Tax Cuts v. Increased Spending

Tax cuts and increased spending having something very much in common. Both increase budget deficits. One reduces revenue. The other increases expenditures. Doing either when there is a surplus is one thing; doing either when there already is a deficit is another. Yet there are times when increased spending, even in the face of budget deficits, is an unavoidable necessity. One example is war, which in the 1940s caused huge budget deficits because even increased taxes could not offset the necessary increased spending. But tax cuts and increased spending are also very different.

A few days ago, the Congressional Budget Office released a report, Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output From July 2010 Through September 2010, which analyzes the multiple components of the legislation enacted in 2009 in an attempt to ameliorate the economic crisis gripping the nation. The report groups the components of the legislation into four categories: grants to state and local governments and similar entities, money transferred to individuals, government purchases of goods and services, and tax breaks for individuals and business. The CBO then analyzed the impact of the various grants, transfers, purchases and tax breaks, to determine the impact on the economy. The CBO calculated an “output multiplier,” which measures the impact of the grant, transfer, purchase, or tax break on GDP. For example, a multiplier of 3 means that a $1 grant, transfer, purchase, or tax break generated $3 of GDP. The CBO calculated low and high boundaries for the multipliers. How did the various incentives in the 2009 legislation fare?

The most effective incentive was the purchase of goods and services by the government, generating a multiplier of between 1.0 and 2.5. Grants to state and local governments and entities for infrastructure purposes generated a multiplier of between 1.0 and 2.5, and grants to state and local governments and entities generated a multiplier of between 0.7 and 1.8. Transfers to individuals generated a multiplier of between 0.8 and 2.1, and the one-time payment to retirees generated a multiplier of between 0.3 and 1.0. What the CBO calls two-year tax cuts for lower-income individuals generated a multiplier of between 0.6 and 1.5, and the extension of the first-time homebuyer credit generated a multiplier of between 0.3 and 0.8. The least effective incentive was the two-year tax cuts for higher-income individuals, which generated a multiplier of between 0.2 and 0.6

These results are not in the least surprising. Assuming the choice is between tax cuts for the wealthy and increased spending on infrastructure – directly or through states and localities – there is much more bang for the buck in taking care of the nation’s infrastructure. The flip side is that letting the tax cuts for the wealthy expire has far less negative effect on the nation’s economy and all of its people than does letting the nation’s infrastructure rot and crumble away.

I’ve been arguing this point consistently and almost incessantly. For example, in Funding the Infrastructure: When Free Isn’t Free, I explained how refusal to let the gasoline tax keep pace with inflation, because of politicians’ inability to resist the siren song of the anti-tax movement, has been imposing a toll in lives, property, and money on taxpayers throughout the country. I returned to this point in The Return of the Federal Gasoline Tax Increase Proposal. Last year, in So How Does This Tax Provision Stimulate the Economy, I criticized the enactment of the qualified motor vehicle sales tax deduction, using these words:

Though the notion that federal spending, either of tax revenue or borrowed money, will stimulate the economy, that notion ought not support the contention that any infusion of money into the economy is fiscally stimulative. It would make much more sense, for example, to invest the money in assets, such as infrastructure, schools, homeless shelters, prisons, and energy facilities, because the outlay would be matched, at least to some extent, by the production of an asset owned by the government and because there would be no doubt that the outlay would create and preserve jobs. It is difficult to imagine that whoever lobbied for this qualified vehicle sales tax deduction made that sort of strong case that it would rev up the engines of the automakers' production facilities.

The CBO report certainly proves the point I was making. Recently, in Being Thankful for User Fees and Taxes, I explained why increased government spending on highway infrastructure coupled with increased taxes is much cheaper than reduced taxes coupled with even higher increased individual spending on automobile repair and operating costs.

Just as consistently and perhaps incessantly, I’ve been arguing that enacting, and, worse, extending, tax cuts for the wealthy is not a solution to the nation’s economic woes. The CBO report bears out that position. Not only is there little bang for the buck, there actually is a negative effect on the economy when tax cuts are enacted or extended for the wealthy. Why is this so? Unlike lower-income individuals, who translate their reduced tax liabilities arising from tax cuts into local spending, and unlike government expenditures on local infrastructure, the wealthy are in a position to ship their tax savings arising from tax cuts to investments overseas. If their tax cuts are creating jobs, they’re creating jobs elsewhere, not at home. As I have mentioned previously, the wealthy can reduce their tax brackets by hiring people and taking the deduction for compensation paid to employees. But businesses aren’t going to hire unless they need workers, and they don’t need more workers if people aren’t buying goods and services and governments aren’t investing in infrastructure repair and maintenance. People reduce their demand for goods and services when their incomes fall, which has been the case for pretty much everyone but the wealthy. Governments reduce their investment in infrastructure repair and maintenance when their tax revenues are decreasing because of the combination of tax cuts and reduced economic activity.

Closer study, reaching back beyond 2009, will reveal that the current economic downturn began with the tax cuts almost a decade ago, despite the momentary, misleading, and phantom bubbled blip of economic growth in the earlier part of the decade. Logic tells us that the key to reversing the decline is to remove its cause and undo what should not have been done. Even if the trillions in lost revenue cannot be recovered, at least the bleeding can be stopped by taking tax cut extensions for the wealthy off the table.

Do The Wealthy WANT Tax Cuts?

According to this Philadelphia Inquirer article, “more than 400 U.S. business owners and professionals signed a petition [more here]” asking Congress and the Administration to let the Bush tax cuts for the wealthy expire. Some of the thoughts expressed by several of the people who signed the petition mesh with arguments I have been advancing for the past several years.

One signer pointed out that low taxes are an incentive not to hire. In contrast, he explained, higher tax rates on upper-end income encourage wealthy business owners to hire employees, because the deduction for compensation reduces the owners’ taxable incomes. In effect, the higher the marginal tax rate, the higher the “subsidy” provided for hiring new employees. I made this point two weeks ago in Job Creation and Tax Reductions.

This individual pointed to a Mark Buchanan article, Wealth Happens: Wealth Distribution and the Role of Networks, excerpted here that “associates lower tax rates with greater wealth disparity, and vice versa.” I mentioned the same effect in Taxes, Bailouts and Socialism, arguing:

Obama's tax plan is to increase taxes for individuals with incomes exceeding $250,000. Most Americans do not fall into that category, and 95 percent are unaffected by this particular proposal. Americans in that category are paying taxes at lower rates than they were paying a decade ago. The theory was that reducing rates on the rich would generate benefits not only for the rich, but also for everyone else. This "trickle down" theory turned out to be a failed experiment. All that trickled down was the economic pain inflicted on America by the casino capitalist gamblers. Technically, Obama proposes revocation of tax cuts for the wealthy. They had their chance. It failed, other than to make the wealthy wealthier, the middle class smaller, and the gap between the haves and have-nots wider.

It is becoming increasingly clear to more and more people, including the wealthy, that focusing tax breaks on investment at the expense of wages causes wealth to concentrate even more intensely in the wealthy. That increases the odds faced by the non-wealthy who think that tax cuts increase the prize waiting for them if they happen to win the “break out of the low or middle class into the upper income stratum” lottery. The reality is that no matter by how much tax cuts increase the “I’ve made it” prize, they decrease the odds of winning by orders of magnitude beyond the potential benefit. Can anyone spell “con game”?

Another signer trashed the “trickle down” theory that has been used to obtain and defend tax cuts for the wealthy. According to Warren Buffett, “trickle down” simply “has not worked.” He added, “I hope the American people are catching on.” I wonder if members of Congress are catching on. I doubt it. I, too, have trashed the “trickle down” theory on many occasions. In New Jersey to Follow in California’s Tax Footsteps?, I noted:

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

In Tax Cut Advocates – Like the Poor – Will Always Be With Us: Part Three I concluded:

After several decades of supply-side, trickle-down, spend-but-don’t-tax, and other voodoo tax and economic policies, it’s time to put those bad ideas into the dustbin of history.

It’s heartening to learn that hundreds of wealthy individuals agree.

Yet another signer of the petition noted that one effect of tax cuts for the wealthy has been a decrease in the nation’s investment in its infrastructure. In contrast, he points out, nations such as India are “moving in the right direction because they have invested in their national infrastructure. Meanwhile, we’re cutting back. It’s a moral decision, and it’s a business decision, and it’s wrong.” I tried to hammer home this point, shortly after the bridge collapse in Minnesota, in Funding the Infrastructure: When Free Isn’t Free. This signer explained that in his travels around the world for professional purposes, he could not help but notice that when the national infrastructure crumbles, workers suffer even more. Ultimately, I contend, it will hurt even the wealthy, proving that tax cuts for the wealthy are short-term treats infected with long-term economic disease that afflicts everyone.

I connected the complex relationship among tax cuts, infrastructure spending needs, and the menace of federal budget deficits in Tax Policy: It's OK for Us But Not For You, building on my warning five years ago in Government Budget Math: $1 + $1 + $1 = $1 + $1 that unbridled tax cuts for the wealthy – not only in the form of low marginal rates but also the dangerous even lower rates for capital gains and dividends, which populate high-end tax returns disproportionately more than they appear on other tax returns – would lead to economic crisis. The question is whether enough of the wealthy will learn what the signers of the petition have learned, and whether this education will occur soon enough to permit remedial action before the nation’s economy spirals into a black hole.

Chocolate: Good News. Bad News. Tax News?

Although the primary focus of MauledAgain is taxation, the blog description leaves room for me to wander into a few other areas that are of interest, perhaps even more interest, to me than taxation. One of those is chocolate. Several news stories during the past few weeks have inspired me to write about chocolate, yet again.

First, the good news. My youngest sister, who also considers chocolate to be important and wonderful, sent me a link to a Science Daily story, whose headline, Why Chocolate Protects Against Heart Disease almost says it all. After doing the sort of experiments that tax practitioners never get to administer, researchers at Linkoping University discovered that dark chocolate contains a substance that inhibits the enzyme ACE. This enzyme “is involved” with blood pressure regulation and the body’s fluid balance. One of the researchers explained that “the object of her studies is not to design new pharmaceuticals.” Of course not! The prescription simply is to consume more chocolate with a cocoa content of at least 72 percent. Don’t go for the 99 percent stuff, though. Take my advice, based on experience, it’s just way too bitter.

Second, the bad news. According to this Philadelphia Inquirer article, which mirrors similar articles popping up throughout cyberspace, the Court of Justice of the European Union ruled on Thursday – yes, that’s Thanksgiving here in the States – that there is no such thing as “pure chocolate.” At first glance, that’s bad news, the idea that all chocolate is impure. Horrors! The court’s decision capped a long adventure only lawyers could love, pitting EU nations against each other in a battle over labels. The disagreement arose between counties where chocolate is manufactured using only cocoa butter and countries using vegetable fats. Italy tried to get a step up on the competition by passing a law describing chocolate items made from 100 percent cocoa butter as “pure chocolate.” Other nations, such as Britain, objected. The Court of Justice decided that the place to let consumers know that the chocolate is made from 100 percent cocoa butter is on the table of ingredients, and that “EU’s chocolate labeling rules make no room for a ‘pure chocolate’ reference such as the one Italy enacted.” The court also held that if vegetable fats are included, the label must state, “contains vegetable fats in addition to cocoa butter.” A spokesperson for the EU explained that Europe has “two chocolate cultures,” one that uses only cocoa butter and one that includes other vegetable fats. Does the court’s decision put an end to the chocolate culture wars? Apparently, as the 1999 agreement to use the word “chocolate” no matter the ingredients and to leave the components to the table of ingredients resolves the matter. Fortunately, the decision does not prevent ordinary people from referring to the really good chocolate as “pure chocolate,” though some prefer to use the term “pure bliss.”

Third, one must wonder what will happen when and if advocates of taxing beverages, sugar, and other “sinful” foodstuffs get around to trying to tax chocolate. Will distinctions be made between pure chocolate and the other, impure, chocolate? Will there be litigation over the meaning of chocolate? The first story causes me to wonder whether, in a state that imposes a sales tax on food or on carry-out food but not on medicines, will chocolate qualify for non-taxation because it is a medicine?

There’s a sad thread running through these stories. It’s disappointing how lawyers and tax practitioners can make something as wonderful as chocolate the focal point of legal arguments and tax debate.

Being Thankful for User Fees and Taxes

One of the t-shirts I wear to the gym declares “We Love Taxes” in a script just above a logo for the Villanova University Graduate Tax Program. There’s an older gentleman at the gym who, when he first saw the shirt, became quite agitated. He proceeded to tell me why all taxes should be abolished. I explained what life would be like if there were no taxes. He relented, shifting his complaints to the woeful administration of taxes in the state of Florida. For that, I was in no position to disagree, because I was not familiar with the particular inefficiencies he had encountered.

Though anti-tax sentiment is popular, it too often is expressed in thoughtless condemnation of all taxes, as well as user fees. At some baser level, perhaps tied into the limbic system, humans simply prefer to get as much as they can get for free. They dislike taxes, but complain no less when paying bills or forking over cash at the checkout counter. Perhaps the trait is acquired and refined during childhood, when life for many people does appear to be an experience of getting things for nothing.

An excellent example of why taxes and user fees are, in the long run, effective and sensible appears in Future Mobility in Pennsylvania: The Condition, Use and Funding of Pennsylvania’s Roads, Bridges and Transit System, issued by TRIP, a “non profit organization that researches, evaluates and distributes economic and technical data on surface transportation issues.” Lest anyone doubt the nonpartisan character of the organization, it “is sponsored by insurance companies, equipment manufacturers, distributors and suppliers; businesses involved in highway and transit engineering, construction and finance; labor unions; and organizations concerned with an efficient and safe surface transportation network.”

After reading the report, I wondered how the yes and no responses would turn out if each motorist in Pennsylvania were to be asked this question: “Would you be willing to pay an addition $1 per gallon in gasoline taxes if the proceeds of that tax were used to improve and repair Pennsylvania highways and bridges?” My guess is that most people would say “No.” I wonder what would happen if people understood that those improvements and repairs, by decreasing congestion, enhancing safety, and reducing vehicle operating costs, would save each motorist an average of $800, to say nothing of creating jobs. Motorists in Philadelphia would save $1,500 each year, while those in other urban areas would save between $900 and $1,000.

Indeed, according to the report, the miserable condition of Pennsylvania’s roads contributes to traffic fatalities, wasted fuel, lost time, increased wear and tear and damage to vehicles, business supplies delivery delays, and a variety of other “hidden” costs attributable in significant part to inadequate funding of public roads and bridges. Though costs of keeping roads safe and in good repair have increased, and though use of this infrastructure has skyrocketed, gasoline taxes and user fees have not kept pace.

Rational logic dictates that it makes more economic sense to pay higher gasoline taxes and/or user fees when doing so reduces other costs by more than the increase in the taxes and user fees. Intuitive reaction, which is that there must be some sort of trick to this assertion, fails to consider that the reason for the savings is the efficiency of collective action. Widening a road, installing a median barrier, resurfacing a road with pothole-resistant material, modernizing traffic signals, realigning dangerous intersections, installing traffic cameras and sensors, and similar improvements are less expensive than the collective cost of replacing tires, realigning wheels, incurring lost profits caused by delivery delays, repairing and replacing wrecked vehicles, caring for people injured in accidents, burying traffic fatalities, replacing what those injured and dead individuals would have contributed to themselves, their dependents, their employers, and their communities.

The problem is that taxes and user fees are visible, but many of the costs of underfunded roads and bridges are hidden. A person paying for a wheel alignment required because of a pothole encounter might realize that he or she is shelling out almost half of what a $1 per gallon gasoline tax increase would cost, but how many people calculate the additional gasoline they purchase because they’ve burned it while sitting in traffic jams caused by inadequate highway capacity, accidents attributable to highway defects, and choke points cause by the need to deal with bridge weight restrictions? How many people know the amount by which what they pay for an item would be reduced if the seller wasn’t passing along the costs incurred by the seller, the wholesaler, the manufacturer, and everyone else in the supply chain because of inadequate road funding?

Consider what would happen if all road taxes and user fees were removed. We’d be dealing with streets and highways that would rapidly crumble into muddy tracks flecked with loose stone, highlighted by deep ruts, and yielding nothing but rough rides. Speeds would be reduced to the point of utter frustration for motorists. Would it be too much sarcasm to note that the anti-tax crowd would be delighted, singing songs of joy at the demise of transportation taxation, sparing them a few hundred dollars while they cheerfully incur visible and hidden costs running into the thousands?

I wonder how many people, fortunate to be doing their Thanksgiving driving on good and excellent roads, gave thanks that there exist taxes that made their journeys possible. I did. I suspect I was alone, or nearly so, just as I am when I wear that t-shirt.

First Philadelphia, then Harrisburg, now Washington?

Four and a half years ago, in A Memorial Day Essay on War and Taxation, I pointed out, among other things, the foolishness of fighting a war while not only failing to raise taxes but recklessly lowering them. Though there is a danger that by quoting one segment of the piece I will shortchange the analysis that led to this conclusion, the warning that I issued about the long-term catastrophic risk of a “fight war, lower taxes” policy needs to be highlighted:

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.

Six months later, in War Taxes: Even a Discussion Can Teach Lessons, I supported a proposal by Senator Joe Lieberman for a war tax to fund the wars being waged. Almost a year ago, in The Obey War Tax Proposal: Sensible?, I expressed support for a similar proposal by Representative David Obey. In both instances I referred back to the quotation from A Memorial Day Essay on War and Taxation. I did so again in Peacetime Tax Policy While Waging War = Economic Mess.

Two years ago, in Does It Matter Who or What is to Blame?, I repeated this quotation, introducing it with this explanation of how America let itself get suckered into tolerating such bad judgment:

So long as the message sent by advertisers, politicians, and the entertainment industry is "You can have it all and you can have it all now," then it's no surprise that people behave in ways that jeopardize not only the nation's financial health but its survival.

Shortly thereafter, in Leaders as Teachers: Fixing the Financial Fiasco, I explained how Paul O’Neill, the Secretary of Treasury who opposed cutting taxes while continuing to spend substantial amounts for the waging of war, ended up as an ex-Secretary of the Treasury. I pressed home the point that good leaders know how to help those whom they lead understand what needs to be done, and demonstrate the courage required to do what is right rather than what is popular. Recently in Tax Incentives Can Do Only So Much and Some Insights Into the Tax Policy Mess, I expressed concern that until and unless Congress understands the impact of the “wage war while cutting taxes” decision, accepts what needs to be done, and does it, the nation, at best, will continue to wallow in economic doldrums and, at worst, will tumble into economic chaos.

Now comes news that Alan Simpson, a former Senator, a co-chair of the White House Fiscal Commission, and a Republican no less, has criticized Congress for its failure to increase taxes to provide funding for the wars being waged. He explained, “We have had a tax to support every single war in our history, the Revolutionary on in. We’re fighting two wars with no tax to support it. If you’re going to fight a war, much less two of them, you ought to have a tax to support it to let the American people know there’s a sacrifice involved other than the people who are fighting it.” Simpson isn’t saying anything different from what I shared in A Memorial Day Essay on War and Taxation:

The notion that a country can fight a war without general sacrifice of resources is mind-boggling. Our nation is at war. War has been declared on our nation, not by some relatively harmless but disturbed individual, but by an organization and movement that presents a genuine threat while changing the rules of war. Yet too many of us continue to think that war is something going on somewhere else, fought by others, and beamed into our homes by all sorts of spontaneous communications technology. But for that technology, the funerals of fallen heroes, and the fact today is a day we are reminded to stop and meditate on these matters, one might not know that a war, a global war, is underway. Televisions can be turned off, few visit the maimed veterans undergoing treatment at military hospitals here and abroad, and life pretty much goes on as it otherwise would.

I wasn't around during the last full-fledged, unlimited global conflict. Yet I've listened to as many tales as were shared with me by those alive at the time as I could find, and I've read and watched a lot. So I've heard and read about rationing, double shifts, postponed plans, substituted products, and sacrifice. Every tax practitioner, and every citizen, should understand that during World War Two income tax rates skyrocketed, wage withholding was introduced, and the entire revenue-expenditure structure was altered. War hung as a cloud over every life, and over every dollar. Is that good? I think so. Why? Because war is so serious and so terminal a course of action that it should not be permitted to recede to the background.

Yet the current global war has not been managed in the same manner. Politicians have chosen to fight without increasing revenue, imposing rationing, or deferring projects and activities. In their defense, they argue that none of these things are necessary, that a nation can have its guns without giving up its butter. I disagree, and I happen to think that politicians are reluctant to do what needs to be done because they are more concerned about maintaining their position in office than in making the tough decisions that war requires. So our national leaders have chosen to put the cost of the current war on our children and grandchildren. Those who decry the huge deficits, triggered in part by war and in part by the almost insane concept of decreasing tax revenues (mostly for the wealthy) during wartime, pretty much focus on the economic impact. They ask if, or suggest that, our grandchildren will be facing income tax rates of 80 percent in order to reduce an unmanageable deficit. I think it will be worse. I think our children and their children and grandchildren will become subservient to our nation's creditors. The sovereignty of the United States of America is far from guaranteed, and is at risk. Were these considerations discussed when those in power decided that war can be done on the cheap?

I get the sense that Alan Simpson would agree with my more extensive take on the matter. But I fear he continues to be in the minority.

Coming on the heels of last month’s Life for My Proposed Marcellus Shale User Fee? and And So Now Philadelphia Listens?, in which I explained that two of my tax policy proposals had shown up in Pennsylvania and Philadelphia tax policy initiatives, respectively, this most recent development closes the federal/state/local “are they listening to me?” tax policy trifecta. Unfortunately, as momentarily gratifying as this vindication might be, it means nothing if the respective legislators don’t buckle down and fulfill their civic obligation to set the city, state, and nation back on a robust economic track. If that means taking on the special interests who narrow-mindedness generated and nurtured the foolish ideas-turned-actions significantly contributing to the present dilemma, then that is what courageous leaders do. Otherwise, no matter their party allegiances, their failure speaks volumes about the relative priorities afforded certain special interests and afforded the American nation and its citizenry.

A Grander Delusion: Cut Taxes, Don’t Cut Spending, Cut the Deficit

A year ago, in Poll on Tax and Spending Illustrates Voter Inconsistency, I commented on the results of a poll in New Jersey that showed only 23% of those queried favored state tax increases whereas 68% supported reductions in spending on state programs and services. Yet when specific state programs were nominated for reduced state funding, a majority of respondents failed to support cutting that program’s funding. I noted:

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

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

Now a poll taken in California has confirmed that this paradoxical, and irrational, desire on the part of Americans to acquire benefits provided with public dollars, but to pay little or no taxes, is alive, well, and growing. When asked about ways to cut the state’s budget deficit, respondents preferred spending cuts to tax increases, but they also rejected spending cuts for programs constituting 85% of the state’s spending. The notion that “trimming waste,” as some suggested, can balance the budget when deficits are gargantuan is, as has often been demonstrated, nonsense. How can something as illogical as “I want the sun to rise in both the east and the west” or “I want it to snow but I want the temperature to be in the 90s” prosper in modern civilization without ultimately destroying it? The choices are clear: increase taxes, cut spending, do some of each, or suffer the consequences of huge government budget deficits.

Who is going to stand up and educate America to the realities of taxes and spending? Who has the courage to explain that the price for low taxes is low government spending? As I pointed out in The Grand Delusion: Balancing the Federal Budget Without Tax Increases, if taxes are to be reduced or tax cuts extended, and at the same time the federal budget balanced, there needs to be wholesale cutting of federal programs across the board. Yet it is clear that the majority of Americans object to those cuts. Americans cannot have it both ways. That’s been tried. It was tried when, during the early part of this decade, the decision was made to make simultaneous tax cuts and spending increases. This pairing contributed in a variety of ways to the economic crisis that followed, and continues to erode the economic foundation of America. How long can a political entity survive when its economic foundation crumbles? In this instance, ignorance is not bliss.

Does Cutting Tax Expenditures = Reducing Spending?

A reader reacted to Monday’s post, The Grand Delusion: Balancing the Federal Budget Without Tax Increases, by noting that “it seems like you left tax expenditures off the table” and pointing out that the Wall Street Journal article, and accompanying “Receipt,” to which I referred did not include tax expenditures because they aren’t cash outlays. The reader shared this link to the twelve largest tax expenditures. I agree with the reader that these amounts are significant.

In my response to the reader, I explained that I should have been more specific about the challenge of cutting federal spending. The challenge, in response to those who advocate balancing the federal budget by cutting spending and refusing to raise taxes, is for those people to identify the cuts they would make in federal spending. To me, cutting tax expenditures is the same as raising taxes. If exclusions, deductions, and credits are removed, taxpayers’ taxable incomes increase, and thus taxpayers’ tax liabilities increase. Thus, removing tax expenditures, whether in the form of exclusions, deductions, and credits, raises taxes and does not qualify as cutting spending. In fact, if the advocates of balancing the budget without raising taxes resort to removal of exclusions, deductions, and taxes, then they would be acting inconsistently with the avowed goal of not raising taxes. I’m not rejecting the removal of tax expenditures as a tax reform goal, and in fact, I support the removal of many tax expenditures; I’m simply pointing out that removing tax expenditures does not qualify as the identification of spending cuts.

If the advocates of cutting spending while not increasing taxes do slide over to the world of tax increases disguised as tax expenditure reductions, they run the risk of making after-tax life for the wealthy disproportionately better than after-tax life for the not-so-wealthy. Depending on which tax expenditures are cut, the middle class could wind up yet again bearing a disproportionate burden of the increased revenue. Consider two taxpayers, M and W, both of whom are unmarried. M’s taxable income puts M in the 25% marginal bracket, whereas W’s taxable income puts W in the 35% marginal bracket. M’s taxable income is $80,000 and M’s federal income tax liability is $16,181. W’s taxable income is $1,600,000 and W’s federal income tax liability is $537,643. M owns a home purchased for $250,000, on which there is a $200,000 mortgage. W owns a home purchased for $5,000,000, on which there is a $4,000,000 mortgage. M pays mortgage interest of $10,000 and W pays mortgage interest of $200,000. Under section 163(a), after taking into account section 163(h), M deducts the entire $10,000 mortgage interest payment, and W deducts $55,000 of the $200,000 mortgage payment ($200,000 x $1,100,000/$4,000,000). The mortgage interest deduction is the third largest tax expenditure, and it is one often nominated for full or partial repeal. If it is repealed, what happens to M and W? M’s taxable income would increase to $90,000, putting M into the 28% bracket, and increasing M’s tax liability to $18,909, an increase of $2,728. W’s taxable income would increase to $1,655,000, leaving W in the 35% bracket, and increasing W’s tax liability to $ 556,893, an increase of $19,250. M’s tax liability increases 16.9% ($2,728/$16,181) and W’s tax liability increases 3.6% ($19,250/$537,643). Though there probably are a few tax expenditures repeal of which would not disproportionately disadvantage lower-income and middle-income taxpayers, the repeal of most, if not all, of the significant tax expenditures would generate similar instances of higher percentage tax increases for the middle class than for the wealthy.

Years ago, the “hide the tax increase and put it on the middle class” trick was tried and, at least for a while, worked. Congress enacted phaseouts of itemized deductions and the deduction for personal and dependency exemptions, which increased the taxes paid by middle-class and wealthy taxpayers, but claimed that because it did not increase tax rates, it did not increase taxes. Many Americans bought into that lie until they discovered, through the educational efforts of those who understood the subterfuge, that the phaseouts created a bubble, which in effect subject middle-class taxpayers to higher marginal rates than the marginal rates applicable to wealthy taxpayers. Eventually, political pressure forced Congress to phase out the phaseouts, though absent Congressional action, they return, like a seemingly dead monster in a horror flick, in 2011. This time, if Congress appears serious about repealing things such as the mortgage interest deduction and the exclusion for employer-paid health care premiums, the howls that will be heard will be louder than the ones reaching our ears when social security benefit cuts are mentioned. Even though there are good arguments for eliminating many tax expenditures, including the two that I mentioned, the political reality is that doing so in order to preserve or even reduce the already low rates to which the taxable income of the wealthy is subject won’t work. There might be some chance if the tax increase generated by repealing tax expenditures is dedicated to reducing the federal budget deficit, but even that approach faces an uphill political challenge.

What’s need is leadership and education. Americans need to learn the extent to which the nation’s economy is in trouble, how it happened, and what needs to be done to fix it. Until this happens, any improvement in the economy will be negligible and job growth minimal at best. It takes strong leadership to persuade a nation’s taxpayers to focus on the problems, and to pay attention to solutions. It is easy to shoot down every idea, which takes us back to why I issued the challenge in The Grand Delusion: Balancing the Federal Budget Without Tax Increases: If you truly believe that you can balance the federal budget without raising taxes and without raising taxes surreptitiously by eliminating exclusions, deductions, and credits, tell me which federal spending outlays, and how much of each, you plan to cut. Show me the numbers. Show the nation the numbers. The nation will appreciation your answers, as will I, because they will demonstrate why tax increases – including tax expenditure elimination – are unavoidable if the nation is to avoid falling into economic devastation that will make the Great Depression appear to be no big deal.

Job Creation and Tax Reductions

The rhetoric surrounding the debate over extending the Bush tax cuts is moving from absurd to ridiculous. Advocates of extending the tax cuts for the wealthy are trying to convince the 99 percent of the population that is NOT wealthy that it is in THEIR best interest to support tax cuts for the wealthy. Apparently having decided that the “you middle-class people don’t get an tax cut extension unless the wealthy also get theirs” threat wasn’t working, the supporters of lower taxes for the wealthy are now taking a slightly different approach. They’re trying to link employment prospects for middle-class and lower-income workers to more tax cuts for the wealthy.

Over the weekend, John Boehner, the representative who most likely will become Speaker of the House in January, uttered this bit of reasoning (see, e.g., this report): “I think that extending all of the current tax rates and making them permanent will reduce the uncertainty in America and help small businesses to create jobs again. You can’t invest when you don’t know what the rules are.”

There are at least four major flaws in Boehner’s reasoning. What he said sounds good, at least to those who don’t understand the deeper issues. But sounding good isn’t good enough.

First, though Boehner is correct that uncertainty can generate indecision and stagnation in all sorts of economic activity, including investment, hiring, project initiation, and similar efforts, as I explained in Tax Politics and Economic Uncertainty, uncertainty can be resolved no less definitively by letting the tax cuts for the wealthy expire as it can by letting all of the tax cuts expire or by letting none of the tax cuts expire. Eliminating uncertainty is not something that occurs ONLY if tax cuts for the wealthy are extended. Certainty is more likely no matter what is done, so long as something is done.

Second, there is no certainty in the true sense of the word. No matter what Congress does, the same or a future Congress can change tax rates. One Congress cannot bind a future Congress. Even if advocates of low and lower taxes for the wealthy managed somehow to get their silly idea adopted as an amendment to the Constitution, there’s no guarantee that it would not be removed at a later time. One need to think only of the foolishness surrounding the Prohibition Amendment to understand the elusiveness of certainty.

Third, the financial cost of extending the tax cuts is enormous. Recall, as noted on Monday in The Grand Delusion: Balancing the Federal Budget Without Tax Increases, it would require cutting almost all federal expenditures, assuming Social Security, Medicare, Medicaid, military operations, and interest on the national debt are not cut, just to eliminate the existing deficit. Extending tax cuts makes the deficit even larger. What gets cut to fund tax cut extensions for the wealthy? There's not much left to cut, is there? The answer, of course, which the advocates of those tax cut extensions won’t state publicly, is to cut social security and Medicare benefits for the middle class. In the long-term, the effects of cutting Social Security and Medicare to compensate for tax cut extensions favoring the wealthy will be further economic erosion, and a loss of jobs making the current unemployment rate look like “the good old days.”

Fourth, reducing tax rates or extending low taxes for the wealthy, which is what Boehner advocates, does not create jobs. Extending tax cuts for individuals with incomes exceeding $250,000 (for purposes of simplicity, without getting into the slightly different numbers for individuals in different filing status categories) in addition to extending tax cuts for individuals with incomes under that amount would have no effect on small business owners who do not generate that much income from their business. And that's most truly small business. What about individuals with incomes exceeding $250,000? Will they create jobs if their taxes are reduced or if their tax cuts are extended? Not necessarily. A person does not “create a job,” that is, hire a person for a position that previously did not exist, simply because the person’s tax cuts are extended. People do not hire other people for the sake of doing so. They hire other people if they have work that needs to be done. Extending tax cuts does not cause an increase in the amount of work that needs to be done. Even if it did, would the extension of a tax cut that means roughly $35,000 to someone with income of $1,000,000 generate a new job of any significance? Considering that it costs roughly $1.40 to pay $1 in salary, even if the person with $1,000,000 of income needed work to be done, at best they could “create” a job that pays roughly $25,000. One job. One job paying very little. On the other hand, if the person really needed to hire someone, the tax law provides a zero tax rate on the income used to pay a new employee. Thus, no matter the tax rate, if the person with $1,000,000 of income needed to hire someone to do work for $25,000, by doing so at a rough cost of $35,000, the person’s taxes would be reduced under current law by roughly $12,000, and under a tax-cut-expiration situation, by roughly $14,000. In other words, the “we aren’t creating jobs because our taxes might go up” is utter nonsense. If the person has work that needs to be done, $2,000 isn’t going to make or break the decision. Better yet, the wealthy person can hire enough people so that their taxable income sinks below $250,000 and they won't need to bother themselves with what the tax rates for the wealthy are, and in the process they can learn what it's like to live like most people do. What will create jobs is an increase in demand, 90 percent of which comes from the 99 percent who are not in the economic top one percent, and the best way to stimulate demand among the 99 percent is to extend their tax cuts. Ironically, where work needs to be done, such as highway and bridge repair and maintenance, refurbishment of public infrastructure such as storm sewer systems, firehouses, schools, sanitary sewage systems and plants, dams, national cybersecurity, and similar public improvements, the advocates of tax cuts for the wealthy hold a position that guarantees the lack of funding for most, if not all, of what needs to be done to keep the nation vibrant in a changing world economy.

It should be obvious what this debate is all about. It’s about greed. Hiding the role of greed as the motivating factor for misrepresentations and half-truths becomes difficult when people can see the true agenda. If the wealthy wanted to create jobs, they could be creating jobs as I write while getting tax benefits in the form of deductions and even, in some instances, credits. Instead, they hold the nation hostage while claiming, falsely, that jobs will be created only if tax cuts on the wealthy are extended. They don’t mention what economic life would have been like had taxes for the wealthy not been cut when the nation went to war.

The Grand Delusion: Balancing the Federal Budget Without Tax Increases

The debate between the choices of raising taxes or cutting spending continues, and is certain to become more intense, louder, and more confusing. One problem is that the two choices are not mutually exclusive. It is possible to raise taxes and reduce spending. In fact, that might be the remedy, considering that a significant reason the federal budget deficit is so large is the decision to cut taxes while raising spending. I’ve written about the foolishness of that decision several times, most recently in Some Insights into the Tax Policy Mess, in which I wrote:

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.

In FICA, Medicare, and Payroll Taxes, I noted that “Advocates of tax cutting need to identify the cuts they would make to balance the budget, and if they don’t touch defense, Medicare, Social Security – and they’re stuck with the interest payment on the debt – there’s not enough to cut.”

So today I invite the advocates of using spending cuts as the sole solution to the budget deficit crisis to identify sufficient cuts to bring the budget into balance. Off the table is the “trickle down” nonsense that claims tax cuts increase revenue, because when that was tried it didn’t happen. Though there was a momentary upward blip in tax revenues, the long-term experience demonstrates that short-term success is simply that, transitory illusion.

A month and a half ago, the Kaiser Family Foundation released poll results revealing that 40 percent of Americans “think that foreign aid is one of the two biggest areas of spending in the federal budget.” This, of course, is totally incorrect. Once again, the question pops up, “Why are Americans so wrong about something so easy to learn?” The Wall Street Journal, in this article, reported on the poll results and asked the Washington think tank Third Way to prepare “A Taxpayer’s Itemized Receipt” that shows where federal tax revenues go. The “Receipt,” which accompanies theWall Street Journal article, shows what happens to the $42,978 of total income and payroll taxes paid by a working couple with income of $200,000, and what happens to the $7,555 of total income and payroll taxes paid by a retired couple with income of $100,000. What I have done is to convert the figures to show how much of every $1,000 of total income and payroll taxes is expended on some of the categories.

Of the $1,000, $192.64 is paid out in Social Security benefits. Military operations account for $179.29, of which $41.42 is attributable to operations in Iraq and Afghanistan. Another $120.76 is used for Medicare, and $71.32 goes for Medicaid. Interest on the national debt takes $53.16, and veterans’ benefits and health care consume $25.24. Food stamps cost $15.38, the CIA gets $14.15, and federal highways, $11.83. The amounts spent on NIH, Department of Energy, housing subsidies, and each of the other categories is even less. Foreign aid takes $8.53, an amount which puts it far down the list, certainly not one of the top two categories.

Seen another way, the proposed 2011 federal budget, according to this summary, would consist of receipts totaling $2.567 trillion, expenditures amounting to $3.834 trillion, and a deficit of $1.267 trillion. To balance the budget without raising taxes, $1.267 trillion of the $3.834 expenditures would need to be cut. That’s 33 percent of the expenditures. Social security, Medicare, Medicaid, military operations, and interest on the national debt alone constitute 62 percent of the expenditures. Unless those are cut, then 89 percent of all other expenditures, including veterans’ benefits and health care, the CIA and other intelligence activities, NIH, military retirement, border security, immigration, the FBI, the courts, FEMA, the Coast Guard, federal prisons, and a long list of services that the country surely needs, would need to be axed.

Some might propose cutting Social Security, Medicare, and Medicaid, but that proposal would bring howls of opposition from across the spectrum, with people of all ages and political stripes objecting. There are those who would cut military operations, but again, objections would pour in from those concerned about the consequences. Who would rejoice at cutting almost 90 percent of national intelligence activities, border security, federal highways, and the Coast Guard? How about NASA? Having already had its budget cut, it has cancelled the program to replace the shuttle, which means China, or perhaps Japan or Russia, will put people on the moon, plant their flag, and leave the United States gasping in the wake of these other nations’ successes. Cutting interest on the national debt would destroy the country’s credit, and accelerate the deep spiral into which it already is heading. Note that to reduce interest on the federal debt, the debt must be cut, which means chopping even more expenditures in order to generate a budget surplus that can be used to pay down the debt.

Those who claim that there is waste that can be eliminated want us to believe that one-third of federal expenditures constitute waste. That simply isn’t so, and no study of the question has ever projected a ratio anywhere near that level. There are those who would cut all the social programs other than Social Security, Medicare, Medicaid, and veterans’ benefits, but that won’t generate a 33 percent reduction in spending. With state and local governments unable to take up the burden, that sort of cutting would create a desperate conglomeration of destitute individuals driven to do more than demonstrate. Do the people who advocate this sort of cutting ever stop to picture or imagine what society would become under those circumstances?

Those who want to tinker with various spending cuts -- as well as revenue adjustments -- will find this interactive federal budget puzzle to be interesting, and in some strange way, almost fun.

I find it interesting to consider what would have happened had taxes not been cut, let alone raised, when the nation went to war nine years ago. Imagine the trillions of dollars that would have been collected during that period. Imagine the impact on credit markets. Imagine an economy not bloated with tax cut money and thus not sucked into bubbles that eventually burst. It’s too late to go back and do the right thing that should have been done. It’s politically impossible to collect “back taxes” with interest to compensate for the error in judgment. And until Americans understand the reality, it’s politically impossible to put an end to one of the principal causes of the economic mess in which the country is mired. With 40 percent of the nation’s citizens thinking foreign aid is one of the top two federal expenditures, we have a very long way to go before Americans are cleansed of the lies and misleading sound bites of the extremists and ready to tackle the problem. By then, it will be too late. Unless taxes are raised – and that’s not saying there should be no cutting of expenditures – but, I repeat, unless taxes are raised, America will be a second-order, or perhaps even third-order, nation by the end of this century.

Stamping Out Tax Misinformation

It’s a long story with a simple lesson. Not only is the story long, it’s about taxes. Nonetheless, it’s worth reading. I’ve tried to shorten it without losing the message.

It begins with a TaxProf blog post about a Canadian couple who won a lottery and gave almost all of their winnings to charities. In his post, Paul Caron pointed out that if the couple lived in the United States, they would have a tax problem, because only 50 percent of their charitable contributions would be deductible, leaving them taxable on roughly half of their winnings. Roughly, because they did not give away all of their winnings and they probably would have other deductions; perhaps they have other taxable income. But, give or take a little bit, they would be paying federal income taxes.

A student in a course taught by another tax law professor saw the TaxProf blog post and directed that professor to this Wall Street Journal article. In the article, the author tries to explain that deciding whether to make charitable contributions in late 2010 or early 2011 isn’t as easy as it might appear. Though some advisors suggest waiting until 2011, when higher rates might generate larger tax savings that offset the reduction in the present value of the tax savings arising from the delay, there are other considerations that favor donating in 2010. The author then writes:

Another consideration is the absence of limits this year on itemized deductions for charitable giving. Limits tied to income will come back next year unless Congress acts to stop that.

When I saw that, my immediate thought was, “Whoa! Was there a tax law change that I missed? When the basic tax course reaches the charitable contributions deduction topic in a few days, will I be teaching the wrong law?” I stopped what I was doing and did some research, even though the tax law professor to whom the student had pointed out the Wall Street Journal article had noted that this was something of which she had been unaware. But perhaps she and I were wrong. When in doubt, research it.

What I discovered is that there is nothing in section 170 suspending the 50 percent limitation on charitable contributions to public charities. I found nothing in any amendment to section 170 suggesting such an outcome. I found nothing in uncodified legislation. I discovered that the people at Grant Thornton think the limits are still in place; Go to their Year-End Tax Guide For 2010, go to chapter 7, and from there go to the charitable contributions chart. I shared with my tax law professor colleagues across the nation not only the results of my research but this thought: “I wonder if it was a change in a limit on something else related to charitable contributions?”

In response, another tax law professor noted that he did not see anything in section 1400S, where, to quote him, “most of the [section] 170 percentage limitation suspension rules reside.” He also informed us that he and his co-authors had not discovered anything suspending the 50 percent limitation while they were preparing their current developments outline, which, as he explained, “requires reading every new tax provision.” This response was comforting. I, too, read every new tax provision and had not seen anything. The fact that, by this point, four of my colleagues across the country were reaching the same conclusion reduced the odds of my having missed something.

Another tax law professor suggested, “Perhaps it had to do with charitable contributions of IRA accounts.” Yet another colleague chimed in that it was “probably a reference to the temporary elimination of the income-based deduction phaseout in section 68.” That phaseout affects many more itemized deductions than charitable contributions, and has no effect on the 50 percent charitable contributions deduction limitation. This same law professor had taken the research effort in a different direction, sharing a link to the IRS web site, where the August 25, 2010, version of Publication 78 Help, Part II, describes the 50 percent charitable contributions limitation as still in effect.

Still another tax law professor opined that the author of the Wall Street Journal article must have been referring to the return of the section 68 phaseout. He explained that there have been some articles, such as this one from SmartMoney magazine that recommends increasing 2010 charitable giving, especially if the taxpayer’s only itemized deduction, or perhaps only significant itemized deduction, is charitable contributions. This professor then warned, “these sorts of articles can confuse people into thinking that the [section 68 phaseout] is only for charitable gifts, when in fact it applies to all itemized deductions.” Exactly. The lack of precision opens the door to misunderstandings.

Someone suggested that the student who brought the Wall Street Journal article to the attention of his professor be encouraged to contact the Wall Street Journal and identify the error. We’ve been told that the student has been so advised.

One way of checking out something that is alleged about taxes is to put the question to others who have expertise in the matter. That is what happened in this instance when the professor to whom the Wall Street Journal article was shown had doubts and asked her tax law professor colleagues throughout the country for their reactions. Unfortunately, most people, when hearing or reading something about taxes, simply treat the information as true. And therein lies the lesson.

Whether the misinformation is accidental, as I’m very certain is the case with the Wall Street Journal article, or deliberate, its impact can be damaging. It’s not just the taxpayers who accelerate or delay charitable giving when in fact they should have done the opposite. Sometimes a substantial portion of the electorate can go to the polls and make decisions based on deliberate misinformation with respect to taxes, as discussed in this analysis. The ultimate lesson for everyone, not just tax law professors, tax students, or tax practitioners, is to figure it out for one’s self, with the help of the source material and those with expertise in the matter. Otherwise, tax misinformation that needs to be stamped out will proliferate. There is no good to be found in that outcome.

And So Now Philadelphia Listens?

Several months ago, in A Tax on Blog Writing or on Blog Business?, I reacted to the news that Philadelphia was subjecting bloggers to its $300 business privilege license fee no matter the amount of income received by the bloggers, even in instances where the blogger’s advertising receipts fell far below $300. I noted:

There’s a simple solution. City Council needs to define “business” so that the business taxes and fees apply only to those taxpayers who file a Schedule C or Schedule C-EZ with their federal income tax return.

Now comes news, as reported in thisPhiladelphia Inquirer story, that Councilman Bill Green, joined by five other members of Council, has introduced legislation that would prevent the city from imposing the business privilege license fee on individuals whose blogging is a hobby. The determination of whether the individual’s blogging was a hobby would be determined using federal income tax law. In other words, if the blogging income showed up on a federal Schedule C or Schedule C-EZ, the blogging would be treated as a business, but if the de minimis blogging income showed up as miscellaneous income, and was not treated as a business for federal income tax purposes, the blogging would be treated as a hobby. For federal income tax purposes, the effect of treating an activity as a hobby is that any deductions that would otherwise be deductible in full are limited to the total income, except for deductions allowable in any event, such as interest and taxes. For those interested, here is the text of the proposed Philadelphia legislation.

Coming on the heels of the news, on which I commented two days ago in Life for My Proposed Marcellus Shale User Fee?, that Pennsylvania legislators are now considering Marcellus shale natural gas extraction user fees as I suggested in Tax? User Fee? Does the Name Make a Difference?, this most recent development has me thinking that perhaps, just perhaps, legislators, or at least members of their staffs, are paying attention. It remains to be seen whether this change in Philadelphia tax law gets enacted.

Life for My Proposed Marcellus Shale User Fee?

More than a month ago, in Tax? User Fee? Does the Name Make a Difference?, I suggested that a key to breaking the stalemate in the Pennsylvania legislature, and between the legislature and the governor, with respect to the taxation of Marcellus shale natural gas could be reliance on user fees rather than on a tax. I reiterated this point almost a month later, in Giving Up on Taxes = Surrendering Taxpayer Rights?

Now comes news, in a Philadelphia Inquirer story, that is best summed up by the headline: “New Pa. GOP Leaders Eye a Fee on Natural Gas Instead of a Tax.” Have these people been reading my MauledAgain posts? It’s possible. One of the legislators, an incumbent re-elected without opposition, and who is moving up to a leadership position, is someone I’ve known since I was in high school. The House Republicans, who at first had been opposed to a tax, but later offered a low-rate version, have explained that they think there should be “a way for industry to contribute to local municipalities to help out with the impact” of road and environmental damage, to name two of the several burdens that otherwise would fall on local taxpayers. Though I commend the announced plans, I am troubled with the phrase “help out” because it suggests something less than a fee sufficient in amount to cover the full cost of what economists call the externalities. And, as usual, it remains to be seen whether the legislature gets anything done with respect to this issue. Announcing plans isn’t quite the same as accomplishing the goal, particularly with so many distractions, interruptions, roadblocks, negotiations, lobbying, and other impediments to legislative progress. Considering that the Republican governor-elect is opposed to taxes across the board, and that many House Republicans are willing to consider a tax, the idea of a user fee – as I proposed more than a month ago – indeed provides a pathway to breaking the legislative logjam.

The Horror of Halloween Widens

Last Wednesday, in The Horror of Halloween?, I noted that I was shocked, and certainly not treated, when a small girl whom I did not recognize and who had arrived at my door seeking candy, saw what I was handing out and said, “No thank you, I don’t like Reese’s Peanut Butter Cups.” There’s someone who doesn’t like Reese’s?

On Thursday, it got worse. A faculty colleague emailed me to tell me that two other faculty colleagues do not like Reese’s Peanut Butter Cups, because they do not like peanut butter. Wow. It’s worse than I realized. But is it bad news because it explains why the Reese's four-packs are no longer available in the places I look due to a declining market? Or is it good news because it means there are more Reese’s Peanut Butter Cups available for those of us who think they are the elite candy, even if they come in those tiny two-packs?

Perhaps I should be asking more people about their views on Reese's Peanut Butter Cups? Then emails such as the one I received on Thursday would not be so shocking?

Taxes and Religion: A Totally Different Perspective

No, this isn’t a post about the tax-exempt status of religious institutions. It’s not a post about the relationship between theological principles and tax policy. It’s about, well, keep reading.

Several days ago, while continuing a long project of working methodically through the database holding information on the descendants of Thomas Maule of Salem, Massachusetts, I reached the entry for Louis Blaul, who had married Mary C. Clendenon, a descendant of Thomas Maule through the Clendenon branch of the family. Louis was a well-known photographer in Philadelphia, operating a business that was taken over by his son, also named Louis, when he died. My google search for “Louis Blaul” brought me to an entry on google books. It was Volume 10, No. 1 (Jan–Feb. 1910) of the Single Tax Review, subtitled “A bi-monthly record of the progress of single tax and tax reform throughout the world.”

What was the single tax? A tax on unmarried individuals? No, it is a tax on the value of land, proposed by Henry George in the latter part of the nineteenth century. The theory was, and remains, that the revenue collected from taxing land would be sufficient to permit elimination of all other taxes. The underlying justification for the tax is that, although a person should be treated as the owner of all that he or she creates, that which is found in nature, such as land, belongs to society as a whole. The point of this post is not to get into a discussion of the single tax. It’s something else.

What caused google to send me to the Jan-Feb 1910 edition of the Single Tax Review was an obituary for Louis Blaul. Unfortunately, it contained no genealogical information, though it did illuminate some aspects of his personality. In a short, two-paragraph write-up under the simple headline, “DEATH OF LOUIS BLAUL,” an unidentified writer shared this information:

The death of Louis Blaul, of West Philadelphia, robs that city of an earnest and devoted Single Taxer. Though for years he has been a helpless invalid he has made his influence felt through an ever increasing circle of friends.

Though informative and interesting, the first paragraph is not what triggered the thought of “taxes and religion.” It was the second paragraph, which described something that I had not previously encountered:

The funeral was conducted as he had desired, not according to the rites of any church, but by officiating Single Taxers. Mr. Ross read from Progress and Poverty, portions of the “Central Truth,” and “The Individual Life.” Among other Single Taxers present were Henry C. Lippincott, Chas. F. Shandrew, Haines D. Albright, Miss Musson, Dr. and Mrs. Wright, and Dr. Sullivan, of Albany, N.Y.

The idea of having one’s funeral conducted by members of a tax reform movement opens up all sorts of stupefying possibilities. Would a staunch advocate of the, or should I say, one or another, flat tax want someone to read a portion, or perhaps all, of proposed flat tax legislation? Would an defender of the progressive income tax want someone to read from the legislative history of the Internal Revenue Code? Would a supporter of the unitary method of apportioning income for state income tax purposes prefer that someone read from the latest judicial opinion on the matter? Would anyone want a reading from a United States Supreme Court opinion dealing with a tax issue? People often cry at funerals and memorial services. I can’t imagine giving them even more reason to do so.

Could it be that devotion to a tax reform concept can rise to the level of being itself a religion, under which, for example, funerals are held? Would that open the door to weddings performed under the auspices of adherents to a VAT? Would meetings of consumption tax proponents morph into some sort of worship service?

At what point does it become, not “Taxes and Religion,” but “Taxes as Religion”?

The Horror of Halloween?

For me, Halloween started when, during an afternoon conversation with my neighbor, he asked me if I was planning to hand out candy this year. I assured him I was ready. He told me that I had a reputation in the neighborhood for handing out good candy. No kidding! I’ve been distributing Reese’s Peanut Butter Cups for years. True, my inability to find the four-packs has compelled me to hand out the smaller two-pack, but Reese’s Peanut Butter Cups it will be. This is the fifth year that I’ve come up short in the four-pack department, with the first episode of the bad news described in Happy Halloween: Chocolate Math and Tax Arithmetic, the continuation noted in Tricky Treating: Teaching Tax Trumps Tasty Tidbit Transfers and in A Truly Frightening Halloween Candy Bar. By last year, I had become so accustomed to the disappearance of the four-pack from my shopping venues that I considered it no longer noteworthy. This time around, I want to reassure the neighborhood children that I continue to look, and if I see four-packs return, I will acquire them. I have a candy-distribution reputation to maintain!

Shortly after 6 in the evening, children – many accompanied by parents, some coming to the door because they were carrying, or holding the hands of, little ones, and some standing off at a short distance – began ringing the bell, knocking on the door, or simply making noise loud enough for me to notice. They were delighted with the Reese’s Peanut Butter Cups. Having the chance to see what was in their bags, pumpkins, or other containers – hats off to the young teen who was using a 30-gallon drawstring plastic trash bag – it appeared to me that the per-ounce take from my premises was on the high side.

But then came the shocking non-treat of the night. A small girl whom I did not recognize said to me, “No thank you, I don’t like Reese’s Peanut Butter Cups.” I found some other candy to give her, though it may have been sitting around long enough to have become stale. That didn’t dawn on me until after she walked away. I was still in shock. There was someone who didn’t like Reese’s Peanut Butter Cups. Horrors! Later that evening, I wondered if perhaps she had turned it down because she was allergic to peanuts and didn’t want to disclose that fact. There’s a young man in the neighborhood who is allergic to peanuts, and who would tell me that every year. But a year or two ago, he stopped telling me that and took the Reese’s Peanut Butter Cups. Did he outgrow, or get cured of, the allergy? Perhaps, and hopefully so, but I think it is more likely that he uses the Reese’s Peanut Butter Cups as trade bait. We could have a future professional sports general manager in the making in our neighborhood.

The following morning, I heard on the radio that someone had ranked candy from worst to not-so-worst in terms of health aspects. After digging around, I discovered that the source must have been this candy ranking. The radio announcers disclosed the ten worst, and Reese’s Peanut Butter Cups was not among them. Of course not. Peanuts are protein and chocolate is, yes, medicinal. It took many, many clicks – as each candy has its own slide in the slide show – to determine that Reese’s Peanut Butter Cups came in 32nd out of 40. That means there are 31 candy bars worse for one’s health than the Cadillac of candy. But does this mean that, considering there must be hundreds of different kinds of candy bars, let alone candy – though I was unable to find any sort of accurate count or estimate – this could be even more bad news. Imagine this conclusion: “There are 643 types of candy healthier than Reese’s Peanut Butter Cups.” Impossible. How could, for example, hard candy – which is pure sugar – be healthier than Reese’s Peanut Butter Cups?

But the real horror was the percentage of children toting UNICEF trick or treat boxes. Zero. In a conversation at the gym the following morning, several other people noted the same phenomenon. What has happened to the UNICEF tradition? My children abandoned Halloween candy acquisition expeditions years ago, so I’m out of the loop. Perhaps we need a tax credit for families whose children take UNICEF boxes and collect money for a good cause while they make their candy rounds? That would be even more horrible. It reminds me of a parent I once overheard saying to a child, “If you’re nice to your brother, I’ll pay you a dollar.” Ouch.

Could Tax Law Professors Be More “Tax Return Hands-On” Than Tax Practitioners?

Thanks to an item on Paul Caron’s TaxProf blog, I found myself reading a Time Magazine article, “Why $1,700 Means Joel Stein is Rich.” There are all sorts of blogworthy tidbits in the article – ranging from the definition of income subject to the proposed $250,000 cut-off for extending tax cuts to some amusingly sarcastic commentary about how a tax cut should be used by the taxpayer – but the one that gets attention today is the comment made to Stein by a tax lawyer he contacted about the tax cut debate. Mike Foster, who practices with Venable LLP, said, “I don’t even do my tax returns anymore. I don’t know any tax lawyer who does their own tax returns. The forms are Greek even to us.”

Hopefully someone does a survey to determine how many tax lawyers do their own returns. Anecdotally, there is evidence that among tax law professors, a more than insignificant number do their own returns. I use that phrase generously, as I include not only those who prepare their returns manually but also those who use software such as Turbotax. Even if the latter doesn’t count as “doing one’s own return” – though I wholeheartedly think that it does – there are tax lawyers who do their own returns. It is interesting to me that one can find these tax lawyers in academia, whereas one might expect there to be a higher percentage among full-time practitioners. If Foster is correct, there exists what I would consider to be the reverse of the stereotypes, namely, academics doing tax returns and practitioners handing the task off to someone else. Hence the desire for a survey to corroborate or rebut this apparent counterintuitive outcome.

So here’s a project for someone in need of a research topic, particularly if it is one for which empirical research would be valuable. Are there any LL.M. (Taxation) students about ready to enroll in a Tax Research and Writing course? The only price I charge for coming up with the idea is a request that you share the results of the survey and provide a link to the paper that you write.

Happy Halloween: Revenue Department Scares Kids Into Abandoning Pumpkin Sales

It’s Halloween! It’s a frightening time of the year. Actually, considering how frightening the world has become for the rest of the year, let’s say that it is an even more frightening time of the year. And what could be more frightening than employees of a state revenue department descending on two children, both under the age of 7, and shutting down their pumpkin-selling fund-raising efforts?

Is it more frightening than Taxing "Snack" or "Junk" Food (2004)? More unnerving than Halloween and Tax: Scared Yet? (2005)? More intimidating than Happy Halloween: Chocolate Math and Tax Arithmetic (2006)? More alarming than Tricky Treating: Teaching Tax Trumps Tasty Tidbit Transfers (2007) and Halloween Brings Out the Lunacy (2007)? More unnerving than A Truly Frightening Halloween Candy Bar (2008)? More terrifying than Unmasking the Deductibility of Halloween Costumes (2009)?

Indeed, in many ways it is. According to this story, two children, ages 4 and 6, decided to raise money for school sports. They set out to sell pumpkins at a roadside stand outside their family home. Along came a state tax collector who told the children, and their parents, that because they did not have a state sales tax license they had to shut down. Shades of the Philadelphia business privilege license fee being imposed on baby sitters, as I discussed in A Tax on Blog Writing or on Blog Business?.

If I had any worthwhile artistic skills, I’d crank out a cartoon, showing two terrified youngsters looking up aghast at a big, stern, glowering tax department employee. The caption would simply be, “What’s a sales tax license, mister?”

The sad, ironic, and perhaps galling aspect of the story is the part that hasn’t been told. Why would two children who haven’t even reached the age of reason decide they needed to raise money for school activities? Is there some background information missing? Could, perhaps, their efforts be a reaction to the consequences of insufficient funding, a by-product of opposition to tax increases? I don’t know. Perhaps someone in Lewiston, Idaho, where this took place, can let us know. That’s assuming someone in Lewiston reads MauledAgain. I’m afraid that’s a mighty monstrous assumption. But I could be wrong, and wouldn’t that be such a nice treat?

P.S. Please do read the five-sentence story. See if you can find the five plays on words.

Juggling Tax Return Due Dates

The American Institute of CPAs (AICPA) has forwarded to the Congress a proposal to alleviate the procedural challenges posed by the current set of due dates for filing corporate and partnership returns. The problem that the proposal addresses is a serious one. For example, under current law, an individual who is a partner in a partnership must file his or her tax return by April 15, but the partnership is not required to file its return until April 15. As a practical matter, the partner does not have, by April 15, the information that is required to file the return by April 15. Even though extensions of time to file the returns can solve the problem in many, though not all cases, the taxpayer nonetheless must pay his or her taxes by April 15. This requires cautious taxpayers to overestimate their tax liabilities to avoid possible interest and penalty charges.

The AICPA proposal suggests the following:

Moves the original due date of partnership returns one month earlier and reinstates a 6-month extension (3/15 and 9/15);

Separates the due dates of S and C corporation returns;

Maintains the longstanding due dates of Form 1040 (4/15 and 10/15);

Moves the original due date of S corporation returns to two weeks after partnership returns and two weeks before the original due date of individual, trust and C corporation returns (3/31);

Moves the extended due date of both S corporation and trust returns so that they are two weeks after partnership returns and two weeks before the extended due date of individual and C corporation returns (9/30);

Moves the original and extended due date of C corporation returns one month later (4/15 and 10/15); and

Maintains the original due date of employee benefit plan returns on July 31 but allows for automatic three and one-half month extension by moving the extended due date one month later (11/15).

The proposal explains the reasoning for these changes, and the reasoning makes sense.

However, I would go further. Because there are so many partnerships that, in turn, are partners in other partnerships, I would set up an even more gradated schedule. Partnerships that have other partnerships as a partner would be required to file by the last day of February. Partnerships that do not have other partnerships as a partner would be required to file, as the AICPA proposes, by March 15. By providing an earlier due date for partnerships with other partnerships as partners, partnerships that do not have other partnerships as partners will not be delayed by having a due date that is the same as the due date for the partnership from which they are waiting for information. It would be nice if this pattern could be extended so that partnerships with partners that are partnerships with other partnerships as partners would have an even earlier due date, but two limitations make this unwieldy. First, it would move a due date to the middle of February, which is too early to have all the information ready. Second, a partnership with other partnerships as partners knows that it has other partnerships as partners, but does not necessarily know if that other partnership itself has other partnerships as a partner.

Further, in an effort to spread the demands on the IRS return processing functions over a longer period. I would move the due date for certain individuals to March 15. Individuals who have no gross income from partnerships, S corporations, trusts, estates, or other pass-through entities, and who thus are not waiting for information returns from pass-through entities, should have all the necessary information for filing their returns by the end of January and thus should be able to meet a March 15 due date.

Even without my suggested modifications, the AICPA proposal makes sense. It’s a substantial improvement over the current system. And it’s a far better idea than the one floated some years ago by a member of Congress who wanted to make tax returns due on the taxpayer’s birthday. Imagine how that would work.

Yet More Reasons to Prefer User Fees

Earlier this month, in Better to Tax Gross Receipts, Net Income, or a Combination?, I revisited the question of whether, and if so, how, the Philadelphia business tax structure should be changed, following up on comments I made on the issue in Don’t Like This Tax? How About That Tax?. The core question in the discussion, as framed by the City Council members advocating a change and those supporting the idea, is whether businesses should be taxed on gross receipts, on net income, or on some combination of the two. From my perspective, there exist other alternatives, such as the imposition of user fees to charge businesses for the costs that they impose on the city.

On Sunday, Mark Zandi, chief economist of Moody’s Analytics Inc., published an opinion piece, Philadelphia Business-Tax Code Needs Change, in the Philadelphia Inquirer. The point made in the headline is one with which few people disagree. The city’s business tax structure is antiquated, and does not serve well the city, its citizens, or the businesses operating in it. The challenge is identifying what sort of tax structure would be a worthwhile improvement.

Zandi argues in favor of shifting away from a hybrid structure that taxes both profits and sales to a tax based on sales. The existing structure, if left alone, will shift, by terms of already-enacted legislation, from its hybrid form to a tax on profits. Zandi advances several arguments in favor of a tax based on gross receipts.

First, he claims that taxing gross receipts “broadens the tax base,” by spreading the tax burden from profitable businesses to businesses that are profitable and businesses that are unprofitable. Here’s the catch. One of Zandi’s arguments demonstrating the need for business tax reform is the claim that combined with all other taxes, it puts businesses in a position where they “could pay more than half” their profits in taxes. If that’s a terrible thing, then how does one react to a tax that would be imposed on a business with little or no profits? Even if a business with $100 in profits pays $51 in total taxes – with the Philadelphia business tax being a small portion of that – is it better to ask a business with a loss of $20 to pay $5 in sales-based taxes, or to ask a business with $4 in profits to pay $5 in sales-based taxes? The broadened base would quickly disappear as these borderline businesses closed their doors or moved out of the city. Zandi’s goal of “lightening the load . . . for successful firms” would end up increasing the load for those firms as they ended up being the only businesses remaining in the city to be taxed, until, of course, they, too, departed.

Second, in a related argument, Zandi claims that by taxing profits and not taxing sales, the city will encourage successful businesses to leave the city. There’s logic in that argument, but shifting the tax burden in order to kill the chances of barely profitable firms becoming successful merely changes the sequence and timing of continued erosion of the city’s business tax base, as explained in the preceding paragraph. Though Zandi seems to argue that the many businesses that already have left the city did so because of taxes, other factors also entered into those decisions, including the decision to move operations to areas where employees live and customers and clients live and do business. Many suburbanites are reluctant to go into Philadelphia, for reasons other than tax policy, and thus to retain customers from among those individuals, it made sense for businesses to relocate.

Third, Zandi argues that a profits-based business tax is more easily avoided than is a sales-based business tax. He claims that profits are “harder to accurately measure and easier to manipulate than are sales.” It would be helpful to see proof of this proposition, particularly when far more tax dollars are evaded in the federal income tax arena through under-reporting of gross income -- think of the cash skimmed from the register – than are avoided through overstatement of deductions. A sales-based business tax would encourage more of the “pay cash, pay less” schemes. The advantage of a profits-based tax is that the city could let the IRS and state revenue departments do a good chunk of the auditing work. Granted, Zandi’s argument that “[a]nything that simplifies the tax code is likely, therefore, to produce greater compliance and more tax revenue” is valid in a general sense, but the argument carries within its message a suggestion that the answer might lie in something other than sales-based and profits-based business taxes.

Fourth, Zandi argues that profits are “extraordinarily volatile, swinging wildly with changes in the economy,” and thus making revenue based on profits unreliable and difficult to predict. That’s also the case with sales, as Zandi concedes, and though he claims that sales are less volatile, it isn’t difficult to appreciate that profits drop when the economy tanks because revenue declines faster than expenses can be cut. If anything, Zandi is again making a strong case to minimize reliance on both sales-based and profits-based business taxes.

Fifth, Zandi dismisses the impact of a profits-based business tax on small firms by pointing out the $100,000 sales exemption that is included in the most prominent of the proposals to reform the business tax. He also dismisses the impact of a profits-based business tax on less profitable companies by suggesting the concern about the impact “probably is overdone, as such firms also likely have weak sales.” Brushing aside the concern in that manner neglects the principal danger of a profits-based business tax on less-profitable enterprises, namely, these are often the fledgling companies whose rise to success would contribute to the well-being of the city’s economy, but are most at risk of going under if their $4 profit must be used to pay a $5 sales-based business tax.

Sixth, Zandi concedes that shifting to a sales-based tax “would benefit professional-services firms such as accountants, lawyers, and management consultants, along with some manufacturers, information-service companies, and the publishing and broadcasting industries.” No kidding, though I think very few manufacturers and very few publishers would be better off. Zandi also notes that “[h]otels, retailers, and construction firms would be hurt” by a sales-based business tax. His response to this issue is to claim that the companies that would benefit “generally employ educated workers, who bring lots of income and wealth to the city,” and that the businesses that would suffer “are less likely to leave the city even if they face higher taxes.” Is there any evidence suggesting that the “educated workers” employed by the firms that would be shifting their tax burden to the companies that are easy tax targets actually bring income and wealth into the city? Don’t most of these workers live in the suburbs? Don’t most of them spend most of their discretionary dollars outside of the city? Isn’t there something a bit alarming about a tax proposal that shifts the tax burden from highly profitable companies with their highly-paid educated employees to businesses employing lower-compensated individuals and having little or no opportunity to escape?

Zandi argues for a “more rational tax code.” Is it not more rational to determine the costs that a business imposes on the city and to charge it accordingly? Do not general taxes, such as a sales-based or profits-based exaction, skew the relationship between the benefits accorded a business and the amount it pays for those benefits? Don’t businesses have an obligation to bear the costs of their operations? Would it not make sense for the city to identify the services it provides to businesses and to utilize some cost accounting techniques to calculate the cost? Perhaps there is justification to calculate cost for a few services based on sales. For example, jewelry stores have relatively higher sales receipts per transaction, are more in need of police protection – perhaps because of the high-end value of their merchandise – whereas other enterprises are far less likely to be criminals’ targets, and thus dividing some portion of the cost of the police department by total sales in the city and allocating the cost in that manner would make more sense and move the tax system closer to a more rational, fair outcome. Fire protection should reflect the asset value of a business, an amount that may or may not be proportional to sales or profits. Businesses and their employees use city streets, and what an interesting opportunity to impose mileage-based road (or street) user fees. The city provides services that makes it a source of customers and clients, and ought not businesses be charged a user fee for this benefit, best measured by profits, not sales, because profits reflect not only the sales revenue brought by those customers and clients, but also the costs that a business must incur by reason of doing business in the city.

Reforming taxation in the 21st century, whether federal, state, or local, demands more creativity and courage than to kick around the same tired, worn-out, disproven, ineffective, and irrational tax structures that have been in place for more than a century. It is time for tax policy, and the politicians, economists, commentators, and others who are involved in tax policy decision making, to think beyond what they learned in school however many years ago they underwent that experience, to open their eyes and ears to ideas coming from sources other than the traditional power brokering segments of society, and to move past the present. Why? Because the citizens and taxpayers deserve nothing less.