Life Without Tax Increases

Recently, in Snow, Budgets, and User Fees, I concluded my thoughts with this prediction about the impact of cutting taxes and user fees too sharply:

Of course, if the anti-tax crowd continues to influence the unwitting and uninformed by appealing to emotional distaste for taxation, it might persuade the entire nation to eliminate all taxes and user fees. What must be understood is that we would then be living in a country with no national defense, no police protection, no fire fighting services, no snow removal, no trash pick-up, no airspace allocation for airliners, no food, housing, or medical care for the folks who have lost jobs because of corporate greed and corruption, no prescription drug approval, no highway maintenance, no national or state parks or recreation areas, and all other sorts of inadequacies. What we would have is a large-scale version of those youngsters rioting in center city Philadelphia, except that the rioters would not simply be expending excess energy because they have nothing better to do. They would be fighting for survival. The price that would be paid would far exceed the inconveniences of taxes and user fees.

Now comes news from a city that has chosen to cut back services rather than raise taxes. According to this CNN report, officials in Colorado Springs, Colorado, have decided to remove the trash cans from its neighborhood parks, to eliminate evening and weekend bus service, and to remove one-third of the city's street lights. Brilliant. Well, ok, sorry. Brilliant it's not, and that's not simply because there will be less night-time lighting. Brilliant it's not because it's a short-term solution to a long-term problem that will generate even more long-term problems requiring far more resources to fix than the few dollars being saved by making the city dirtier and less safe. No trash cans? There will be more litter blowing around on the streets. No bus service during evenings and weekends? That means more vehicular traffic, with its accompanying pollution and congestion. Reduced lighting? That means an environment more conducive to accidents, pedestrian injuries, and crime. And in what appears to be a theme, the city is selling its police helicopters. The decision to close community centers that serve children and seniors is apt to put a lot of youngsters on the streets, and we know what happens when youngsters are out on the streets with nothing to do rather than busy with supervised after-school activities or jobs.

In Colorado, state and local governments cannot raise taxes unless voters approve. When asked to increase taxes, residents of Colorado Springs voted no. One politician reacted by saying, "You can cry about the fiscal situation ... or you can take it as an opportunity to change, reinvent yourself and innovate and that's what we're going to do in Colorado Springs." Change surely there will be. From illuminated streets and sidewalks to darkness. From clean parks to wind-blown litter. From energy-saving and pollution-reducing bus service to vehicular congestion.

Colorado Springs is considered by some to be a "libertarian paradise." Not only is its philharmonic orchestra privately funded, a not unusual situation that makes sense, but its garbage collection is privately funded. If that means that a private enterprise has a franchise to collect fees from residents for garbage collection or that multiple enterprises are permitted to compete to do so, that's close enough to a user fee to satisfy my prefernce for user fees. But what happens if the private sector enterprises decide to close down and leave because the residents of the city, accustomed to and intent on paying as little as possible, resist increases in the garbage collection fee. Those who argue it cannot happen should visit towns where there are no services of a particular kind because the economics did not work out. So much for the joys of the free market.

Perhaps in this "libertarian paradise" they can simply get rid of the police department. The town can rely on its residents using privately-held weapons to combat criminal activity. Surely posses and vigilante groups operating in the private sector are so much more efficient, safe, and sensible than police departments. Yes, I'm being sarcastic.

Yet one of the city's politicians argues that government should not provide the services that it has been providing, and that "the solution may be in weaning people off of government services. The larger the government is, the more conditioning with certain people that they don't need to take personal responsibility of their life." So according to this official, individuals, acting in their own capacity, and not the city, are responsible for illuninating the streets, providing airborne police protection, and driving vehicles rather than taking the bus.

This politician continued his explanations with this comment: "Should it be doing all of these things, or should it really be focused on the vital things that clearly have a public interest?" Excuse me, but is the city of Colorado Springs focusing on vital things that clearly have a public interest when it cuts back street lighting, police protection, neighborhood park trash cans, and bus service? What remains as a a vital thing that clearly has a public interest? Perks for the city officials? Money to dish out to influence voters? The key to the answer is the phrase "certain people" in the official's claim that, "The larger the government is, the more conditioning with certain people that they don't need to take personal responsibility of their life." So somehow by having evening and weekend bus service for people who need to commute to evening and weekend jobs conditions those people to be irresponsible? So somehow by illuminating the city's streets people are encouraged to be irresponsible? Sorry, but none of this resonates with logic.

Though this may seem to be a tempest in a teapot, or the detritus of a Tea Party, it's more like a canary going quiet in a mine. As the weeks and months of 2010 progress, we will be reading and hearing more stories about state and local governments cutting back services because the powers-that-be either stand in the way of appropriate tax increases or dupe the less affluent and the poor into voting against taxes on the wealthy, without disclosing that the less affluent and the poor will bear the burden of the service cuts that accompany the fiscal irresponsibility that plagued the nation at the federal level during the past decade and that is spreading like a viral disease among states and localities. Today, Colorado Springs. Tomorrow, your town and my town. But, hey, at least we'll be free of taxation and we can tea party all day and all night, well, at least during the day because there won't be any lights on at night, no bus to take us there, and no trash cans into which we can put the soiled tea bags.

A Law School Outline Vendor I Will Not Be

About a month ago, in Caveat Emptor, Law Students Seeking Outlines, I expressed disapproval of an enterprise that encouraged the sharing of outlines by law students for a long list of reasons that I explained in that posting. I had half expected to hear from someone at Outline Depot defending the enterprise's operations but I did not. I had one comment, from a current law student, who tried to persuade me that using old outlines was the way to get through law school successfully, at least for him.

So imagine my surprise when late last week I received an email from Outline Depot. The subject caused me to laugh. "Easy money at Villanova Law!" Are you kidding me? I had to open this email. So I did. It was an invitation! Here's what it said:

Apply to be an on-campus rep for OutlineDepot today!

It's super easy and you can start earning extra cash instantly.

OutlineDepot.com

Wow. Instead of criticizing my position, instead of arguing in favor of law student outline use, instead of offering empirical proof that using old outlines works, the folks at Outline Depot decided to follow some variation of the old adage, "If you can't beat them, join them." In this case, it must be "If you can't disprove their position, invite them to join you." Or perhaps it was a matter of the wisdom that one catches more flies with honey than with vinegar. Who knows what the Outline Depot folks were thinking?

Unfortunately, it isn't going to work. I haven't applied and will not apply to be an on-campus representative for Outline Depot, or any other business that trades in law school outlines. Even an offer of five million dollars, which by my calculation would set me up for life, will not change my mind. No, I don't think such an offer would be forthcoming. My guess is "extra cash" is something less than that. Much less. I'm laughing again.

So what am I to think? An enterprise that engages in circulation of old law school outlines invites an outspoken critic to represent it. Actually, I know what I think. What do you think?

Taxes and Disgust

Early this week I wrote about Taxes and Anger. Today I will describe how taxes can trigger disgust. There’s simply no point in getting angry. It’s simply so beyond that.

On Tuesday I sat down to do the tax returns for TaxJEM, Inc., the corporation through which I marketed and update computer-assisted tax law instruction exercises for law students and others interested in determining how well they understood federal income tax law. The federal 1120S, which is filed for federal income tax purposes, was easy. The Pennsylvania PA-20S/PA-65, which is filed for state income tax purposes, was manageable despite the bizarre attempt to use one form for both S corporations and partnerships. The Pennsylvania RCT-101, which is filed for Pennsylvania corporate franchise tax purposes, was disgusting. It’s not just that the RCT-101 combines the franchise tax, the loans tax, and the corporate net income tax. It’s not just that the RCT-101 must be used by S corporations even though the corporate net income tax does not apply. It’s not just that the form is six pages long, printed in small font with places to enter numbers that must be written in extremely small script. It’s not the absurd layout. It’s the computation of the franchise tax. I’ve filled out this form for several decades, so it’s not a surprise. It’s just that the more I deal with the form the more I wonder why it needs to be what it has become.

The RCT-101 requires the taxpayer to fill in book income for the current year and each of the preceding four years, but if there are any short years, those, too must be entered. The amounts are totaled, and divided by the number of years, which is usually five. The result is “average book income,” and if it is less than zero, it is reset to zero. Then it is divided by .095. This is an attempt to determine what amount of investment would generate that income. How many people or companies are getting a 9.5% rate of return these days?

Next, the taxpayer is required to enter, on line 7, the shareholders’ equity at the end of the current year. On line 8, the taxpayer must enter the shareholders’ equity at the beginning of the current year. The next step is priceless. I’ll quote. “If Line 7 is more than twice as great or less than half as much as Line 8, add Lines 7 and 8 and divide by 2. Otherwise enter Line 7.” Think about that for a while. Pick two random numbers and put one in line 7 and one in line 8. Then figure out the next step. If you have flashbacks to the SAT or some other standardized test that asked what you would be viewing if the object had a transverse axis more than twice as great as its length but less than half as much as its width, I apologize. It is an averaging device, but why not just average lines 7 and 8? Granted, this is a creature of the legislature and not the people who create the form, but does it really need to be so disgustingly complicated? Why?

If the outcome of the computation is less than zero, it is reset to zero. Then it is multiplied by 0.75, and the result is added to the amount that was generated when average book income was divided by 0.95. The combined amount is divided by two. Then $150,000 is subtracted, and if the result is less than zero, it is reset to zero. At this point, I am finished, because TaxJEM, Inc. is small. Trust me, it’s not worth anything near $150,000. But if subtracting $150,000 yields a positive dollar amount, it is then multiplied by the “proportion of taxable assets or apportionment proportion,” a percentage which requires filling out yet another schedule on the form, a process that might involve filling out a manufacturer’s exemption schedule that is a separate four-page folded-over delight whose center pages contain 32 rows and 10 columns. In other words, there are 320 little boxes, or cells, each possibly commanding a number.

Though I defend the need for taxes, I do not try to justify unjustifiable complexity. The state of Pennsylvania is trying to phase out the franchise tax, but economic conditions and budget deficits have stalled that endeavor. That’s too bad. This is a tax, and a form, that needs repeal or serious overhaul, sooner than later. Surely simplification ought to outweigh whatever considerations brought about this level of computational complication.

Snow, Budgets, and User Fees

The news that Philadelphia already has incurred $11.5 million in snow removal costs this winter isn’t the startling part of this story. Three huge snowstorms blanketing a large city will require huge outlays to clear roads and sidewalks. What’s surprising is the news that Philadelphia had budgeted zero, yes, that’s zero, for snow removal costs for the 2009-2010 winter season.

In another story, it was reported that Governor Rendell “understood Philly's decision not to budget for snow. ‘Based on the previous years, I think it's a decision based on sound evidence. Philly is not the only city taken unawares.’” The meteorologists who predicted a colder than normal winter with significant snowfall would disagree. According to another source, the snow removal budget was set at zero because the city faced a “massive cash crunch.” The state agency that must approve the city’s budget wants the mayor to return to the practice of budgeting for snow removal, and using that money to fix other street problems if snow does not materialize. The city’s budget director responded that “We said to each other that if it did snow, we would simply find the funding for that elsewhere. And that's what we're doing.” No one has yet identified where the snow removal funds are being found. It remains to be seen what programs are being cut. Interestingly, according to still another source, the Pennsylvania Department of Transportation has spent only $132 million of its $182 snow removal budget.

The cost of snow involved more than the cost of snow removal. The snowstorms deterred people from coming into the city to shop, caused workers who stayed home to cancel visits to restaurants, stores, and other establishments, compelled businesses to close, and scared away tourists. So the tax revenue that would have been generated by shoppers, by workers buying lunch, and by tourists spending money in the city went down. Sales tax revenues alone are estimated to have fallen by $8 million.

These developments demonstrate the risks of relying on general revenues to pay for specific government services. Though not every government service can be funded through a dedicated revenue source, it makes sense to convert to a user fee system. The primary advantage of a user fee is that it lets people see why they are writing checks to a government. If people pay for services indirectly, they are more likely to conclude that because they pay taxes they ought to get every service that they want. If, instead, people were required to pay a user fee for snow removal, they would see a direct connection between the fee and the service. If it did not snow, the fee would be zero for the year. Another advantage is that when people see the actual cost of a service, they have more incentive to reduce the cost by making fewer demands. A user fee for trash removal encourages people to make less trash and to do more recycling. A snow removal fee would be lower if what the city needed to do was reduced, so perhaps people would grab shovels and start removing snow so that city employees could reduce their time on the streets, and thus city payroll, by an hour or two. Perhaps all those youngsters rampaging in Center City last week could be put to productive use in the snow removal effort. By the time they’re finished, they won’t have the energy to be destructive forces that add to the cost of government.

User fees also focus attention on the benefits of planning ahead. A system of collecting general revenues to pay for specific services makes it too easy to spend today and worry about tomorrow later, only to discover that when tomorrow arrives, it brings a crisis. Planning ahead is difficult when taxpayers are encouraged by the anti-tax crowd to oppose all taxes. Greater reliance on user fees would bring the spotlight to bear on the silliness of the anti-tax crowds slogans. When the leaders of the anti-tax movement start yelling “We want trash pickup but don’t want to pay a trash removal fee” or “We want our streets plowed but don’t want to pay a snow removal fee,” those who at present are being seduced by the anti-tax instigators will realize what those anti-tax folks really preach. It will be easier to see that they are claiming a right to all that they want and freedom from any responsibility to pay for what they take or use. When they defend themselves by claiming that they don’t oppose all taxes, and don’t mind paying taxes – or presumably user fees – for trash pickup or snow removal, they don’t do a very good job of listing government expenditures that they would cut in order to eliminate most taxes. Most of them don’t realize that they get many more benefits from the existence of government than they admit.

Ultimately, user fees give citizens who decide that they don’t want the user fee to vote to eliminate the service that the fee provides. Of course, if the anti-tax crowd continues to influence the unwitting and uninformed by appealing to emotional distaste for taxation, it might persuade the entire nation to eliminate all taxes and user fees. What must be understood is that we would then be living in a country with no national defense, no police protection, no fire fighting services, no snow removal, no trash pick-up, no airspace allocation for airliners, no food, housing, or medical care for the folks who have lost jobs because of corporate greed and corruption, no prescription drug approval, no highway maintenance, no national or state parks or recreation areas, and all other sorts of inadequacies. What we would have is a large-scale version of those youngsters rioting in center city Philadelphia, except that the rioters would not simply be expending excess energy because they have nothing better to do. They would be fighting for survival. The price that would be paid would far exceed the inconveniences of taxes and user fees.

Taxes and Anger

Joseph Stack was angry. A lot of things went wrong in his life, as outlined in a posting that was taken down from the internet but not before bloggers like Peter Pappas preserved it. Stack’s violent reaction to the miseries of his life have triggered all sorts of commentary, some of it constructive and some of it not very helpful.

When anger leads to someone crashing an airplane into a building, one question is what could or should have been done, by that person or others, to dissipate the anger or vent it in some other, non-violent manner. The answer reaches far beyond taxation. In this instance, Stack selected one particular thorn in his life, a particular aspect of the tax system, and made it the focus of anger that was fueled by all sorts of incidents that riled him. That is not an unusual pattern of behavior.

Already, some are claiming that this unfortunate episode should be the catalyst for reforming the tax system. For example, Aaron Greenspan, after describing the maze of federal and state tax and other filings that he must submit in running a business, calls for tax simplification. I agree, and I agree with Greenspan that simplification ought to be pursued because it is the right thing to do, not because a criminal act has highlighted a particular person’s anger about taxes (and all other sorts of things). Unfortunately, after accusing the IRS of making too many errors, of ignoring taxpayer complaints, and of engaging in abuse, Greenspan proposes that “We should make the agency [IRS] do the calculations for us . . as a recent New York Times article by Randall Stross suggested.” Please. Just last month, in Federal Ready Return: Theoretically Attractive, Pragmatically Unworkable, I explained why, in yet another post on the matter, it makes no sense to commit federal income tax liability computation to the IRS. I’ll add another reason. Doing so makes it easier for the proponents of complexity to argue that complexity is no longer an issue because “the IRS is taking care of it.” We ought not allow the designers of complexity to hide behind the Ready Return excuse.

Greenspan, however, also suggests that it is understandable why someone would be angry at the IRS. He describes the inappropriate behavior of IRS personnel that came to light in hearings before Congress. Yet subsequent revelations have demonstrated that much, if not most, of the testimony was contrived, and that the entire process of holding hearings was yet another ploy of the anti-tax crowd to build up citizen resistance to taxes, as though magic angels will show up to plow streets, drive fire trucks, chase down criminals, assist the injured, and defend the nation. Those hearings ended up making it easier for Congress to shift blame for its actions onto the IRS. And apparently, and certainly in Stack’s case, it succeeded.

In his posting, Stack complains about an uncodified provision of the Tax Reform Act of 1986, which precluded technical services providers, such as Stack, from making use of a safe harbor relief provision set forth in yet another uncodified provision, section 530 of the Revenue Act of 1978. The Congress made this decision because it had concluded technical services providers were using the safe harbor provision as an abusive tax shelter providing benefits far beyond what was intended to be generated by the safe harbor provision. Congress used the revenue generated by the Tax Reform Act of 1986 change to offset the revenue loss created by a totally unrelated provision providing tax benefits to other taxpayers. There is a good explanation of the technical aspects of this issue in Joseph Henchman’s Tax Foundation post,, “Austin Suicide Pilot Allegedly Upset By Denial of Ind. Contractor Status to Non-Ind. Contractors.”

Though violence is no answer, it is understandable that a taxpayer in Stack’s position would be annoyed, frustrated, even angered, by what Congress did, and by its inability to deal with the employee versus independent contractor issue at the root of this particular set of uncodified provisions. Yet Stack came to the conclusion that the IRS was responsible, and did not steer his anger in the direction of Congress. The Congress has done a very good job making Americans think that all their tax woes, all their tax complaints, all their tax unhappiness, all the pitfalls in the tax system, and all the aggravation that federal taxation causes them is the work of the IRS.

One ironic aspect of this tragedy is that Stack could have avoided the independent contractor versus employee tax hurdle that he cites as one of many things in life that angered him. In his posting, Henchman points out that this issue “seems to have vanished over the last 20 years, since the consultant can incorporate himself or herself.” I wonder if Stack knew that. Why should citizens be compelled to undertake ploys and maneuvers to get to where they want to be, tax-wise, because the tax law is unduly complicated? Perhaps if someone had helped Stack with his tax issues when he confronted them, things would have turned out differently? But how many people have the ability to provide accurate and sensible tax advice? Not as many as the current tax system, riddled with complexity, special interest provisions, sloppy drafting, incoherent arrangements, and malformed tax policy, requires.

It’s time for America to wake up. At the end of his post, Greenspan suggests, “We as voters should tell our government that we want all of these things,” and by “these things” he means simplification, improved on-line access, accountability, reasonable attempts to empathize with taxpayers, and that well-intentioned but misguided Federal Ready Return proposal. Greenspan is correct. As voters, we elect members of Congress. We don’t elect the IRS Commissioner or IRS employees. Yet, when incumbents run for office, voters continue to send almost all of them back to Washington. Most changes occur when a member of the Congress retires, resigns, dies, or chooses not to run for re-election. Somehow, Americans, who hold the Congress in very low esteem, seem to think that the failures and dysfunction of Congress are caused by everyone except their two Senators and their representative. Happy with a $50,000 pork barrel bone, they send the same person back to do more damage, ignoring the $10 million burden on people living in their district caused by Congressional incompetence, sloth, and corruption with respect to the federal tax system.

It won’t get better until American voters decide to make it better. It won’t get better if the electorate continues on the same path. It won’t get better when attempts to change things are obstructed by those with vested interests in the mess that generates so much anger among the Joseph Stacks of the nation. Hopefully the nation is learning that effective change requires more than changing a few things in Washington. Those who have contributed to the deficiencies of the federal tax system ought to step aside, and the electorate needs to send that message convincingly, in the voting booth. Piloting the anger into an office building brings the wrong sort of change in the form of innocent individuals’ deaths, and it makes it too easy for the advocates of the existing federal income tax system and its deficiencies to dismiss calls for change as the agenda of a fringe element. The need for tax law change is not so limited. The call for change must be heeded, sooner than later. Far more than several lives and an office building hang in the balance.

So Are Law Grads Ready to Be Tax Auditors?

A thought-provoking suggestion from Rob Nassau at Syracuse has turned attention to the question of whether it would make sense for the IRS to hire law school graduates to be tax auditors. Nassau suggests that if the IRS hired 2,500 law school graduates and “put them to work auditing people and corporations, ... 2,500 well-paying jobs that more than paid for themselves” would be created.

Let’s look at this from the perspective of the IRS. We need to assume that the IRS has the funds to hire 2,500 new auditors or else the idea goes nowhere. If the IRS had the resources to hire 2,500 people to audit tax returns, would it make sense to hire law school graduates? I don’t think so. Aside from perhaps one or two law school graduates who worked as IRS auditors before entering law school, students graduating from law school have not learned the skills required to audit tax returns. There simply are no courses in which law students are taught tax auditing. That’s because people don’t go to law school to become tax auditors. So the IRS would need to put these 2,500 law school graduates into training programs. But if the IRS is going to do the training, then why hire law school graduates who are going to command salaries high up on the GS pay scale? It would make more sense to hire college graduates who have accounting degrees, because they’re at least part-way to where they need to be to become tax auditors, and thus require less training than would the law school graduates. College graduates would not be earning salaries as high on the GS pay scale as would law graduates. In the past, the IRS has even hired people to be tax auditors who did not have college educations, and although that is probably an unwise choice in this day and age, but it demonstrates that in terms of tax auditing, the marginal utility of a law school education, especially one shallow in tax law and replete with theoretical courses, isn’t very much compared to the alternatives.

One of the comments to Paul Caron’s posting on the suggestion hit the nail on the head. Someone with the username save_the_rustbelt noted, “Hire lawyers to do audits? Sorta like using a screw driver to pound nails.” Exactly. This commentator then described a deposition in which a trial lawyer did not know the difference between revenue and income. Strange, because that’s something all lawyers should know whether or not they decide to practice tax.

Someone named Bma shared a desire for clarification, with this comment: “If the good professor means create attorney jobs (requiring Bar admission) in Chief Counsel, they would not be ‘auditing people and corporations.’ I'm confused....” I posted a response to Bma suggesting that Chief Counsel could not absorb or use 2,500 attorneys, even with the huge regulations backlog and the number of cases being litigated. How could the Chief Counsel’s office deal with training 2,500 new attorneys? I’m guessing that the nation’s law schools graduate only a few hundred students who, because of prior work experience, enrollment in a law school Tax Clinic, or a summer job, would be ready to take on the tasks facing Chief Counsel attorneys under circumstances requiring minimal training by the office. The overwhelming percentage of law school graduates leave their alma maters having taken no tax courses or one tax course. And too many who have taken one tax course are far more expert in arguing about what the tax law should be, rather than learning and understanding what the tax law is. Not only are they not ready to be tax auditors, they’re not ready for much else.

Jefferson VanderWolk correctly asserts that there is a “lot of tax due that the IRS doesn’t collect,” claims that the IRS has a shortage of good field agents, and claims that “its current field agents don’t fully understand a lot of what they are seeing, especially in the files of well-advised taxpayers who have done complicated tax planning.” Let’s assume this is true, and it probably is to some extent though I’m not ready to tag every field agent as deficient in the manner VanderWolk suggests. VanderWolk then argues a point that is almost impossible to rebut, namely, that law graduates “who can’t find jobs would rather be employed with a non-law salary than not employed at all.” Somehow, he then takes these premises to this conclusion: “And their legal education would certainly make them better candidates to deal effectively with audits of well-advised taxpayers.” I totally disagree, but for the few law graduates who because of other experience are capable of dissecting the complex transactions that are involved in the sort of tax planning to which VanderWolk refers. Even law students who have worked in Tax Clinics, though perhaps ready to audit tax returns with earned income tax credit, innocent spouse, dependency exemption, and similar basic issues, are totally incapable of dealing with tax returns filed by taxpayers whose tax planning has been put together by tax practitioners with years and years of experience. Yes, they could be trained, but that brings us back to the problem that people with accounting degrees or tax practice experience would require less training.

The person posting under the name save_the_rustbelt concluded, “There are too many law schools and the real solution is becoming very clear.” Again, I disagree. There are too many people in this country who do not get the legal advice that they need. The problem reflects the inability of many of these potential clients to pay attorney fees at levels that attorneys need to charge in order to service the huge debt they incur from attending law school. They incur huge debt because they are financing the “scholarly” writing of law faculty many of whom spend far more time writing than teaching, and when they are teaching, aren’t preparing their students to be of use to law firms or the IRS or anyone else when they graduate because those law firms, or the IRS, must then do the training that is required. The problem isn’t that there are too many law schools. It’s that there are too many law schools not giving the practice world graduates who are ready to do what needs to be done. I’ve discussed these issues in posts such as Evolutionary Changes in Legal Education, How A Transformative Recession Affects Law Practice and Legal Education , and Graduation Day: A Time to Think.

The point isn’t that law schools should teach students to become tax auditors. People don’t need to go to law school to become tax auditors. Law schools should not be teaching people to be tax auditors or rocket scientists. Nor should law graduates be funneled into tax auditing simply because they need jobs. They should be funneled into legal jobs in which their skills are required, and in order to maximize the number of legal jobs in which their skills are required, they need to leave law school with more skills than they currently do.

Snow, Jobs, and Taxes

Yes, notice carefully the commas. It does not say (with apologies to Lynne Truss, author of "Eats, Shoots & Leaves," a must-read for anyone who cares about the quality of his or her writing, a book brought to my attention by my librarian friend whose grammar and punctuation skills make mine look mediocre at best) "Snow Jobs and Taxes." That's another, very different, post, and though it may show up here someday, it's not this morning's topic.

According to a CNN report issued on Sunday, economists estimated that at least 90,000, and perhaps as many as 150,000 jobs "could be lost in February" on account of the snow. They point to two factors. The snow kept people from going to work. The snow kept people from being hired.

If the economists are correct, not only are unemployment benefits going to increase, or perhaps not decline as much as had been expected, but tax revenue will fall because of the reduction in wages. At best, tax revenues will not fall but will increase far less than they would have if jobs had increased as expected. If the economists are correct, the snowstorms of February, which have not necessarily run their course, will turn out to be, at best, a speed bump in the path to economic recovery. At worse, they could be a snow drift that brings economic growth to a standstill.

So are the economists correct? I don't know, but I have my doubts.

First, to the extent that hiring processes slowed, they will resume. There have been days during February when travel has been possible, interviews could be held, and hiring decisions made. Yes, there are delays that might cost a new employee a week, or two, of employment, but that's not the same as four weeks of full unemployment for the job applicant.

Second, have the economists taken into account what I call the storm offset? Snow removal contractors have hired some temporary help, especially when they have more equipment than employees to operate it. If shovels are included in the term equipment, surely there was a temporary bump-up in employment, though probably not enough to offset the delayed hiring. Are the 90,000 and 150,000 figures net of this phenomenon? The storm offset also includes the self-employed, those folks who own a shovel and walked their neighborhood finding opportunities to earn $30, $50, or $100 to clear a sidewalk or driveway. I doubt these folks are on the economists' radar.

Third, when the economists conclude that the snow kept people from going to work, are they taking into account the people who, having decided or having been compelled to stay home, opted for working from home? Anecdotally, I know more than a few people who did so. The economists are using information from the January 1996 blizzard. But they are forgetting that in 1996 the notion of working from home by taking advantage of the internet's capacities wasn't much more than a prospect on the horizon, aside from a very limited number of us who were experimenting with the internet as a means of virtual office presence. Fourteen years is a lifetime in the history of the internet and the impact it has made on the workplace.

Fourth, though some individuals who cannot get to their jobs don't get paid, many others are paid whether or not they show up. A substantial proportion of the latter group make up for their absences, if not by working from home, by going into work on a Saturday or by putting in extra hours on other days. Again, this may not offset all of the job losses, but it's unclear if the economists took this into account, or evaluated whether data from 14 years ago is as relevant as they appear to think it is.

One ultimate measure will be payroll tax withholding for February. Let's see if that information finds its way into the mainstream media.

A Lesson in Use Tax Collection

Unlike the states that try to make out-of-state vendors responsible for use tax collection on behalf of in-state residents who fail to file use tax returns, California has turned to its in-state businesses and requires them to register as use-tax taxpayers, to file returns, and to make payments of the tax. Most states try to avoid the cost of administering and auditing in-state taxpayers because it is cheaper to make out-of-state vendors, who happen to have no voting rights in the state, do the state’s work. As I have pointed out, most recently in Back to the Internet Taxation Future, unless the out-of-state vendor has sufficient contacts with the state in question, there are Due Process Clause problems with this ploy to get someone else to do the state’s work.

The California approach is a good lesson in how states should deal with the issue. Granted, the California approach is not without issues, but those are for the most part the types of issues that pop up when a new law is enacted or, as is the case in California, an existing law is given more attention, and is amended so that it can be enforced effectively. According to this Forbes article, at least 180,000 California businesses are now required to register as potential payers of the use tax. There is nothing new or unusual about the scope of the requirement, namely, any items subject to use tax which the business purchases from out-of-state vendors and then uses within California must be reported, the use tax calculated, and then paid. As might be expected, businesses are asking for a postponement in the filing deadline, currently April 15, mostly because they are somehow unprepared despite the law and the various instructions having been enacted and released last fall. The best that they may achieve is a one-month postponement, which the California Board of Equalization is authorized to approve, but according to this more recent Forbes article, the member of the Board of Equalization supporting a one-month postponement doesn’t know if he has the requisite number of votes. Another complaint is that businesses that do register are being ordered to pay use tax going back to 2007. Yet the requirement to pay use tax has been in place for a long time, so it isn’t as though these businesses are being asked to pay a new tax, or to pay a tax that they did not owe.

The new registration requirement applies only to businesses with gross receipts exceeding $100,000 that are not already registered. Small businesses, those with gross receipts of $100,000 or less, and individuals not conducting businesses are not within the scope of the new requirements. This means that, despite however much revenue the new requirement might generate, another huge chunk will continue to go unpaid, contributing to the state’s budget deficit.

If a business does not register, the Board of Equalization will estimate its out-of-state purchases, compute a use tax, and pursue collection of the tax and penalties. Why this entire arrangement is not made applicable across the board for all businesses and individuals is unclear, though a good guess is that it might have something to do with politics.

There isn’t yet sufficient data available to permit anyone to figure out if California’s sensible and legal approach will let in pull in proportionately more unpaid use tax than the indefensible and legally questionable approaches taken by states unwilling to invest in collecting their own taxes. My guess is that California’s approach will turn out to be worth the effort, and that other states eventually will follow suit, to a greater or lesser extent.

The use tax collection story is a never-ending one. There will be more. Stay tuned.

Time for Some Sales Tax Calculations

According to news released on Tuesday, Pennsylvania's Governor Ed Rendell is proposing that the state reduce its sales tax rate by 2 percentage points and eliminate many of the exemptions currently available. The state-wide 6 percent rate would be reduced to 4 percent, with similar reductions in the cities that have higher sales taxes. The exemptions for food, clothing, and medicine would not be affected. Current exemptions for candy and some beverages, for example, would terminate. According to the report, the change would increase sales tax revenue by $1.4 billion annually.

According to the governor, in an interview on a local television statement and as noted, for example, in this report, the combined effect of ending 86 exemptions and decreasin the sales tax rate would generate annual savings of $17 to the "hypothetical average Pennsylvania household."

Something doesn't make sense. First, is it possible that there are so many purchases of candy and beverages that 4 percent of their total sales price would not only offset the loss of 2 percent of sales of currently taxable items but also generate $1.4 billion in revenue? Do Pennsylvanians purchase $35 billion worth of the 86 items proposed to lose their exemption? That's what must be purchased and taxed at 4 percent in order to generate $1.4 billion of revenue, and that's not counting what must be purchased to raise revenue to offset the revenue loss from the rate reduction. Second, if the proposal is going to increase revenue, how does the average household save $17?

The answer appears to found in the fact that businesses pay sales taxes. Apparently, many of the 86 exemptions are items that are more likely to be purchased by businesses than by households. Business leaders and others contend that the proposed change would cause businesses to cut pay, cut jobs, move out of state, or make other economic decisions that would have an adverse effect on Pennsylvanians. On the other hand, many of the exemptions to the sales tax are the consequence of special interest lobbying. I commented on one specific example of this process in Another Step Toward Elimination of All Taxes?, which involved sales tax exemptions for helicopters manufactured and sold by a specific manufacturer. That the sales tax exemption mess ought to be cleaned up is clear, as I pointed out in Sales Taxes as Logically Illogical?. It may be that removing the inconsistencies in the exemptions, whether or not the overall sales tax rate is reduced, would increase the sales taxes paid by businesses. To cave in to the claim that taxes causes businesses to go under, move away, or cut jobs is to run the risk of surrendering to the argument that any tax on a business is harmful. Who's left to pay taxes?

Until a complete list of the exemption changes is provided, it is difficult for an individual to sit down and determine how he or she would fare under the proposed changes. It's not an easy determination. The actual computation isn't the challenge. The challenge is figuring out how much a person spends on each of the particular items that are subject to, or would be subject to, the sales tax. How much does a person spend on gum at the movie theater? How much does a person spend on candy? How much does a person spend on items currently taxed at 6 percent that would be taxed at 4 percent? Who has time to dig through receipts and rack up the numbers? Who has the receipts from which to determine the numbers? But how else can a person decide if he or she would save $17 a year? Or $10 a year? Or $40 a year? Or perhaps pay more sales taxes? It probably is easier for businesses to compute what they spend on various items, because businesses tend to maintain better records in this manner than do most individuals.

Get out those pencils and spreadsheets. Get out those receipts. Do some arithmetic. Have fun.

Some Insights into the Tax Policy Mess

Those who wonder why the nation’s tax policy is such a mess, and who understand that tax policy is not developed in a vacuum but in the context of, among other things, federal spending decisions, will appreciate the insights provided by the latest exchanges in the continuing partisan dialogue in Washington concerning federal budgets and federal budget deficits. This dialogue reflects growing concern over the size of the federal budget deficits projected for the next decade. In short, these deficits could cripple the nation’s economy and put its security at serious risk.

Not too long ago, Senators Kent Conrad, a Democrat, and Judd Gregg, a Republican, came together to sponsor a plan to create a commission to deal with the deficits. The commission membership would be eight Democrats who are members of Congress, eight Republicans who are members of Congress, and two members of the administration. The proposal would put Congress in the position of choosing to accept or reject the commission’s determinations, and Congress would not be permitted to make changes or pick and choose among the commission’s ideas. Only those recommendations supported by at least 14 of the 18 commissioners would find their way to the Congress.

In late January, the Senate defeated the Conrad-Gregg bill. Sixty votes were required for passage. Only 36 Democrats, 16 Republicans, and an independent voted in favor of the proposal. Republicans who opposed the measure did so chiefly because of fear that the commission would recommend tax increases. Democrats who opposed the legislation worried that the commission might make cuts in entitlement programs. Several of the Senators who voted no did so because they didn’t like the idea of the no-change up-or-down vote concept that would apply. Objecting to the crafting of a budget deficit by a commission, Senator Baucus claimed, “Bureaucrats do not enact great legislation, senators do.” Seven senators who co-sponsored the legislation voted against it, including Senate Republican leader Mitch McConnell who had called the Conrad-Gregg idea “the best way to address the crisis.”

In response to the failure of the Congress to tackle the problem, President Obama has decided to create a commission by executive order. The President’s commission would consist of six members appointed by Congressional Democrats, six appointed by Congressional Republicans, and six appointed by the administration. It is believed that at least two of the six appointed by the administration would be Republicans. The 14-of-18 concept would be retained. However, the Congress cannot be compelled to vote up-or-down with no changes on recommendations coming from a commission established by the President. As can be expected, Republican members of Congress are complaining bitterly about the President’s plans.

Last Friday, according to various reports, including this article, House Republican leader John Boehner called the President’s commission a “partisan exercise” and claimed that it was “’rigged’ to promote Democrats’ spending policies.” Boehner called for a commission that includes Republicans. McConnell now explains that he prefers that any commission be restricted to recommending spending cuts.

There is inherent irrationality in how Congress is dealing with this crisis. For one thing, there seems to be a challenge in getting the facts right. The president proposes putting Republicans on the commission he plans to set up, but Boehner cries out for inclusion of Republicans as though the President is planning to appoint only Democrats. Such assertions are more than misleading; they are designed to stoke the fires of partisan bickering. When Baucus complains that the commission would be a group of bureaucrats, is he somehow overlooking the fact that the Conrad-Gregg bill would have put 16 members of Congress on an 18-person commission? Is he overlooking the fact that 12 of the 18 persons proposed to sit on the president’s commission would be named by members of Congress and thus could be members of Congress?

Congressional management of budget planning is similarly off base. McConnell claims that the problem is too much spending, but where was he when Republicans pushed through funding for war while also cutting taxes? A decision to spend hundreds of billions and more on war should be accompanied by increases in taxes to fund that spending. Somehow, the notion that paying for Medicare, health care, clean water, or any other beneficial social program is awful when it contributes to a budget deficit doesn’t extend to the logical implication that paying for war when it contributes to a budget deficit is no less awful. Worse, cutting taxes when expanding spending is totally inconsistent with the concept of balancing the federal budget, and one wonders how a Congress that created the crisis by cutting taxes while increasing spending is now making all sorts of noise about the horrors of deficit spending. Apparently deficit spending is permissible when it generates tax cuts for the wealthy but not when it is designed to assist the country in digging out of an economic mess caused by cutting taxes for the wealthy while increasing spending. On top of that, the Congress rejects a plan to deal with the problem, even to the point of co-sponsors voting against their own legislation. These are the folks who have been crafting tax policy. Is it any wonder that it is such a mess?

So it is annoying, disappointing, and alarming to hear a member of the United States Senate claim, “Bureaucrats do not enact great legislation, senators do.” When was the last time the Senate enacted great legislation? Surely not the inferior tax law tinkering that gets fed to the American people two or three times a year as members of Congress dole out rewards to their supporters. Bureaucrats cannot enact legislation because they are not legislators, but they can generate regulations and other administrative issuances, which usually are in far better shape than what comes rolling off Capitol Hill.

The deficit cannot be eliminated merely by cutting spending, unless Congress wants to strip the military down to pretty much nothing, eliminate Social Security and Medicare, and put an end to a variety of other programs. The nation faces huge deficits not only because tax rates on the wealthy are lower than they need to be, but also because the deficit reflects eight years of taxes that should have been collected but that were forgiven by a Congress anxious to reward the economic elite and ballooning interest payments on the debt undertaken to finance the deficits generated by trying to finance a war while cutting taxes. As I noted in Tax Incentives Can Do Only So Much:

Those thoughts rested on something I had pointed out in A Memorial Day Essay on War and Taxation, when I wrote:

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 time has arrived to pay that price. It will require more than tax credits aimed at stimulating an economy. It will require more than merely letting the tax cuts for the wealthy expire. It will require much, much more.

Perhaps some of that price could be avoided if those responsible for the bad decision-making of the past decade, and those who unduly benefitted from that bad decision-making, stepped up and repaid the nation for the economic damage that these bad decisions caused. That would spare the less fortunate the agony that will accompany the inevitable outcome of the entrenched budget deficits, whether that outcome consists of higher taxes on the poor, overwhelming cutbacks in assistance to those in need, or surrender of some kind to the nations and economic elite who have become the nation’s creditors. If anyone thinks that the banks were tough on people unable to pay mortgages, wait until the folks to whom the nation is indebted start their own foreclosure process against the United States. It won’t be pretty. It will be painful. And unless the Congress starts dealing with the problem in a realistic manner, giving up its habit of using national crises to advance their own electoral prospects, the pain will be long-lasting, deep, and irrevocable.

Back to the Internet Taxation Future

Several days ago, I received an email containing the text of an article by Eleanor Roberts, Main St. Needs Tax Loophole Closed. It was suggested that I take a look at the information on a web site that supports the same points that were made in the article, and makes even more errors in analysis, such as quoting politicians who conflate the sales tax and the use tax.

According to Ms Roberts, Massachusetts, admittedly in dire need of tax revenue, is collecting less tax than it otherwise could reach because “online-only businesses do not have to collect sales tax.” Several questions came to mind. First, is this an assertion with respect to Massachusetts or is it an assertion generally? Second, is this a situation that exists because Massachusetts law does not impose a sales tax
obligation on online businesses, or because Massachusetts revenue officials aren’t enforcing existing law?

Under Massachusetts Code, ch. 64H, section 2, “An excise is hereby imposed upon sales at retail in the commonwealth, by any vendor, of tangible personal property or of services performed in the commonwealth at the rate of 6.25 per cent of the gross receipts of the vendor from all such sales of such property or services, except as otherwise provided in this chapter.” And under Massachusetts Code, ch. 64I, section 2, “…. an excise is hereby imposed upon the storage, use or other consumption in the commonwealth of tangible personal property or services purchased from any vendor or manufactured, fabricated or assembled from materials acquired either within or outside the commonwealth for storage, use or other consumption within the commonwealth at the rate of 6.25 per cent of the sales price of the property or services.” In other words, Massachusetts has in place the typical retail sales taxation arrangement. A sales tax is imposed on purchases made within Massachusetts, including online purchases made from Massachusetts vendors. A use tax is imposed on purchases made by Massachusetts residents from vendors who are not within the jurisdiction of Massachusetts, whether those purchases are made in person, through mail-order, or over the internet.

So the assertion that “online-only businesses do not have to collect sales tax” is not true. A company organized in Massachusetts, with offices in Cambridge and a warehouse in Boston, that sells goods to someone living in Worcester is obligated to collect and remit sales tax whether the Worcester resident walks into the Cambridge office, orders over the telephone, sends an order through postal mail, or uses the internet to place the order. If the company decided to accept only email and web site orders, the outcome would not change. Though it would be an online-only business, it would still be required, under Massachusetts law, to collect sales taxes. The same obligation would be imposed on vendors located outside Massachusetts if they have sufficient nexus, in other words, contacts, with Massachusetts to justify Massachusetts jurisdiction. These sorts of contacts include sending sales representatives into Massachusetts, maintaining offices there, owning or renting space for the storage of goods in Massachusetts, and so on.

When a state does not have jurisdiction over a vendor, and thus cannot require the vendor to collect sales tax, the state imposes a use tax on the consumer who made the purchase. Massachusetts follows this pattern. The practical problem is that Massachusetts does not want to focus its resources, time, and attention on noncompliant consumers. Like other states, it would prefer to have the vendors do the collection work for them, but the problem is that Massachusetts has no jurisdiction to compel this outcome. So when turning to the second question, it appears that the concern is not that Massachusetts is not enforcing its sales tax, but that it is not enforcing its use tax.

I dealt with this issue almost three years ago in Taxing the Internet: Reprise, in which I commented on the proposed Streamlined Sales Tax Agreement. I explained that “lobbying for the proposal … has been intensifying, orchestrated and led by state governments that somehow seem incapable of enforcing their own use taxes on their citizens.” It appears that Ms Roberts’ article is yet another attempt to sell an arrangement that runs up against basic principles. Some advocates of the SSTA claim that states can impose their sales taxes on vendors who have no contact with the state, simply because a resident of the state contacts the vendor out-of-state and purchases a product that the resident causes to be brought into the state.

Ms Roberts claims that, ”In 1992 the Supreme Court mandated that Congress take appropriate action to force the collection of sales tax over the Internet.” Though she gives no citation so that one can determine which Supreme Court case she wants to highlight, she surely is referring to Quill Corp. v. North Dakota (91-0194), 504 U.S. 298 (1992). Not only did the Supreme Court, in Quill, reject North Dakota’s attempt to require an out-of-state vendor to collect North Dakota use taxes, it imposed no mandate of any sort on the Congress. The Court merely made several observations about the Congress. First, it noted that “while Congress has plenary power to regulate commerce among the States and thus may authorize state actions that burden interstate commerce, … it does not similarly have the power to authorize violations of the Due Process Clause.” Second, it noted that its decision was easier to make because “the underlying issue is not only one that Congress may be better qualified to resolve,… but also one that Congress has the ultimate power to resolve.” Third, it noted that Congress was free to disagree with the Court’s analysis. Fourth, it concluded that “Congress is now free to decide whether, when, and to what extent the States may burden interstate mail order concerns with a duty to collect use taxes.” Fourth, it noted that “Congress has the power to protect interstate commerce from intolerable or even undesirable burdens.” The Supreme Court did not issue a mandate, that is it did not command Congress to do anything. It simply pointed out that Congress has the power to regulate the collection of use taxes, but also that it cannot authorize states to impose requirements that violate the Due Process Clause.

Three years before I wrote Taxing the Internet: Reprise, I analyzed a variety of tax issues that arise when internet transactions are involved. It is useful to look again at some of what I shared in Taxing the Internet:

On the one side is the argument expressed in the title of Dick Armey's Philadelphia Inquirer commentary: "Cyberspace is the last frontie; don't let them tax the internet" . . . Armey advocates keeping the internet tax-free, though that is a misleading goal. The internet has not been tax-free, is not tax-free, and will not be tax-free. Armey argues chiefly against taxing Internet access, but he doesn't distinguish between that sort of imposition, and taxation of transactions conducted through the Internet. The principal argument that he and other "don't tax the internet" advocates raise is the wisdom of letting Internet technology grow and mature without the hindrance of taxation. If we were to abolish taxes on all who need to grow and mature, there wouldn't be much left to tax.

On the other side are the folks who advocate taxing all internet transactions. Chiefly advanced by some state legislators, who are seeking to increase state tax revenues, the argument is that any connection whatsoever between the transaction and the state entitles the state to subject the transaction to its tax system. The best example is that of on-line sales and the extent to which a state sales or use tax should apply. Suppose consumer A, living in New Jersey, uses the Internet to access the web site of a retailer located in Illinois, looks at products, orders a product, pays using a credit card, and receives the shipment in New Jersey. Does a sales tax apply? The answer is found in the tax treatment of a similar transaction, in which the person's neighbor looks at a print catalog, phones the retailer, and makes the purchase. New Jersey cannot require the retailer to pay a sales tax because the sale does not take place in New Jersey, and New Jersey cannot require the retailer to pay a use tax unless the retailer has a sufficient "nexus" (or set of contacts) with New Jersey to justify imposing the tax. Without getting into all the technical analysis, sending a catalog into New Jersey is not sufficient nexus. Why should the Internet transaction be treated any differently? What New Jersey can impose is a use tax, on the purchaser, but effective administration and enforcement of use taxes seems to escape state legislatures. The hole in tax revenue caused by inefficient use tax enforcement existed long before the Internet came into being, but the Internet brought attention, and the attention brought the state legislatures the temptation to make the retailers do their use tax administration and collection for them.

States are strange in this respect. Because Delaware has no sales tax, and Pennsylvania does, many Pennsylvanians drive to Delaware to purchase items on which they do not pay the Pennsylvania use tax. Delaware merchants use "no sales tax" plugs in their advertising. Unlike the Liquor Control Board, which sends undercover agents to the District of Columbia (where alcohol is much less expensive principally because of lower taxes) to look for vehicles with Pennsylvania license tags outside retail liquor establishments, and who then call ahead to officers "waiting at the border," the use tax division doesn't seem to care. Some states now include a "use tax" line on their income tax returns. How effective that will be remains to be seen.

My analysis rests on a premise that I shared at the beginning of that commentary, namely:

The overriding principle that should apply is this: when it comes to taxing transactions and activities conducted on or through the internet, or taxing access to the internet, those transactions, activities and access should be taxed no differently from the way in which transactions and activities conducted through means other than the internet are taxed. This principle, though, is ignored by those who take either extreme position with respect to taxation and the internet.

As I pointed out in Taxing the Internet: Reprise,

the last time I looked at the case law state 1 has no "independent and sovereign authority" to impose a sales tax on a transaction that takes place in state 2. Whether the state 1 resident travels to state 2, phones a merchant in state 2, or contacts the merchant in state 2 through the internet, state 1 is powerless to impose any tax until the state 1 resident returns to state 1 with the item. If state 1's legislature and tax bureaucracy cannot figure out how to do that, perhaps they can resign and make room for those who do.

I also pointed out something that needs again to be given attention:

As I re-read my three-year old Taxing the Internet, I see descriptions of the same arguments being advanced today by the "tax the Internet" crowd and by the "no taxes at all" group. The flaws in the rationales for taxing email continue to exist. I urge all those involved with, or interested in, this latest round of "tax the Internet" to read Taxing the Internet. Then it will be fairly easy to understand my proposal: "(1) tax access as is taxed telephone and cable access, (2) tax retail transactions as catalog sales are taxed, imposing use tax collection responsibilities on those with sufficient nexus to the taxing state, (3) eliminate and prohibit "Internet only" taxes, and (4) find another way to deal with spammers, casinos, and other social behavior that is considered unacceptable or inappropriate."

Now what are the odds that politicians will follow this sensible approach?

The odds of politicians doing the sensible thing remain low so long as arguments are advanced that rest on faulty analyses of Supreme Court opinions, faulty summaries of state statutory tax law, and unwillingness to insist that state revenue departments that seem to be unable to deal with use tax collection take lessons from those states that have done innovative things to bring their use tax collection procedures into the twenty-first century without shifting their responsibility to out-of-state vendors because those vendors are easy targets given their lack of voting rights in the state in question. Instead of arguing for the closing of a tax loophole that does not exist, the advocates of SSTA or other use-tax-collection-burden-shifting devices ought to lobby their state legislatures to compel their revenue departments to figure out how to do their job.

Repeals, Expirations, and Reinstatements: A Taxing But Critical Difference

Words are precision instruments, but too often, even in the hands of professionals such as lawyers and journalists, they get used as though they are blunt instruments. In the hands of politicians, lobbyists, and special interest groups, words get transformed into sound bites, twisted assertions, and outright lies. An unfortunate, but telling, example has moved into the spotlight on account of what can be found in the President’s proposed budget.

In his proposed fiscal 2011 budget, the President proposes to let certain provisions enacted in 2001 and set to expire in 2010 by terms of the 2001 legislation to expire as scheduled. Among those provisions are the tax rate reductions enacted in 2001 for taxable income in the 36% and 39.6% brackets. Other rate reductions enacted in 2001 and set to expire would be extended. The break point essentially is taxable income of $250,000, or $200,000 for unmarried taxpayers, expressed in 2009 dollars and set at some higher amount after adjustments for inflation. The proposal to let the tax cuts for taxpayers in the high income brackets has come under fire from the usual crowd. Another provision is the special low rates of zero percent and 15 percent for capital gains and certain dividend income, rates that expire in 2010, and that by terms of the 2001 legislation return to 20% for capital gains and ordinary income rates for dividends.

According to the General Explanations of the Administration’s Fiscal Year 2011 Revenue Proposals, at pages 127 and 128, what the president is proposing to do is to “reinstate” the 36% and 39.6% rates, to “reinstate” the 20% rates for capital gains, and to “reinstate” the ordinary income rates for dividends. The folks at Bloomberg, in Obama Budget Seeks $1.9 Trillion Tax Rise on Richest, Business, claim that the Administration seeks a “tax increase” though it does carefully explain that the budget “would reinstate” the 36% and 39.6% tax rates. ABC News, in Obama Budget Would Impose Host of Tax Increases, characterizes the Administration proposal as one of “not renewing tax cuts.” Interestingly, though the Wall Street Journal gets it right in an article headlined Tax Cuts to Expire for Top Earners, in a subsequent article, The President’s Priorities, the Journal provides a chart that describes the tax cut expiration as “Repeal Bush income tax rates” even though it also uses the word “Reinstate” to describe the expiration of the phaseout of the itemized deduction and personal exemption phaseouts, and it refers to “tax increases” in the text of the article.

Depending on how one characterizes the proposal, one ends up with very different perspectives on what is being proposed. References to tax hikes and tax increases suggests that if the President proposes that the Congress do nothing with tax rates and the Congress goes along, taxes would remain as they are. That is not the case. If the tax law is not amended, or even if it is and section 1 of the Code is left alone, the tax cuts enacted in 2001 will expire by their own terms. The President has proposed that the Congress extend the 2001 tax cuts, to the extent they apply to taxpayers with income under whatever the inflation-adjusted $200,000 and $250,000 amounts turn out to be. Rather than focus on this attempt to help the middle class, the wealthy elite and their spokespersons – a list far longer than the handful of articles mentioned above – are wailing about the expiration of a decade of unwise tax policy.

To describe the President's proposal as a "repeal" is downright erroneous. One cannot repeal that which does not exist. If nothing is done, the lower tax rates enjoyed by the wealthy will disappear by their own terms. They would not be, and cannot be, repealed. Yet using the word "repeal" is nothing more than a too-obvious attempt to pin the blame on the President for something for which he is not responsible. It's misleading. And it is shame-worthy.

To get this point across, imagine a family wins a one-week vacation. At the end of the week, when the parents tell the children it’s time to go home, they raise a fuss because they perceive their parents as “ending” their vacation. Yet the parents are not the ones who set the terms of the vacation so that it expires in one week. True, they could reach into their pockets and pay for additional vacation time, but when the children start acting as though they are entitled to a longer vacation, they are demonstrating the mindset that has infected the entitlement mentality of those who, rather than being grateful for tax cuts that almost caused another Depression and wisely laying low, jump and scream for more of what has harmed so many Americans. The audacity is appalling.

Or consider the child who asks for a temporary increase in her allowance. The parents agree, and tell the child that for the next four weeks, the child’s allowance will be increased by two dollars. When the allowance reverts to its usual amount, the child complains to the parents, “You reduced my allowance.” Even if taken as literally true, and it isn’t, the expiration of the increase is not the same as a decrease. If the parents let the opportunity to teach the child the difference pass by, the child very well will grow up to be someone who thinks that the expiration of temporary tax reductions constitutes an affirmative tax increase even though no one is doing anything but watching the temporary reduction expire. The language of entitlement can trace some of its origins to this sort of distortion in the use of words.

The advocates of low or no taxes on the wealthy have been stressing the impact of the budget proposal as a “tax increase.” To the extent that the wealthy will be paying higher taxes in 2011 than they paid in 2010 or the preceding years of the decade, there surely will be an “increase” in the taxes that they are paying. But the decrease in the taxes was a temporary measure, and restoration of the tax rates to what they were before they were foolishly reduced is very similar to the expiration of that one-week vacation, except that in the vacation example the family cannot stand accused of having wrested the free resort time through misrepresentation and breach of public trust. There is a story from long ago about a thief who was required to return the stolen goods to the victim, and who complained that the officials involved in the case were “stealing” from him. When warped logic comes to dominate the tax policy debate, the nation’s governance becomes skewed to the point of near failure.

It is obvious that the motivation for accusing the President of increasing taxes is a political one. More voters can be energized by sound bite accusations that someone has “raised taxes” when the truth is that the person did nothing more but stand by and watch tax breaks expire by their own terms. Until American voters acquire the ability to push aside the misleading political sound bites that pollute the electoral process, the nation faces nothing more than continued inefficiencies in governance. It comes down to how many realize that the parents did not end the prize vacation nor reduce the allowance and how many fall for the misleading assertions reflecting the perception of ungrateful and spoiled children.

Caveat Emptor, Law Students Seeking Outlines

The title of this post isn’t designed to demonstrate any sort of proficiency in Latin but to alert law students to the dangers of relying on outlines received from other students. The risks posed by using passed-down outlines have been threatening law students for almost as long as there have been law schools, but digital technology coupled with the internet has multiplied the risk by orders of magnitude. Ten or fifteen years ago, students could get their hands on outlines for courses taught in the law school they were attending. In almost every instance the outline was from a previous semester offering of the course, taught by the same professor presently teaching the course.

Now, students at any law school can obtain outlines for just about any course taught at any law school. Recently, my attention was drawn to Outline Depot, which claims to be “the most comprehensive source of law school outlines anywhere.” (emphasis in the original). Perhaps it is, and I’ve not researched that point. Students earn the right to download outlines by accumulating credits, which can be obtained by uploading outlines or by purchasing the credits.

The point to which students are desperate to get their hands on outlines is apparent from what one finds on the site. There are all sorts of red flags and warning bells.

The first problem is that outlines are being uploaded ostensibly for a specific course at a specific school taught by a specifically identified professor, but yet the outline is not an outline of that professor’s course. How do I know this? Because several colleagues here and elsewhere have looked at the outlines purporting to be for their courses and have determined that the outline was not from their class. The topic coverage, the sequence, the particular cases that were discussed, and other elements don’t match. What a waste of credits to download the outline for Prof. X’s course in subject Y at school Z only to discover it’s useless. Won’t it be fun to see the first lawsuit?

The second problem is related to the first. Students are taking outlines from a course in subject A taught by Professor B at School C and uploading it along with a claim that it is an outline for a course in subject A taught by Professor E at School F. Could there be litigation brewing in this sort of misrepresentation?

The third problem is related to the first two problems. The website asks students who are uploading outlines to identify not only the course, professor, and school, but also the book that is being used. Here are some examples of the books supposedly being used at Villanova University School of Law: “unknown,” “?,” “first semester,” “Civ Pro II,” “Crim,” “Sorry not sure,” and “Property- can’t remember name.” What student in his or her right mind would want to use an outline provided by someone unfamiliar with the book used in the course? It’s either a student who was in the course whose work product is highly questionable, or it’s a student at some other school uploading either an outline acquired from a Villanova student through the internet, email, or some other means, or it’s a student uploading some sort of outline from some unknown source in order to acquire credits.

The fourth problem is related to the first three problems. There are outlines being uploaded for courses allegedly taught by faculty who don’t teach the course. For example, there exists an outline for the Business Associations course at Villanova, though there is no such course. It’s called Business Organizations. The faculty member teaching it supposedly is Leonard Packel. I’ve known Len for 36 years. He and I arrived at the law school together, he as a member of the faculty and I as a student. Len is an expert in evidence, criminal law, and trial practice, and a few other areas related to those three in which he has invested his professional career. Len, who is retired, didn’t teach Business Organizations, or Business Associations, or Corporations, or even tax. With that sort of clearly erroneous tagging information for an outline, how can anyone think that the outline is of any value? What sort of litigation will arise when someone downloads this outline, after having paid in some way for credits, only to discover it’s no better than the misleading identifying information?

The fifth problem is related to the previous four problems. There are outlines on the site for subject G taught by Professor H at School J, but Professor H is no longer at School J. Perhaps the outline would be considered useful by a student at School K, to which Professor H moved and is teaching subject G, but it’s not unusual for the scope of a course to differ from school to school, even when the same professor is teaching it, because of constraints or other parameters caused by the particular structure of each school’s curricular array.

The sixth problem is that the site may be misleading students when it claims, as of the last time I visited, to have “37,503 currently approved outlines.” (emphasis in the original). What is an “approved” outline? Do the site operators intend to imply that faculty have “approved” the outlines for their courses? That would be a foolish claim. Do they mean to imply that they themselves, the site operators, have approved the outlines? What does this mean? That they have checked the outlines for substantive errors? That they have verified that the outline matches the course to which it has been linked? Surely not. Yet law students, particularly first-year law students, can easily be fooled by the “approved” tag.

The seventh problem is that at least some of the outlines violate copyright. Several law faculty have discovered that materials and powerpoint slides in which they, or their institutions, hold copyrights are being disseminated without permission. Could this be the makings of another lawsuit? And lest law students think it’s a problem for the web site, if a law student downloads an infringing outline and then re-circulates it, does the law student run a risk of being sued? Perhaps. Perhaps enough to wonder about the utility of grabbing outlines in this manner.

The eighth problem is that the site perpetuates the inadvisable practice of using someone else’s outline to prepare, or cram, for a law school exam. Using someone else’s outline is like watching someone else exercise. It’s not the same as doing it yourself. The benefit of an outline, or any other assimilation device, is that the act of creating it has far more value than the act of having it. The learning comes from the doing, not from the mere reading, memorization, and regurgitation. Law faculty can tell students repeatedly that they ought not waste time or money on outlines produced by others, but law student insecurity, reinforced when there is lack of semester feedback, will overcome the common sense advice they are given by their teachers.

The last problem can be minimized by teaching and examining in ways that devalue the outlines for a course. I agree with law faculty who reacted to the “news” of the existence of Outline Depot by noting that outlines should be irrelevant if a law teacher is doing what ought to be done, namely, getting students to think for themselves and figure things out rather than just gather and repeat information. The secret, as I tell my students, isn’t the answer. It’s HOW one gets to the answer. Teaching tax is a bit easier in this respect because sometimes the answer changes from year to year, speeding up the decline of outline values. A question that presents a problem, and a solution that contains an error, with a request for an explanation of how that error was made, is far more challenging, but also far more worthwhile as preparation to practice law, than a question that presents a problem and asks for “the” answer.

There’s another way to create student reluctance to rely on outlines. When I’ve gotten my hands on outlines for my courses, usually from students willing to share them for some reason, I go through them, look for errors, and presto, exam question. I tell students I do this. It may be that this dampens the market for outlines in my courses.

Let’s face it. If students would put half as much energy into learning by creating their own assimilation devices as they put into getting "the" outline, they would be much happier in the long run and more likely to do well five years out of school. Using others' outlines encourage the "cram and repeat" mentality. As everyone who has been through law school knows, because hindsight is such a great teacher, the best way to learn something is to work with it. One of my colleagues at another school noted that students who rely on outlines rather than “reading, listening, assimilating, and thinking … won’t do well.” He’s right, especially when he adds, “Everyone’s looking for a shortcut. Most shortcuts are longer than just doing the assigned work.” Indeed. I’ve had students ask me to explain why something in so-and-so’s outline for the course conflicts with something in a hornbook or something I’ve said in class. I explain that they’re investing time trying to figure out why an outline has an error when they could be using that time to focus on the course assignments.

What should students be doing? They should be assimilating on their own, they should be doing practice questions, such as the ones at CALI, they should be determining which topics for which they have a good handle on things and those for which they need to upgrade their understanding, they should be going to specific chapters or subchapters in recommended treatises, hornbooks, or student guides that deal with those specific topics, and they should be re-assimilating those topics. It makes no sense to resort to a student outline when it is clear that student outlines are almost always of lesser quality, because I’ve yet to see a student outline that was error-free and up-to-date on the law.

Even if outlines were repositories of correct answers to all the questions that a law professor could possibly ask in a course, outlines would still be worthless in the long run. These sorts of outlines reinforce the student tendency to prefer "information gathering" and to focus on "what's the answer?" Students do this even when there is no "answer" because there is a lack of authority or a disagreement among authorities, such as a circuit split or an IRS position inconsistent with a Tax Court holding. This student approach, and the outlines that enable it, gets in the way of learning. Unfortunately, law faculty who want to get law students into the correct approach to learning are stuck with undoing the effects of too much bad undergraduate teaching styles.

So the students who pay money, or upload outlines that they may or may not be able to identify, in order to get their hands on outlines for a course are wasting their time and their resources. Now that it is so much easier to get outlines, the temptation to do so increases, and the fear of not doing so increases as well. Students who think outlines are the solution to doing well in a course are fooling themselves, for no outline is going to be the solution to doing well in law practice. Law schools cannot ban outlines, but they can continue to emphasize their danger and adverse impact. The existence of Outline Depot doesn’t help in this respect, even if it were providing outlines that didn’t include mismatched, misidentified, and similarly questionable content.

I suppose I write in vain. Outlines have been around longer than I've been teaching and they'll be around long after I'm gone. Oh, well.

Tax Incentives Can Do Only So Much

Last Wednesday, in his State of the Union address, the President put forth several specific suggestions for changes in the tax law:

I'm also proposing a new small business tax credit – one that will go to over one million small businesses who hire new workers or raise wages. While we're at it, let's also eliminate all capital gains taxes on small business investment, and provide a tax incentive for all large businesses and all small businesses to invest in new plants and equipment. . . . . And to encourage these and other businesses to stay within our borders, it is time to finally slash the tax breaks for companies that ship our jobs overseas, and give those tax breaks to companies that create jobs right here in the United States of America. . . . To make college more affordable, this bill will finally end the unwarranted taxpayer subsidies that go to banks for student loans. Instead, let's take that money and give families a $10,000 tax credit for four years of college and increase Pell Grants. . . . To help working families, we'll extend our middle-class tax cuts. But at a time of record deficits, we will not continue tax cuts for oil companies, for investment fund managers, and for those making over $250,000 a year.

Each of these suggestions poses its own set of disadvantages and dilemmas.

There already exists a credit to encourage employers to hire individuals who might otherwise not be hired. There’s no need for a new credit. It’s guaranteed that adding a new credit to the tax law for small businesses that hire new workers or raise wages will add to the complexity and offer more opportunities for the game players to find a way to take a well-intentioned provision and use it for unintended tax breaks for the wealthy. Would it not make more sense to extend the existing credit to cover individuals who have been out of work for more than a specified period of time? As for tax credits to employers who raise wages, isn’t that an objective inconsistent with the need to minimize inflation, a risk that is looming ever larger as the impact of a decade’s worth of federal budget deficits begins to erode the nation’s borrowing capacity? Using the tax law in this manner is unwise, unnecessary, and needlessly complex.

The tax rates that are applied to capital gains arising from selling stock in small business corporations already is near zero. Section 1202, by excluding from gross income one-half of the gain from the sale or exchange of qualified small business stock, effectively cuts the already-low special capital gains rate in half for taxpayers holding that sort of stock. If the president is suggesting that section 1202 be extended to include sales of partnership interests, including LLC interests, that might make sense. On the other hand, whereas C corporations and their shareholders are taxed at least twice on the same income, extending the tax break to partnerships and S corporations isn’t as essential, because those entities permit taxpayers to structure their business operations in a manner that avoids double taxation. The basic flaw in the proposal is that it keeps alive one of the most flawed provisions in the tax law, namely, the taxation of certain investment income at rates lower than those applied to wages and salaries. The capital gains preference encourages all sorts of game playing by those who seek to trick the Treasury into thinking wages or other ordinary income are capital gains. The partnership carried interest trick is one such absurdity, and without elimination of the capital gains preference, the nation is stuck with a tax law that contains an ever-increasing number of “anti-abuse” provisions, such as the one suggested to deal specifically with carried interests, rather than a tax law that removes the root of the problem.

It always sounds good to propose tax breaks for businesses to invest in new plants and equipment, but those tax breaks already exist. Section 179 and section 168(k), for example, to say nothing of the wonderful depreciation deduction for buildings that increase in value during their existence, should be incentive enough for business to make the investments it needs to make. No business is going to make an investment that it does not require just to get a tax break. The problem isn’t the absence of a tax break. The problem is that in order to make these investments, businesses need to borrow, but the banks aren’t lending. The banks, which manage to pay out bonuses to their highly compensated employees, claim they don’t have the funds to lend to business. Granted, the President also has proposed a tax on these banks, but that’s too small and brittle of a stick to persuade banks to get back to the business of lending money to businesses and individuals rather than playing games in sophisticated financial markets that resemble casinos more than quality lending practices.

It also sounds good to propose tax breaks for companies that hire people in the United States, with elimination of tax breaks for companies that hire people outside the United States. Putting aside the restrictions on this sort of tax policy that are presented by assorted treaties and international conventions, this proposal is a two-edged sword. Companies hire overseas because they can find workers for a fraction of the cost that they must pay in the United States. Moving production and other business activities back to the United States, which may be something essential for national security at least with respect to certain industries, means that the cost of the products and services provided by a company that makes this move will increase, unless there is some magic provision unmentioned by the President that would keep domestic salaries low enough to prevent this sort of inflationary development. If prices go up, American consumers will buy less product and fewer services. The lesson is that national tax policy is constrained by global economic forces.

There already exist several tax credits designed to assist individuals who wish to obtain additional education. Perhaps the President’s reference to a $10,000 credit is a suggestion to increase the amounts set forth in section 25A. The difficulty with the credit is that it doesn’t evaluate the quality of the education for which tuition is being paid with the assistance of a federal income tax credit. The energy credits, for example, set forth specific, and rigorous, standards that must be met before purchase of, or investment in, the item in question can qualify for the credit. Perhaps the education credits ought to be reserved for people who pay tuition to universities and colleges that focus on teaching, and whose graduates can pass independent examinations that demonstrate acquisition of sufficient skills, rather than to institutions of higher education so focused on research, development, and athletic competition that too many of their graduates sail through taking soft courses, acquiring inflated grades, and falling on their face when encountering the demands of the workplace or graduate education. Making higher education available to more people without doing something to increase its quality is a waste of tax expenditure dollars.

The idea of extending middle-class tax cuts makes sense considering that the middle class has been ravaged by the misguided economic policies of the past decade. But those cuts are relatively small compared to what the wealthy obtained, so the extension of middle-class tax cuts is as much symbolic as it is valuable. The concept of letting the tax cuts for those making more than $250,000 a year is long overdue, but it needs to be clarified. Is the $250,000 a reference to taxable income? Gross income? Adjusted gross income? It makes a difference? And will there be no difference between those making $500,000 and those making $50,000,000? There should be. Why single out oil companies? Are other industries somehow deserving of having tax cuts extended?

But the President did get something very, very right, much to the annoyance of certain members of Congress who stalked out when the address was finished. He said, referring to the huge budget deficits, “Most of this was the result of not paying for two wars, two tax cuts, and an expensive prescription drug program.” How many times have I argued that it was downright foolish and dangerous to the long-term security of the nation to fight two wars while not only failing to raise taxes but having the audacity to cut taxes for the wealthy at the same time? Perhaps the President read my argument in Peacetime Tax Policy While Waging War = Economic Mess, in which I answered an important question:

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.

Those thoughts rested on something I had pointed out in A Memorial Day Essay on War and Taxation, when I wrote:

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 time has arrived to pay that price. It will require more than tax credits aimed at stimulating an economy. It will require more than merely letting the tax cuts for the wealthy expire. It will require much, much more.