's because there are fewer and fewer people choosing to do tax returns for a living. It's getting more difficult to get it right, it's getting more aggravating, and it's getting too complicated even for many of those who are fairly bright and experienced with tax.

They have changed the name from rebate to stimulus payment. Technically, I suppose that is because a person who has not paid income tax cannot get a rebate of something that has not been paid. But if the payment is stimulating anything, it is stimulating confusion for some, and extra work for many. The number of taxpayers who are getting rebates, sorry, stimulus payments on account of qualifying income that is not taxable is estimated to include 20 million senior citizens and 250,000 disabled veterans. So to those 20 million plus, let's say, "Welcome to the tax system. Enjoy your filing experience."

And I suppose the Congress added to the IRS appropriations bill money to be used to mail the notices. I suppose the Congress has made funds available to the Treasury Department to process and mail the checks. Or, as often happens, will some other program, such as enforcement or taxpayer assistance, be cut in order to fund this election-year "I voted for a rebate" ploy?

Can Tax Rebates Help Prove Malthus Wrong?

Joe Kristan, who writes the Roth & Company, P.C. Tax Update Blog, has reacted to my most recent tax rebate post, Can a Tax Rebate Band-Aid Stop the Economic Bleeding?, in which I note that the economic problem at which the tax rebate is directed is only going to worsen because of increasing world population and diminishing supplies of essential materials. In a post the headline of which must have startled his many readers, GOOD MORNING! WE'RE ALL DOOMED!, Joe notes that he is an optimist and is putting his money on human ingenuity and the supply-demand curve.

Once upon a time, I was an optimist. Then I became a guarded optimist. Then I began to worry. And now, I am beginning to wonder. I would like to agree with Joe, as I once would have. Let me see if I can.

We begin with the supply-demand curve. That curve works well for some things, but it becomes very inelastic when dealing with life's basic necessities. The supply-demand curve can bring some sort of economic equilibrium if we're talking about a nonessential good. As supply shrinks, prices rise, which in turn cuts demand, which brings the supply and demand back into balance. In contrast, when it comes to the things I mentioned in Can a Tax Rebate Band-Aid Stop the Economic Bleeding?, oil, clean water, concrete, steel, natural gas, health care, copper, agricultural products, and similar life-essential ingredients, demand will continue to rise even as supplies shrink. People can choose to refrain from purchasing a nonessential item, but people need clean water, energy, food, and items requiring concrete, steel, oil-based materials, copper, and similar items, such as homes and vehicles. In theory, people can choose not to purchase water or heat, but that's pretty much tantamount to people choosing self-destruction. When the price of scarce items reaches near-infinity, people will be compelled to forgo essentials. What happens?

Some claim that demand cannot exceed supply, but that assertion rests on a definition of demand as a measure of the quantity of the item in question being purchased. What truly matters, especially with respect to essential items, is the quantity of the item that is required. Though there may not be such a thing as "supply shortfall," as some claim, there are such things as shortages. There also are items that aren't available at any price.

Turning to the human ingenuity factor, one can only hope, not predict with certainty, that some genius will discover the ideal vehicle fuel, abundant, clean, and technologically useful. Perhaps some other genius will discover a way to prevent water pollution and clean up existing fresh water supplies. Yet, with world population records being broken every day, the need for a parade of genius inventors becomes extremely pressing, and the likelihood is low that substitutes or work-arounds for all of the impending shortages will be forthcoming in time, if at all. Do tax rebates somehow encourage bright people to focus on these problems instead of applying their skills elsewhere? Does the tax system reward the sort of activities and endeavors that would generate the products of human ingenuity that are so desperately required?

I wish I could agree with Joe. I wish that it was as rosy as he describes. I might be so inclined if it had worked out that way in the past. Even though the world's population, as a whole, is wealthier than ever, as Joe explains, the distribution of that wealth, and the distribution of resource ownership, is out of balance. Systems in disequilibrium are not foundations for stability. Malthus was wrong in terms of his time scale. Much of what he predicted has come to pass on a smaller scale, but yet on an increasingly more frequent and deeper cycle.

Have the supply-demand curve and human ingenuity prevented the death by starvation of millions in developing nations? Have the supply-demand curve and human ingenuity eased the spread of new and dangerous diseases throughout the planet? Have the supply-demand curve and human ingenuity lengthened life expectancy in the former Soviet Union? Have the supply-demand curve and human ingenuity prevented the riots that have broken out in various places when supplies of drinking water, gasoline, food, or other essential items become exhausted? Did the supply-demand curve and human ingenuity prevent the massive death and destruction of a world war fought principally over access to land, oil, rubber, and other supplies?

Over what essential commodity will the next global war be fought? Oil, as many predict? Food? Or perhaps fresh water? Or will it erupt when the teeming masses of the planet's overcrowded cities, afflicted by disease, shortages of food and water, and lacking the optimism Joe exhibits, decide that there is no other recourse but to strike out in fear, anger, desperation, and hate?

If the Treasury is going to borrow money to fix things, I'd rather the money be used to solve the underlying problems rather than encourage the outcomes I described in Can a Tax Rebate Band-Aid Stop the Economic Bleeding?. It is no surprise that what happens in some remote corner of the world today boomerangs throughout the American economy tomorrow. Will the predicted use of the tax rebates change what happens in that remote corner, with sufficient speed and sufficient impact?

I would like to be wrong. I would like Joe to be right. And he well could be, if people and governments mobilize to deal with these issues while there still is time. Dishing out tax rebates isn't going to get the job done.