When Tax Cuts Are Part of the Problem, They Ought Not Be Part of the Solution

On at least two occasions in the recent past, I have criticized the Congress for contributing to the expanding budget deficit and for failing to deal with the consequences, specifically, the debt ceiling. In What Sort of War is the “Real Budget War”?, I proposed “that the uncertainty raised by the dilly-dallying and political posturing infecting the process is one of the most significant reasons American businesses are hesitant to expand, hire, borrow, lend, produce, or commit to much of anything other than what is imminently necessary.” In Paying Interest Alone Does Not Foreclose Treasury Default, I explained how Senator Toomey’s statements concerning the debt ceiling and U.S. government default on its obligations demonstrates a serious misunderstanding of the situation, a problem that afflicts many more people than just Senator Toomey.

Now comes news that after several months of negotiations with respect to the debt ceiling, Republican legislators participating in the process walked out. Why? They were unhappy that “Democrats were pushing for higher tax revenues.” If everyone who disliked what the other party requested during negotiations walked out of those meetings, negotiations would never be successful. Some quoted in the story suggest the walk-out could be a negotiating ploy. I don’t think so. I think the anti-tax movement is firmly committed to shrinking the federal government into the size of a meaningless formality.

The problem, though, is much worse than negotiating procedures gone awry. In an article appearing the same day as the negotiating walk-out news, two economists offered their take on the debt ceiling issue as part of a larger exploration of the sad state of the economy. Both stressed the importance of raising the debt ceiling. One proposed that doing so would be “the quickest solution” to restore “investor and consumer confidence,” and that it needs to happen “sooner rather than later.” The other economist added the warning that simply chopping federal spending would “dramatically increase unemployment and put us in a double-dip recession.”

The nation’s budget deficit is a problem. Problems need solutions. Solutions arise from identifying and examining the causes of the problem. The causes of the budget deficit are easily identified. There are two causes. One is insufficient revenue. The other is spending that exceeds available revenue. In solving a problem, it also helps to identify when the causes came into existence. The latest budget problem, one of hyper-deficits unlike any previous deficits, arose when Congress decided to increase spending in order to fund two wars while simultaneously cutting taxes. Another mechanism for solving problems and dealing with the causes of problems is to examine similar situations. In 1941, when Congress moved forward with huge increases in military spending, did it cut taxes? Of course not. Aside from a fringe element, Americans did not demand tax cuts during wartime. Americans knew that wars cannot be fought on the cheap. Americans sacrificed. Those Americans, though, were of a different generation, perhaps the greatest, perhaps not, but surely smarter and more patriotic than the crew that demanded tax cuts to increase discretionary spending while they continued living their lives as though war were something on a movie or television or laptop screen. Where was the sacrifice? Aside from the devoted few who have given of their lives and time in military service, most Americans bought into the “we can have our butter and buy guns too” siren song of the economically short-changed pipers.

So if a combination of tax cutting and spending increases created the problem, does it not make sense that a combination of tax cut repeals and spending reductions should solve, or help solve, the problem? The Democrats have suggested spending cuts, even though that would, to some, be contrary to the stereotypical Democratic economic policy. Republicans, however, have no hesitation in continuing to resist restoring taxes to what they were before the Great Mistake was made. As I wrote in Paying Interest Alone Does Not Foreclose Treasury Default:

The nation is approaching, more and more quickly, the point of no economic return. I wonder when someone will make it clear to the entire nation, and not just to the few readers of this and a few other blogs who understand the maxim, a nation is doomed when it spends trillions on war while simultaneously continuing and increasing tax cuts that especially benefit the wealthy. I wonder when someone will succeed in persuading the nation that the only hope is a reversal of the mistake, even though it cannot be fully reversed. Even a partial reversal poses the possibility of redemption. Toomey wants “concrete steps toward fiscal sanity.” Would not undoing the fiscal insanity of the past decade be the place to start?

There is a very real risk that the Great Mistake will evolve into the Great Implosion.

The Tax Consequences of Being Paid to Date

Of the thousands or tens of thousands of readers who read the Philadelphia Inquirer article, Site is Pay for Play, perhaps I am the only one who immediately thought of the tax issues. When fall semester arrives and I again take students through the fun analysis of “what is a gift?” as we explore the section 102 exclusion, this story will ramp up the hypotheticals that I usually use. In attempting to get students to understand that it isn’t as easy to characterize a transaction as a gift as they might think, I ask them to consider a variety of relationship experiences. Among the situations I present is dating, with its many forms of expectations and conditioned acceptances.

According to the Philadelphia Inquirer article, someone set up a website called WhatsYourPrice. Notice that I’m not providing the link, and those who are sufficiently curious can find their way there on their own. I haven’t visited the site, so I’m relying on the reporter who wrote the article. What makes this web site different is that “so-called generous members (most men) open their wallets and bid real money for a first date with members who list themselves in the ‘attractive’ category (mostly women).” The web site makes its money by charging members for the right “unlock e-mail conversations with attractive members.” Winning bidders pay a separate amount to the person with whom they sought a date. The article explores the psychology and social implications of the arrangement, including charges that the web site is nothing more than a fancy escort service. Members claim that’s not the case. No matter, what I found most interesting is the tax angle.

Clearly the amounts charged by the web site constitute gross income. Whether it pays income tax depends on whether it’s collecting more than it is paying in expenses, and only the owners of the site know the answer to that question. As a visible business, it’s quite likely that the web site operators are filing tax returns. They’re not the ones with the interesting tax question.

What are the tax consequences of being paid to go on a date? One woman interviewed for the story explained that she received $120 in a card handed to her by the member who successfully bid for a few hours of her time, which she says was spent at dinner at a fine restaurant. Is the $120 gross income? How can it not be? It’s not a gift. It was delivered in exchange for a few hours of the woman’s time, company, conversation, and attention. How does that $120 differ from $120 paid to a psychologist, plumber, or painter? What are the tax consequences of the meal received by the woman? Does the fact that she was paid to go to dinner make the value of the dinner she received additional compensation? Assuming that people who are treated to dinner on dates for which they are not being paid almost surely are not reporting the value of the dinner as gross income – though there are arguments that they should be reporting it – does the tax nature of the dinner transaction change because of the $120 compensation? If so, should the tax treatment of other dinner dates depend on what other “consideration” is involved in the overall transaction? One member’s explanation of her goals may come back to haunt her come tax time: “If it's going to be a big, huge waste of time, at least I'm going to get paid for it. A lot of these guys are wealthy gentlemen, and I think my time is as valuable as their time." Getting paid for one’s time is compensation gross income. As for deductions, apparently the “attractive” members don’t pay the web site to unlock emails. No payment, no deduction. The ones paying the web site fees aren’t carrying on a trade or business or for-profit activity, and the payments surely aren’t charitable contributions. No deduction.

In contrast to my guess concerning the web site owners’ tax compliance, I am rather confident that the people being paid to go on dates are not even thinking about the tax consequences and very likely are not reporting gross income, or, for example, state sales tax. I am just as confident that they would characterize the payment as a gift, though the fact that they entered a market place, albeit digital, to acquire the payments makes the gift argument almost frivolous.

Is this a trivial issue? No. The web site claims to have 50,000 members. It says that bids average $138. One woman reported bids of $300. It appears that members are getting three to five dates per month, though it’s not clear if those are actual dates or unlocked email communications seeking dates. But even a cautious estimate of two dates per month for 50,000 members for $138 per date generates $3,312 of annual gross income per member and $165,600,000 of gross income. The income might not be much when compared to the off-shore tax shelters of wealthy individuals and corporations, but often is said, “Every little bit helps.” There’s probably $10 million of sales tax revenue lurking in these transactions.

Will the IRS and state revenue departments chase after these monies? Probably, if nothing else but for the fun of auditing transactions far more entertaining than checking on cost of goods sold calculations, home office deductions, or medical expense deductions. I do think, though, that I and my students will have at least as much fun, if not more, when we get to the fifth or sixth tax class of the fall semester. As I and my colleagues frequently tell them, “We don’t need to make up this stuff.”

EDIT: A former student who now teaches as an adjunct in the Graduate Tax Program emailed me to let me know that he, too, thought about the tax issue and looming IRS audits. So I'll amend the "Perhaps I am the only one . . ." to read "Perhaps I and a few others were the only ones . . ." I wonder how many other former students have "TAX ISSUE!" screaming in their heads when they read or see things. Hopefully I'll hear from so many graduates that I need to amend yet again, along the lines of "Perhaps I and an ever-growing number of tax-educated people are the only ones . . ."

The Realities of the Soda Tax Policy Debate

As I pointed out in the update to The Broccoli and Brussel Sprouts of Taxation, Philadelphia City Council last week opted for an increase in the real property tax rather than the enactment of a tax on sugary beverages. In How Mayor Nutter’s Soda-Tax Proposal Lost Out to Property Tax, Philadelphia Daily News writers Catherine Lucey and Jan Ransom explore the impact of politics on tax policy debates. According to the article, when Council met, it appeared that neither tax proposal had the necessary nine votes. Allegations that the mayor’s team made promises for support and threats for opponents were neither confirmed nor denied. By early afternoon, nine votes were lined up for the so-called soda tax. One member of council explained that he left the negotiations momentarily, and when he returned, the ninth vote had disappeared. It seems that the lobbyists working against the soda tax had managed to persuade someone not to go forward with an affirmative vote. In the meantime, another member of Council opted to support the property tax rather than the soda tax, but on condition that one of the property tax advocates on Council vote for a sick leave ordinance that has absolutely nothing to do with the tax issue. The Mayor then pressed for a real property tax hike that would raise more revenue than the soda tax would have raised, but Council rejected that demand. Is it any wonder that municipal tax policy is a mess?

The disconnect between careful analysis of a tax proposal and the realities of how legislators, and those pushing them to act one way or another, is no more evident than in the post-defeat lamentation and promised resurfacing of the soda tax proposal by Jeff Gelles. In Consumer 11.0: The Soda Tax’s Time Will Come, Gelles predicts that the soda tax eventually will be enacted, despite opposition from soda manufacturers, distributors, retailers, and truck drivers, because “it makes too much sense for the rest of us.” To his credit, Gelles addresses two questions that I have been asking throughout my series of soda tax postings (What Sort of Tax?, The Return of the Soda Tax Proposal, Tax As a Hate Crime?, Yes for The Proposed User Fee, No for the Proposed Tax, Philadelphia Soda Tax Proposal Shelved, But Will It Return?, Taxing Symptoms Rather Than Problems, It’s Back! The Philadelphia Soda Tax Proposal Returns, The Broccoli and Brussel Sprouts of Taxation), namely, why tax sugary beverages and not other items containing sugar, and why focus on sugar and ignore other ingredients that can be unhealthy?

Gelles likens “Big Soda” to “Big Tobacco” in his attempt to classify soda as a pernicious item. He cites a Yale University researcher whose target of “high-calorie, low-nutrition foods” has been twisted into a campaign against one specific type of such items. This researcher claims “[Soft drinks are] completely empty calories. I mean, even a Twinkie has some nutrition.” Gelles claims that research “suggests . . . that people’s bodies react differently to calories consumed in sweetened drinks than in food [because l]ess sated by the sugary liquids than by solid food, they are more likely to consumer additional calories beyond their basic needs.” Gelles lumps soda with “pollution and tobacco” as “externalities” that should be taxed to reduce “public harm that everybody must pay for.” Gelles quotes a University of Pennsylvania economist for the proposition that sugary drinks “imposes costs that we all may have to pick up” and that “it’s very likely that your future self would prefer that the government impose taxes to prevent your young dumb self from destroying the body that your future self will inherit, the same way that my future self would want higher cigarette taxes to prevent my current self from destroying my lungs.”

The problem with these attempted explanations for why sugary beverages are singled out in the “we need revenue, let’s tax something” version of the defeated proposal is that they rest on erroneous factual assumptions, conflate information, and ignore reality. First, though moderate and sensible use of sugar does not trigger obesity and other illnesses, there is no such thing as moderate use of tobacco because any use of tobacco ramps up the risk of cancer and other disease. Second, sugar is not the only substance that, consumed excessively, causes health problems. Excessive intake of fat, for example, is just as dangerous, if not more so. Even water can be deadly, as evidenced by people who have died in foolish water drinking contests. Where is the logic behind “Sugar is bad, tax it, fat is bad, don’t tax it”? The notion that people will take in more sugar drinking soda because soda is not filling ignores the fact that gulping down a huge amount of liquids will leave a person with less stomach room, and less desire, to take in food. Does it make sense to encourage the ingestion of Twinkies rather than soda because it’s better to fill the stomach with sugar and fat? Finally, the notion that cigarette taxes has cut smoking is debatable, particularly with respect to tobacco use among younger people, who supposedly are the targets of the “tax will teach you a lesson” proponents.

From a health perspective, the target needs to be the items originally indicted by the Yale researcher, namely, high-calorie, low-nutrition substances. The issue isn’t so much the item, other than the true poisons such as nicotine and trans-fats, but the quantities being consumed. Even low-calorie, high-nutrition foods can be dangerous if consumed in excess. The focus on soda, intense as it is on the part of the soda tax advocates, suggests something more is at work. I wonder if we would be seeing “donut tax” proposals offered with the same zealousness had it been donut manufacturers who tossed money at school boards to install vending machines in the schools. I wonder.

All of this suggests that what people have learned in civics classes – few and far between as they are – about how legislation gets enacted is woefully inadequate. Legislation, including tax legislation, is far more influenced by back-room deals, promises, threats, and proliferation of overhyped allegations than it is by careful analysis, research, and thorough consideration of the bigger picture and long-term consequences. I could mention the sausage factory, but I won’t. It might just give someone an idea of something else to tax.

Another Reason the Tax Law Needs Simplification

The latest issue of the IRS Statistics of Income Bulletin (Vol. 30, No. 4) has some interesting information that suggests the deep flaws in the income tax system now in place. For 2008, the latest year for which the information is available, there were 4,375,660 individual income tax returns with adjusted gross income of $200,000 or more. According to the IRS, there were 4,416,986 returns with expanded income of $200,000 or more. One problem with this information is that because expanded income is measured by adding to adjusted gross income items of income discernible from the return, it does not include the gross income or excluded income not revealed by the return. So the analysis is limited to what is available.

Of the 4,375,660 returns with adjusted gross income of $200,000 or more, 18,783 reported no U.S. income tax liability. That’s a significant increase from 2007, when 10,465 out of 4,535,623 returns with adjusted gross income of $200,000 or more reported no U.S. income tax liability. What does this mean?

For there to be no U.S. income tax liability, the taxpayer either has deductions exceeding adjusted gross income or credits exceeding tax liability computed on taxable income. Though individuals paying income taxes to foreign countries can “wipe out” their U.S. income tax liability, 10,824 of the 4,375,660 returns with adjusted gross income of $200,000 or more reported no income tax liability to any nation, period. The corresponding number in 2007 was 4,841.

The IRS does not disclose the specifics of what causes the zero tax liability. The IRS provides some general explanations of how a taxpayer can have zero tax liability, and presents some information showing what sorts of deductions are claimed on these returns, but that data does not answer the question. Nor do the combined tables help, because they don’t pinpoint what deductions or credits are wiping out taxable income or tax liability on specific returns. The “largest effect” tables also don’t provide a clear answer.

It does appear that for returns showing tax liability to other nations, the foreign tax credit is the most significant reason for the reduction of U.S. income tax liability to zero. The individuals filing those tax returns are paying income taxes, just not to the U.S. On the other hand, individuals not paying income taxes to any nation aren’t claiming the foreign tax credit. Other things are the cause. Huge unreimbursed casualty losses are a possibility, but how many can there be? Because charitable contribution deductions are limited, those cannot account for zero taxable income. Is it a consequence of one or more of the dozens and dozens of credits? If so, are the credits being claimed by the individuals and for the activities that Congress intended? Knowing how badly the first-time homebuyer credit worked out, is there a possibility that other credits similarly are abused?

A simpler income tax also can be a more transparent tax. The fewer gimmicks, loopholes, special provisions, and other warps in the system, the less likely that two people in the same situation end up paying different amounts of federal income tax. Complexity provides a shadow in which too much tax avoidance can hide.

The Broccoli and Brussel Sprouts of Taxation

Last week, in It’s Back! The Philadelphia Soda Tax Proposal Returns, I included, among the many reasons the proposed Philadelphia soda tax misses the mark, the fact that it would not apply to all sugary products but only to beverages. Earlier this week, according to Joseph N. DiStefano’s PhillyDeals column in the Philadelphia Inquirer, beverage entrepreneur Harold Honickman made the same point. It’s not that Honickman opposes taxes, or even opposes paying a tax. What he wants is fairness. He commented, “I think there should be a sugar tax in the whole city. Why isn't ice cream, cookies, candy part of this?” Indeed. Why soda and not other items? A caterer interviewed by DiStefano explained that from servicing high school proms all over the metropolitan area, he has observed that soda drinking is rampant among public school children, whereas private school students, having been educated about the adverse effects of excessive soda drinking, frequently ask for water. Though it’s doubtful that the city’s mayor intended to work the apparent class difference into his proposal, the soda tax would have such an effect. As Honickman put it, “The rich have better choices.” No kidding.

In an editorial the other day, Jonathan Saidel made the same point. Calling the proposed tax discriminatory, he notes, “Taxing these particular products and this particular industry, while exempting many other products containing high levels of sugar or other potentially unhealthy ingredients, would be simply unfair.” Saidel also suggests that the tax would cause job losses and encourage black market activity. In another twist that had not crossed my mind, he also suggests that some or many city retailers would tax all beverages, even those not containing sugar, “to simplify their bookkeeping.”

In related news, a member of City Council declared the soda tax proposal “dead on arrival.” At least six members of the 17-person Council have expressed complete opposition to the idea. Although they may have been influenced by the anti-soda-tax rally outside City Hall, they had announced their opposition long before the rally.

I wonder whether the mayor re-floated the soda tax idea to provide a backdrop against which to set his proposed real property tax increase. If City Council decides to increase real property taxes – and signs are that it dislikes that idea no less than it dislikes the soda tax – the mayor can respond to complaints by claiming that he had offered a soda tax option that Council refused and thus it isn’t his fault that real property taxes were raised. Perhaps the mayor belongs to the school of parenting that thinks a good way to get children to eat broccoli is to offer them brussel sprouts.

UPDATE: Philadelphia City Council again rejected the soda tax, opting for an almost 4 percent increase in the real property tax. The blame-shifting and finger-pointing is inevitable.

Who’s More Important in the Tax World? People or Machines?

More than two years ago, in Just Because It Didn’t Work the First 50 Times Doesn’t Mean It Will Work Next Time, I criticized the revival of section 168(k) bonus depreciation and the expansion of section 179 first-year expensing. I argued that these changes to the tax law don’t help restore vitality to the American economy. I wrote:

Does it make sense to increase deductions for acquisitions of equipment? How does that restore confidence in the economy, which is essential to putting the nation back on track. How does a tax provision that encourages businesses to use their limited funds to buy machinery put people in this country back to work? Nothing in the provision requires that the property be built in the United States, and it's almost certain that such a requirement would violate at least a few trade agreements and treaties. What's the point of enacting tax breaks that create jobs in other nations? Dollar-for-dollar, a tax break for creating jobs directly is worth much more than a tax break for purchasing equipment.

Almost a year ago, in If At First It Doesn’t Work, Try, Try, Try Again, I criticized the Obama Administration** for proposing a change in the tax law that would permit taxpayers to deduct the full cost of asset acquisitions made in 2011. I noted:

Such is the life of one of the business world’s favorite tax breaks. Entrepreneurs salivate at the idea of getting a deduction for making an investment. The idea of getting a tax break for swapping cash for equipment of equal value is the sort of thing that makes lower-income taxpayers roil, because they don’t have the opportunity to get, in effect, cash flow from the government in the form of lower taxes by swapping cash for equipment of equal value.

I then asked:

The previous incarnation of section 168(k) “bonus depreciation” as well as continual expansion of section 179 expensing have been consistently hailed as solutions to the nation’s economic woes of the moment. Yet no evidence exists that these tax giveaways have had the claimed effect. Why is it, for example, that during 2008 and 2009, while businesses basked in the benefit of 50-percent bonus depreciation, the economy got worse, not better? Where are all the jobs whose creation was promised when the proposal for the 2008 and 2009 tax break was being trumpeted as the answer? Where is the economic recovery that supposedly was an inescapable consequence of enacting those tax breaks? Similar questions can be asked about the long parade of tax breaks for business investments during the past 50 years. Though the economy doesn’t benefit, though economic fundamentals do not improve, though joblessness doesn’t abate, something fuels the repetitive re-enactment of this bundle of tax breaks. Could it be that it’s good for business? Could it be that what’s good for business isn’t necessarily good for those in need, especially if the funds generated by the tax break go the same way as the excess cash that businesses have been accumulating during the past year and a half, namely, somewhere other than the economy?

Last December, in When the Bonus Depreciation Tax Deduction is Not a Bonus for the Economy, I concluded:

This expansion of section 168(k) bonus depreciation is touted as yet another essential piece to putting the economy back on track, which is pretty much the equivalent of asserting police departments would be improved if they hired and gave guns and badges to convicted felons. This approach hasn’t worked in the past, and it won’t work now. It’s yet another unnecessary concession to those holding lower-income and middle-income citizens hostage.

Now comes an interesting report that explains why companies awash in cash are spending, when they choose to spend, on equipment but not people. We are told that equipment “is getting cheaper” and workers “are getting more expensive.” We are told that in order to compete with China and other countries providing cheap labor, processes need to be automated. Using equipment rather than people is efficient, because the economy “is producing as much as it was before the downturn, but with seven million fewer jobs.” Machines, we are told, don’t need to be trained, whereas people require training and clearances that cost money and the time of more experienced existing employees. Business spending for workers has grown 2 percent, whereas spending on equipment and software has grown 26 percent. The article then points out that tax incentives to make equipment and software purchases makes it likely that this trend will continue. The article confirms another complaint that I previously voiced. We are told that “much of the equipment used to replace American workers is made by workers abroad.” None of this is good news for the unemployed and the underemployed.

After reading the article, it occurred to me that there is something more than the tax subsidy that helps tilt the equation even more in favor of equipment investment. The tax law process also encourages businesses to prefer asset acquisition over employee hiring. Although there have been several employment credits put into the tax law, companies are reluctant to hire because employment involves a different sort of commitment. A tax break that encourages the purchase of a piece of machinery does its job in the year the machinery is acquired. The business no longer worries about the effect of future tax law changes on its decision. In contrast, a tax break that encourages hiring encourages the employer to make a long-term commitment, and if the tax break is repealed or adversely modified, the employer can find itself out on a limb. Compounding the problem is a concern that the article mentions in passing, namely the “uncertain future costs of health care and other benefits,” which, I hasten to point out, are regulated in part through the tax law. Making the tax break permanent would alleviate this problem, but Congress refuses to do that because it removes the opportunity to solicit funds from lobbyists as the tax break reaches its expiration date. As I noted in Congressional Mis-delegation Endangers Tax Collections, “Most of the tax breaks come with expiration dates, most of which are annually extended by a Congress that can hold the extension hostage to the vote collection process. There’s much more leverage available to a legislator when a tax break is on the verge of expiring than there is when a tax break is permanent.”

Business leaders explain that workers seeking new jobs require retraining, but that it is difficult to accomplish this in the short term. Job applicants lack the “right skill sets to work in modern manufacturing.” They are, according to one business owner, “deficient in computer, mathematics, science and accounting skills.” That’s no surprise to me, nor to anyone else who has been questioning the course and major selections of college students and the scope of high school education. When the same business owner claims, “It seems as if technology has evolved faster than people,” he misstates the case. The problem is that technology has evolved faster than has the education system.

Here is what needs to be done. First, as I suggested in When the Bonus Depreciation Tax Deduction is Not a Bonus for the Economy, section 168(k) bonus depreciation and expanded section 179 first-year expensing should be limited to the excess of the taxpayer’s business equipment expenditures for the current year over the average of the taxpayer’s business equipment expenditures for the three previous years. That rewards business expansion rather than mere continuation. Second, the deduction should be limited to purchases of equipment produced in the United States by American workers. Third, the deduction should be available for American-manufactured equipment acquired by domestic taxpayers and put into service overseas. Fourth, Congress needs to enact a non-expiring credit based on the excess of the taxpayer’s inflation-adjusted current year domestic payroll for employees earning less than the cut-off for the highest income tax bracket over the average of that amount for the previous three years. Fifth, Congress needs to tailor education loans, including issuance and repayment terms, so that they favor students who enroll in, and earn above-average grades in, the majors and courses teaching the skills that are needed in the American workforce, provided those students remain employed for at least ten years in positions that make use of that education.

Though the preference for investment in equipment rather than workers comes across as a short-term problem, it is a long-term issue and a pending permanent disaster for the economy. In many ways it is not so much a problem but a symptom of a deeper flaw. What Congress has done with the tax law, though perhaps good for Congressional campaign fund-raising, undermines the health of the nation. Not only does the tax law need to be fixed as I’ve suggested, the process by which it is changed needs to be altered. It is time for a cultural revolution in the Congress, a reform whose necessity is reflected not only by the tax law mess but by the other Congressional nonsense that has been gathering so much attention during the past two weeks.

**Something that should be noted carefully by those who suggest that my tax policy positions are one-sided. When it comes to criticizing flaws in the tax law, I am quite generous, and party affiliation protects no one from my remonstrances.

If Congress Says So, Don’t Blame the IRS

At least thousands of persons were startled last week to learn that the organizations with which they are affiliated in some manner had lost their federal tax-exempt status. In many instances, because state tax law mirrors federal tax law in this respect, they also lost state tax-exempt status. The IRS press release explains that 275,000 organizations became taxable entities because they failed to file legally required annual reports for three consecutive years. It is likely, according to the IRS, that many or most of these organizations went out of business, so to speak, long ago. The list of organizations losing their exempt status is here. According to this Philadelphia Inquirer story, one of the tax-exempt organizations to lose its status is the Philadelphia Housing Authority Development Corporation, an affiliate of the Philadelphia Housing Authority that has been riddled with all sorts of problems. Apparently those responsible for filing the returns concluded that the entity was not required to do so.

In 2006, Congress enacted legislation requiring tax-exempt organizations to file annual information returns. Previously, smaller organizations were not required to do so. The new law also provided that failure to file for three years in a row automatically revokes tax-exempt status. Fortunately, the IRS has instituted a procedure that can be used to reinstate tax-exempt status. The IRS has invested time, money, and other resources trying to make tax-exempt organizations aware of the change in the law. It sent more than 1,000,000 notices to organizations that had not filed, published a list of those at risk of losing tax-exempt status, extended the deadlines by five months, and set up transition relief for very small tax-exempt organizations, including a reduction of the $850 or $400 filing fee to $100.

What’s interesting is the reaction of at least one person connected with an organization that lost its tax-exempt status. According to another Philadelphia Inquirer article, the vice president and treasurer of one such organization stated, “I guess they want more paper so they can keep themselves busy.” He explained that his organization was properly registered with the state’s Bureau of Charitable Organizations, but that he was not aware of the federal return filing requirement. He intends to file what needs to be done to be reinstated as a tax-exempt organization, noting, “I’m sure they’ll need to hire five more people to read it.”

This outlook suggest that the IRS is not busy, is looking for work, and yet needs to hire more people to do that work. Aside from the internal inconsistency, the comments reflect a misunderstanding of what happened. The Congress decided that information filing for tax-exempt organizations should include those previously excluded from the requirement, because too many organizations not required to file were taking advantage of that lack of oversight to abuse the system. Surely the IRS, already overburdened with tax and social program administration, was not looking for more work. It was the Congress, not the IRS, that enacted the law imposing automatic revocation on organizations failing to meet their filing obligations.

So long as people view the IRS as the source of all that is wrong with taxation and the tax system, or the cause of anything they dislike about tax law and tax enforcement, and overlook the responsibility of the Congress for the tax law, tax policy, and tax administration deficiencies afflicting the nation, the problems will not be solved. Once people understand what Congress has done and is doing, there may be increasing numbers of incumbents who fail to be re-elected. But until Congress understands what Congress should be doing, replacement of incumbents by newcomers who continue the bad habits of Congress will continue unabated.

More Criticism of Non-Tax Tax Credits

According to this BNA Daily Tax Report story, National Taxpayer Advocate Nina Olson declared that the first-time homebuyer credit should never have been part of the Internal Revenue Code. She criticized the credit not so much because it is a social program operated through the tax code, but because it missed its mark. A person who purchases a home in year one only to wait until year 2 to claim the credit on the return isn’t being helped in terms of cash flow. Converting the credit from a loan into a outright credit partway through the process didn’t help matters. Worse, with three different versions, the credit became confusing, and its administration was, to use Olson’s words, “a nightmare.” The IRS rejected returns from taxpayers in 22 states because those states do not use HUD settlement statements, which the IRS required taxpayers to provide as proof of the home purchase. Hundreds of thousands of returns were frozen when taxpayers who had claimed the earlier loan version of the credit tried to make the required repayments. Stories about prisoners claiming the credit abound. This story is just one of hundreds.

Olson proposed that the “simple solution” is a HUD-directed spending program. For years, I have been advocating leaving social welfare spending out of the Internal Revenue Code and sparing the IRS the task of doing other agencies’ work. Most recently, in Congressional Mis-delegation Endangers Tax Collections and The Problem with Income Tax Vehicle Credits, I criticized the Congress for burdening the IRS with administration of all sorts of programs that ought to be handled by the federal agencies charged with oversight of those sorts of programs. I noted that The IRS Oversight Board Annual Report to Congress 2010 corroborated my position. Now the National Taxpayer Advocate has joined in the criticism.

So why does Congress continue to put non-tax programs into the tax law? Olson pointed out one of the factors. A spending program administered by an agency other than the IRS is “scored against the budget,” that is, it is characterized as spending. On the other hand, by hiding the spending as a tax reduction in the form of a tax credit or tax deduction, the Congress makes no less of an increase in the federal budget deficit but can claim that it has not increased spending. Until people understand that a $100 tax credit issued to ten million taxpayers is no different, for federal budget purposes, than the writing of ten million $100 checks, the nation’s attempt to get its fiscal house in order is doomed. Worse, by distracting the IRS with additional program responsibilities without increasing its funding, Congress forces the IRS to divert resources from its primary mission, namely, protecting the revenue.

Members of Congress have figured out that if they enact legislation granting $3 billion to a pet project, they risk taking heat for bestowing taxpayer dollars on a special interest. They have also learned that if they jam a tax credit into the Internal Revenue Code that reduces the tax liability of the taxpayers operating that pet project, not only is the give-away not treated as federal spending, it is also much more likely that no one will notice. But a few of us do, and my hope and goal is to cause most of us to notice. Perhaps then the betrayal will be sufficiently visible to bring about the electoral upheaval that betrayal should bring.

Toll One Road, Overburden Others?

According to a Monday news story, Pennsylvania’s Transportation Funding Advisory Commission is receiving reports on, taking testimony with respect to, and studying a proposal for the imposition of tolls on a 25-mile portion of Route 422 northwest of Philadelphia. Regional planners, after investing $625,000 in a multi-year study, suggest creating a local authority and giving it power to levy an 11-cents-per-mile toll on the road. The road is in need of repair and could benefit from the addition of more travel lanes. Currently, it is an extremely congested highway. Approval of the plan requires consent from the federal Department of Transportation, Pennsylvania’s Department of Transportation, the Pennsylvania legislature, and the County Commissioners for the three counties that the road traverses. The Advisory Commission has no power to approve the plan, but its support is being sought as a matter of practical leverage.

One question that needs to be considered is the impact of such a toll on adjacent highways. It is not unreasonable to suppose that motorists unwilling to pay the toll will return to the local roads that they used before Route 422 was constructed. Indications of that outcome are provided every time an accident forces travelers off Route 422 and onto local roads. The congestion is horrendous. With local traffic also having increased, complete gridlock is not out of the question. Those who are willing and able to pay the toll will discover that they are driving on a much less congested highway because some or much of the traffic has been pushed off the road by the tolls.

Am I suggesting that charging for use of highways is foolish? No. I’m suggesting that imposing a toll on a short stretch of one road can backfire. Tolls work when motorists have no alternative. For example, anyone trying to drive from southeastern Pennsylvania into New Jersey, or vice versa, must cross a toll bridge. There are no feasible alternatives to most toll roads in the country, and where tolls have been imposed on highways to which there are viable alternatives, the toll roads have not done well. I wrote about this phenomenon in Selling Off Government Revenue Streams: Good Idea or Bad?.

There is a better solution. Readers of MauledAgain know what I’m going to suggest. Yes, it’s the mileage-based road fee. I’ve written about this approach many times, beginning in Tax Meets Technology on the Road, and thereafter in Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, Change, Tax, Mileage-Based Road Fees, and Secrecy, Pennsylvania State Gasoline Tax Increase: The Last Hurrah?, Making Progress with Mileage-Based Road Fees, Mileage-Based Road Fees Gain More Traction, Looking More Closely at Mileage-Based Road Fees, The Mileage-Based Road Fee Lives On, and Is the Mileage-Based Road Fee So Terrible?

The toll being proposed for Route 422 would be collected using the EZ-Pass system. The per-mile charge can be set at different levels depending on the classification of the vehicle, as currently is done with tolls on the Pennsylvania Turnpike. The mileage-based road fee can be collected in the same manner, though it would require installing EZ-Pass sensors on at least all arterial highways. A more efficient mechanism, of course, is reliance on the odometer readings of vehicles that are reported on annual vehicle registration applications and by state vehicle safety inspection stations during the annual vehicle inspection. The mileage-based road fee would prevent the shifting of costs from motorists to the residents of the towns whose local streets would become clogged by drivers seeking to avoid paying the toll. A toll system works when, like the increasingly obsolescent gasoline tax, it is inescapable.

The president of the King of Prussia Chamber of Commerce, as reported in this story, suggests building high-speed lanes on Route 422 and imposing a toll only on those lanes. Though possible on that road to some extent, this approach permits those with monetary resources to enjoy a pleasant commute, while saddling the economically disfavored with increasing congestion consequences. The idea would widen the gulf between the haves and the have-nots, in contrast to setting aside high-speed lanes for carpools and environmentally beneficial vehicles, which is a totally different, and more socially beneficial, separation of motorists.

Proponents of putting a toll on Route 422 know that they will meet resistance. One member of the legislature, whose campaign included state opposition to tolls, claims, “Tolling is just another way of taxing people going to work in these hard economic times.” If a tax is an amount charge for the use of a public service, it’s true that a toll is a tax in that sense. So what? As the writer of the story reports, getting approval for the tolls “might be a tall order considering the current antitax mood of the electorate. Many daily commuters oppose what they see as an imposed cost for a currently free resource.” And therein lies the problem. The legislator complained, “They're already paying a lot of money in gas taxes and other fees.” But are those taxes and other fees enough? Apparently not, because the motorists using Route 422 are dissatisfied with the poor quality of the highway and the congestion that they encounter.

There always is resistance to paying for something, particularly when the something is at some point made available for free. In the long run, however, there is no free. There’s simply the game of shifting costs to others, whether it’s conning someone into picking up the dinner tab or compelling someone to do one’s work. The motorists who use Route 422 should be paying for the cost of their use, but imposing a toll would simply overburden alternative local roads without collecting from motorists using those roads the cost of their use. What is needed is a comprehensive plan that imposes costs on those who benefit, that makes it impossible to avoid paying, that prevents shifting the costs to others, and that protects the local roads adjacent to the tolled highway.

It’s Back! The Philadelphia Soda Tax Proposal Returns.

The Philadelphia School District needs money. It needs quite a bit of money, on the order of at least half a billion dollars. If this funding shortfall is not closed, the district plans to cut all sorts of programs that city residents don’t want cut. So, according to various reports, including this Philadelphia Inquirer story, the mayor of Philadelphia has stepped up to propose that the city funnel roughly $100 million to the school district by, among other things, imposing a tax on sugary beverages. He also has proposed a real property tax increase as an alternative, but he explained that he has done so to provide City Council with a “range of options.”

The mayor explained that he prefers the tax on sugary beverages because it “affects fewer people.” He noted that “It’s paid for by people who access a certain product, versus real estate, which is virtually everyone.” Does it make sense to put the burden of marginal tax increases for school funding on people who drink sweetened beverages? What is the rationale? It can’t be the notion that it “affects fewer people,” because that rationale supports all sorts of taxes, such as one on people who fly kites or one that increases the tax rate on millionaires. A kite tax affects fewer people. The flaw in the mayor’s reasoning is illustrated by his claim that the real property tax affects virtually everyone. It does if one takes into account indirect effects and pass-through, but that reasoning makes the soda tax one that affects virtually everyone.

My opposition to a tax focused solely on soda has been explained in a series of posts, starting with What Sort of Tax?, and continuing in The Return of the Soda Tax Proposal, Tax As a Hate Crime?, Yes for The Proposed User Fee, No for the Proposed Tax, and Philadelphia Soda Tax Proposal Shelved, But Will It Return?. On March 24, 2010, my editorial, Why Phila. Soda Tax Already Has Gone Flat, was published in the Philadelphia Inquirer. Two months ago, in Taxing Symptoms Rather Than Problems, I explained the flaws in Mark Bittman’s lambasting of those who oppose taxes aimed specifically, and only, at sugary beverages.

This time around, the mayor isn’t hiding behind the pretext of using the soda tax to improve Philadelphians’ health. To his credit, Mark Bittman at least argued from the health angle, as did the mayor in 2010. The current proposal does not direct any of the revenue to health improvement, nutrition education, and exercise promotion programs. The current proposal appears to be nothing more than “because we can” as an explanation for the tax. As I’ve argued previously, if the purpose of the tax is to improve health, it ought to be imposed not only on sugary beverages, but on sugary foods, on products containing fat, and on food and drinks containing carcinogens and other harmful substances. Even a wider tax fails to reach those who leave healthy foods, such as whole grains, out of their diet, nor does it reach those who eat such huge quantities of supposedly healthy foods that they violate the chief cause of obesity, namely, caloric intake exceeding caloric burn.

The Philadelphia Inquirer story suggests that the mayor’s proposal will trigger two weeks of backroom negotiations before City Council goes into summer recess. The core of the discussion needs to go deeper than the mayor’s tax and revenue proposals. It needs to address two fundamental questions. Who should pay to educate the city’s children? Why is the cost of that education so disproportionately high? These are difficult questions. One can argue that those who benefit from education should pay for it, but identifying those who benefit from the education of a particular student is challenging. The student benefits. So does the student’s family. So do the employers who seek to hire from a pool of educated applicants. So do the city’s residents, whose lifestyle and living conditions improves with each additional uneducated child being transformed into an educated child. Thousands of articles and commentaries have been written on the question of whether a property tax, a sales tax, an income tax, some other tax, or a combination of taxes should be used to fund schools. Philadelphia’s problem is that its revenue base is shrinking, as tax increases encourage those who are better off to move away, leaving the city increasingly home to lower and low income individuals.

In those discussions, someone needs to explain why the school district’s expenditures exceed its revenue by $629 billion. According to the fiscal year 2009 budget, expenditures were $2.3 billion. Two years later, according to this story, they had risen to $3.1 billion. The current proposal for fiscal 2012 is roughly $2.8 billion. Where does the money go? More than $600 billion is used to pay for the operation of charter and other alternative schools, to which at least one-fourth of the city’s school children have gone, an outcome that speaks volumes about the school district’s own schools. Surely running multiple-track school systems is economically inefficient, as evident from the explanation on page 31 of the fiscal 2012 budget. With an expected enrollment of 145,064, the per-student cost of Philadelphia’s school system is more than $19,000, and adjusting for payments made to charter schools, which brings the enrollment to 206,699, the per-student cost is more than $13,000. The per-student cost of a unified system operated with the features that have made charter schools attractive surely would face a lower per-student cost and thus a lower demand for revenue.

Perhaps the people running the charter schools ought to be handed the keys to the entire district. That, of course, highlights something that doesn’t get enough attention. The charter schools draw students who want to learn. Students who do not have a love of learning, often lacking parental and home support for educational advancement, not only fail to make academic progress but also impose additional costs on the system, ranging from the hiring of additional personnel to deal with the underlying psychological and other issues but also to prevent and react to the physical violence that permeates the Philadelphia school system. The current approach doesn’t work and it needs to be fixed. The explanation of the fiscal year 2009 budget contains a reference to the more than $600 million spent to “reform” the system. Why does it cost that much additional money to get the people who currently are being paid to deliver quality education to provide the quality education they are being paid to deliver? Is it a matter of sending administrators and teachers back to school to learn how to administer schools and teach students? Is it describing the money used to create the alternative charter school system? This definitely is an instance where the pumping of money into the system ought to be preconditioned on an explanation of how the money is being used and what it is purchasing. The problem, it seems, is that the revenue being raised to educate the city’s students isn’t getting the job done.

As one member of City Council put it, “This is a mess. I don’t know what alternatives we really have.” The statement of another member of City Council, “At this time, I’m not comfortable with signing off on any level of contribution until we get an accurate accounting of what is actually needed,” suggests that the sort of deep exploration of the school system budget might happen. Might. In the meantime, the push for a soda tax has resumed. But even if enacted, it would be nothing more than a band-aid for a hemorrhaging school district.

UPDATE: According to this report, Philadelphia's mayor has called for the Philadelphia School District to open its books. I'm not the only one who has asked for an "explanation of how the money is being used and what it is purchasing."

A Tax and Regulation Inconsistency That Might Not Be Inconsistent

Several weeks ago, in the first of three stories summarized in Three Alarming Tax-Related Articles, I commented on a Philadelphia Inquirer story, When Changing Energy Suppliers, Check the Details. I wrote:

If you think deregulation of an industry is a wonderful thing for consumers, think again. The article features a woman who “embraced deregulation” of electricity suppliers, was promised a “big discount,” discovered that the quoted low rate turned out not to be so low, calculated her monthly savings at $1.25, and reported, “I’m unhappy.” No kidding. Perhaps that’s why most Pennsylvanians have chosen not to jump on the “deregulation of business is good for the consumer” bandwagon. Those who have been around long enough have seen those bandwagons crash and burn too many times.

Now comes a report that the Pennsylvania Public Utility Commission, reacting to the Philadelphia Inquirer article, has demanded that the power industry “comply with PUC billing regulations.” Apparently there already exist rules to prevent energy suppliers from hiding information, issuing misleading and erroneous invoices, and duping consumers. One supplier, for example, did not disclose the amount it charges per kilowatt hour. The enforcement action by the PUC is an example of taxpayer dollars providing a valuable return to taxpayers, by saving them from overpaying for electricity and other energy supplies. Sounds good? Wait.

In the same issue of the Philadelphia Inquirer that brought the news of the PUC action, there was another story, this one about a speech by the state’s governor. The governor announced that he was sticking to his campaign platform. “No new taxes. Less regulation. A competitive business environment.” What does this mean? It can mean fewer taxes and thus less funding, or perhaps eliminated funding, for PUC enforcement of its regulations or perhaps even for issuing and maintaining regulations. It can mean, even aside from reduced revenue, repeal of regulations. And perhaps that is the secret to “a competitive business environment.” Reduce the taxes, cut back on supervision, and let businesses function as have some, certainly too many, of the independent energy suppliers that have sprung up out of the woodwork in response to the deregulation of energy in Pennsylvania. The argument that deregulation is good for people is turning out to be nothing more than a mask for the proposition that deregulation is good for a few people. Perhaps if employees could quote their employers a salary and then send invoices reflecting higher amounts but without disclosing the calculation, the business world might get a glimpse of how it feels to experience the situations encountered by the people featured in the Philadelphia Inquirer story.

But, here’s the challenge. A majority of Pennsylvanians oppose improper billing practices by businesses, including energy suppliers, and support regulations and enforcement of those regulations to prevent such business behavior. Yet a majority of Pennsylvanians who voted decided to elect someone who opposes regulation of business and the payment of taxes to fund consumer protection. Perhaps the answer lies in the majority of registered voters who don’t bother to vote. Perhaps they make up a significant portion of the people who oppose improper billing practices and support regulations and enforcement to prevent them, but for some reason didn’t bother to make their electoral voices heard. If that’s the case, something in the electoral system has failed. If it isn’t fixed, the problems of today will become the crises of tomorrow.

Is the Mileage-Based Road Fee So Terrible?

The folks at The Infrastructurist passed along to me a link to No One Likes New Taxes (But How Else Will We Pay for Roads?). This is an important question. It goes right to the heart of the concern that many people want things but are unwilling to pay for those things. As noted in the CNBC clip embedded in that post, the Highway Trust Fund runs out of money next year. The federal gasoline tax has not been increased for 18 years, thus failing to keep up with inflation. Roads are falling apart, bridges are falling down, and tunnels are leaking. Amounts spent by drivers for front-end alignments and wheel and tire repair and replacement on account of potholes and other road defects far exceed the highway funding tax increases they so valiantly oppose. Why they think they are better off economically under these circumstances boggles my mind.

The answer, of course, to the decline in gasoline tax receipts caused by the proliferation of more fuel efficient vehicles and electric vehicles is the mileage-based road fee, or vehicle-miles traveled user fee. My support for this fee was first explained in Tax Meets Technology on the Road, and subsequently in Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, Change, Tax, Mileage-Based Road Fees, and Secrecy, Pennsylvania State Gasoline Tax Increase: The Last Hurrah?, Making Progress with Mileage-Based Road Fees, Mileage-Based Road Fees Gain More Traction, Looking More Closely at Mileage-Based Road Fees, and The Mileage-Based Road Fee Lives On. Yet this sensible solution to an impending national catastrophe is attacked.

One of the commentators in the CNBC clip argued that the mileage-based road fee is contrary to “many of the ideas that America was founded on.” Granted, the Founders did not contemplate mileage-based road fees, nor did they contemplate the internal combustion engine, paved roads, or the interstate highway system. How many Americans want to live in a nation that is stuck in the late eighteenth century? Are we to be restricted to technologies that were in the minds of the Founders? Perhaps the gasoline tax should be declared unconstitutional because the Founders did not have ideas about gasoline. Perhaps antibiotics also should be outlawed? America was founded on the idea of finding solutions to problems. The mileage-based road fee is a solution to a problem.

The same commentator also raised privacy concerns, claiming that the government would insert GPS devices in automobiles and track where people went. The government already knows where people go, that horse left the barn a while ago, and a GPS device would add little to the government’s ability to keep track of individuals. Roadside cameras, satellites, cell phone tracking, EZ-Pass, and a variety of other technologies already feed information into a surveillance grid. But, more important, a mileage-based road fee doesn’t require a GPS device. It simply requires odometer readings. The government already obtains those readings, directly and indirectly. For example, in Pennsylvania, when applying for the annual registration renewal, a vehicle owner must provide the odometer reading. It doesn’t take much effort to calculate the miles that have been driven in the vehicle.

The same commentator claimed that the mileage-based road fee is regressive. It is, if lower-income individuals drive more miles annually than do higher-income individuals. That’s not the case. The gasoline tax, which would be replaced by the mileage-based road fee, is regressive, because lower-income individuals proportionally own more older, less fuel-efficient vehicles than do higher-income individuals. See, e.g., Income-Based Equity Impacts of Congestion Pricing—A Primer (“For example, low-income drivers usually drive older vehicles that are not as fuel-efficient as newer models. They therefore must purchase more fuel per mile driven and consequently pay higher fuel taxes for each mile driven than do those who own newer fuel-efficient models.”) Lower-income individuals make more use of public transportation than do higher-income individuals. See, e.g., Transportation Spending by Low-Income California Households: Lessons for the San Francisco Bay Area (“Low income workers walk, carpool, and use public transit at higher rates than their more affluent counterparts;”).

So why the opposition to the mileage-based road fee? Perhaps the same sort of misunderstanding that causes people to overlook the connection between their increased vehicle repair bills and the erosion of highway funding causes them to think that mileage-based road fees would impoverish the poor, invade privacy, and shake the foundations of the Constitution. Perhaps it’s the same sort of education system shortcoming that causes people to claim that a July with five Fridays, five Saturdays, and five Sundays happens only once every 823 years.

Free, Freedom, Fees, and Taxes

Memorial Day is a day of commemoration that has evolved into a holiday marking the start of the summer vacation season. Though there remain some parades, the percentage of Americans visiting veterans’ gravesites or otherwise honoring those who have served to protect the freedom of the nation is diminishing. Ask 100 Americans at random what Memorial Day means, what it’s about, and what they are doing on that day. Some do, like the Honorable Patrick Dugan of the Philadelphia Veterans Court, who in Keep Alive Those Who Made the Sacrifice writes that “For most of my life, I was like most people: I knew what Memorial Day stood for, but I didn't really stop to think about what it truly meant. That changed after I went to Iraq in 2003 as a civil-affairs soldier with the Army Reserves. When you serve with people who don't come home, Memorial Day means something different.” It’s tough to understand, and even more challenging to explain, that freedom is not free.

Americans surely understand the word “free,” for it shows up frequently in the phrase “free market” and in the slogan “free to do what I want.” Yet when asked to pay for freedom, too many Americans balk, even when the cost facing them is far less than their time, their physical well-being, and their life. The notion that freedom is free is becoming ever more omnipresent in the culture.

Here’s a case in point that pulls together the concept of freedom and the beginning of the vacation season. In Beachgoers: If It’s Free, It’s for Me, the Associated Press reports that for the third time in four years, people voting in the New Jersey Sea Grant Consortium annual contest selected the Wildwoods – consisting of Wildwood, Wildwood Crest, and North Wildwood – as the joint winner. A major factor in the voting is the fact that, unlike many other New Jersey beaches, the Wildwoods does not charge for a beach tag. In the same issue of the Philadelphia Inquirer in which that Associated Press story appears is another report, the headline for which gives away the point in question: New Jersey Shore Communities Scrape to Keep Visitor Services. The mayor of the town of Wildwood, which is facing a $2 million budget deficit, is considering laying off 20 of its 36 police officers, and at least five firefighters. When? On June 1, the beginning of tourist season. Of course, everyone who has weighed in on the question claims that such a move would be disastrous, because, quoting the deputy city mayor of another shore town, “We have a certain level of service in the summer that people come to expect.” As another official put it, “The people who come here for vacation have to feel safe.” During the summer, 295,000 tourists take the town’s population from 5,000 to 300,000, and, according to that official, “aren’t interested” in the town’s budget problems because “[t]hey just want to have a good time.”

Perhaps if the town charged beach fees it would have the resources to cater to the 295,000 tourists who flood the resort. Town official after town official echoed the same theme, that visitors expect services at least as good as those that they experienced the preceding year, that they will not return if the services decline in quantity or quality, that they don’t care about the fiscal woes of the town they are visiting, and that their only interest is in having fun. The notion of “let’s have fun but let someone else pay for the things we get for free” is pernicious.

In order for a person to have something for free, someone else must pay. Most children receive their food, shelter, and clothing for free because their parents pay. But when tourists use a beach for free, requiring lifeguards, safety patrols, litter removal, public restrooms, parking, and other amenities, who pays? Should 5,000 pay for the freedom of 295,000?

The question of who pays the bills to use a free beach would be irrelevant but for the fact that this nation exists, has beaches, and has a citizenry that is free to go to the beach. In some countries, people aren’t free even to travel outside their home village, let alone jump in a car, train, or plane to head for some resort. There are people who paid for that freedom with something far more than suitcases full of cash, namely, with their lives, and they deserve recognition and thanks on this Memorial Day. Paying taxes or beach fees pales in comparison to paying the price that has been paid by the veterans whom we cannot thank in person. The best we can do is to honor their memory. And the best way to do that is to respect freedom and to acknowledge that freedom is not free.

Tax Revenues Used for Replenishment

It was rather startling to read the headline in this story: U.S. Allocates Record Amount for Beach Projects. A government saddled with trillion dollar deficits has found a way to increase the amount of money it spends on pumping sand onto beaches? Almost $150 million is slated for beach projects, which is the highest annual amount since “the nation’s most prominent coastal lobbyist” began in 1995 to record these sorts of expenditures. Most of the money is spent to put back onto the beach sand that storms, through natural processes, have washed out to sea, presumably so that nature can again take the sand out to sea and create more opportunities to spend tax dollars to put the sand back onto the beach.

So how is it that federal spending on beach replenishment can increase when other programs, such as those used to feed hungry people or provide medical care to impoverished children, are being cut? There may be some clues in another article, one that describes the efforts of those who own private beach property to restrict public access to beaches. What the beach replenishment money protects is, according to yet another article, to protect private investment in private homes, privately-held hotels and motels, and privately-owned businesses. In many instances, these structures are built in places guaranteed to be washed out by typical seashore storms. One coastal activist explained, "It's just a bailout for the rich who build homes in dumb places."

I wonder if anyone has done a survey to determine how many people who complain about taxes and advocate reduced government spending own properties whose beaches are being replenished at public expense. In the meantime, the lobbyists are attempting to get the federal government to double the amount of money it is pouring into beach sand that will be washed back out to sea. Even though the story is probably a legend or tall tale, even Canute had the good sense to understand the power of the ocean.

Across America, millions of people experience topsoil erosion, as rains wash dirt off their lawns and into streets, storm sewers, and creeks. How many of these people are getting topsoil replenishment at taxpayer expense? Next time someone heads to the store to purchase bags of topsoil, or pays for a delivery of several yards of dirt to restore the lawn, perhaps they should close their eyes and pretend they’re the owners of a home with a private beach whose sand is being replenished courtesy of taxpayers.

In Tax, as in Life, Just One Word Can Matter

On Sunday, as reported in this story, Senate Republican leader Mitch McConnell stated that he and his party oppose higher tax rates. Most people consider tax rates changes to match tax revenue changes. That’s true for a simple tax that is computed simply by multiplying a rate by a standard measure. But it’s not true for a complicated tax, and there are plenty of complicated taxes, such as the federal income tax. Reduction or elimination of gross income exclusions, deductions, credits, or any combination of those items, can increase tax revenue despite the lack of changes in the tax rates. Enactment of additional exclusions, deductions, or credits can decrease tax revenue even though rates remain the same. Though Congress hasn’t reduced federal income tax rates for almost a decade, it has reduced taxes through a flood of new and expanded tax credits, deductions, and gross income exclusions.

What is significant about McConnell’s statement is that he did not articulate opposition to increased taxes, or increased revenue. When pressed about tax expenditures, McConnell not surprisingly sidestepped the issue. He is under pressure from the extreme right, which seeks reduced tax revenues, reduced spending, and presumably unavoidable consequences of reducing revenue and spending. Yet at least one other conservative Republican, and, yes, that is not an oxymoronic phrase, has suggested that overall tax reform that repeals loopholes and subsidies would be welcome even if it brings increased tax revenues while lowering tax rates.

A simple, or more pragmatically, a simpler, tax code can generate unchanged or increased tax revenues while lowering rates or leaving them alone. On account of all the special provisions and disguised spending buried in the tax law, rates are higher than they otherwise would be. Advocates of cutting federal spending need to look at, and some have started to look at, spending in the form of tax reductions for special interest groups. Imagine, for example, a federal income tax computed by subjecting all income to tax, with deductions allowed only for the direct cost of generating business and investment income, with basis and rates indexed for inflation and with no special rates or other provisions favoring special groups. The tax rates could be lowered to at least half of what they currently are, and perhaps even more. The price for rates that would no longer generate visceral negativity from most taxpayers would be a farewell to depreciation deductions for properties increasing in value, credits for all sorts of personal and business activity that ought to take place only if the market encourages it or citizens vote to require it through direct regulation, exclusions for fringe benefits that generally favor well-compensated employees, and deductions for things such as home mortgage interest that distort the housing market, to name but a few of the things that make the tax law a minefield for well-intentioned taxpayers and a playground for the greedy.

Of course, simplifying the tax law will bring howls of protest. Some might think that those who seemingly benefit from the mess, specifically tax return preparers and tax planners, would oppose the changes, but anyone who listens to tax practitioners, and I do, will learn very quickly that the complexity has made their jobs almost impossible to perform. They are sufficiently wise to know that even with the sort of changes that I, and others, advocate, they will continue to be busy. For example, timing issues will not go away until the earth stops rotating around the sun.

The howls of protest will come from the special interest groups that think they are entitled to special treatment. Like the drivers who go straight out of the left-turn lane as self-appointed VIPs, the special interest groups are quick with the excuses purporting to demonstrate that absent the special break the economy and nation will collapse, but short with the track record of demonstrating that the special break did anything for anybody other than its proponents who paid, excuse me, lobbied for its passage. The murkiness of federal politics makes it very difficult for people who understand the unfairness of the lane jumper to understand the similar inequities fostered by privileged access to the halls of power.

So, let’s stop focusing on tax rates, and put that distraction aside. Let’s turn the nation’s attention to the federal spending that, until recently, has gone unnoticed by the public because it is hidden in a labyrinth of badly drafted and deliberately obfuscated tax law.

What is Income?

In most basic federal income tax courses, students early on confront a question that has accompanied the income tax on its entire life journey. What is income? Section 61(a) defines gross income, the starting point in calculating taxable income on which tax liability is computed, as “all income from whatever source derived.” Thus, before a person can determine gross income, a person must determine income.

Why does this matter? Income is important not only in the computation of gross income, taxable income, and tax liability, but also in determining whether a person qualifies for assistance that is limited to individuals with incomes under specified levels. For example, in New York State, an individual in a one-person household is are eligible for food stamps if his or her annual income is less than $14,088. The cut-off increases as the household size increases, and is further increased if someone in the household is disabled or elderly. Eligibility actually is more complicated, but the essential point is that benefits are geared to individuals with low income.

So what happens if a person wins $2 million in a lottery? Does the person become ineligible for food stamps? According to the Michigan Department of Human Services, no. As reported in this story, a lottery winner who hauled in $2 million was permitted to continue receiving food stamps because lottery winnings are not considered income. Even though eligibility for food stamps “is based on gross income,” lottery winnings are considered liquid assets and not income. Hello? The last time I checked, gross income includes lottery winnings. There are a not insubstantial number of cases and rulings that make that conclusion unquestionable.

I do not understand why lottery winnings are not treated as income for purposes of food stamp eligibility. Food stamps are designed to assist low-income individuals. A person who takes in $2 million in one year is not a low-income person. Certainly not for that year, and certainly not for each succeeding year if the proceeds are invested wisely. After taxes, the $2 million becomes roughly $1.2 million, which should generate something in the neighborhood of $40,000 to $60,000 each year. There are many people in this country who survive without food stamps on annual incomes of $40,000 to $60,000.

The person in question, when interviewed, stated, “If you're going to try to make me feel bad, you're not going to do it.” Legally, the lottery winner is entitled to food stamps, and was told so by the Michigan Department of Human Services. One Michigan state senator commented that for the winner to continue using food stamps, funded by taxpayers, after winning the lottery, is “obscene.” That the winner lacks the moral fiber to waive his right to food stamps is a different question. The winner’s attorney correctly pointed out that he notified the state. He added, “The problem is with the state.”

Technically, the problem is with whoever designed a system that treats someone who wins $2 million as a low-income person, by considering what clearly is income as not income. As the Michigan state senator noted, “What a waste of taxpayer money.”

It’s this sort of bureaucratic nonsense, statutory defectiveness, and regulatory shortcomings that add inspiration for the anti-tax crowd. The effort to help needy people gets targeted because the system is badly implemented. Although Michigan has requested a waiver from the federal government that would permit it to count the lottery winnings as income, the more sensible outcome is for Congress to make it unquestionably clear that excluding lottery winnings from income is total absurdity.

Congressional Mis-delegation Endangers Tax Collections

Several months ago, in The Problem with Income Tax Vehicle Credits, I criticized the Congress for burdening the IRS with administration of all sorts of programs that ought to be handled by the federal agencies charged with oversight of those sorts of programs. I wrote:

During the past two decades, Congress has heaped credit upon credit onto the tax system, putting administration of environmental, energy, health, labor, child care, and all sorts of other matters into the hands of the IRS rather than the federal agencies charged with oversight of these areas. At the same time, the Congress has failed to provide the IRS with sufficient funding to administer these credits. It’s not surprise, then, that the IRS hasn’t developed a full and efficient set of procedures to manage each of the many dozens of credits that it must supervise.

This was not the first time I had emphasized the misguided approach that the Congress repeatedly follows. For example, slightly more than a year ago, in IRS Ought Not Be the Health Care Enforcement Administrator, I rejected the idea that the IRS should become the health care enforcement agency. Three years ago, in Not To Its Credit, I pointed out the foolishness of making the IRS responsible for administering energy incentive payments:

It's not that I object to the goals. I object to the Internal Revenue Service being turned into a institution that is focused more on the technical requirements of energy production activities than on administering revenue laws. I wonder why financial incentives to produce and conserve energy aren't administered by the Department of Energy. Well, I know the answer. The Congress, though every now and then publicly trashing the IRS and characterizing it as harmful, then turns to the same agency to administer its favorite incentives programs. Which should speak more loudly to America? What Congress says when it grandstands or what it does when it overburdens the tax law and the IRS because it apparently doesn't trust other agencies to administer laws relating to agriculture, energy, employment, or health?

I’m not the only one who notices the tax law complexity that is attributable to spending programs hidden in the Internal Revenue Code. In Tax Talk at the Gym, I explained my response to someone who had

stopped me and asked why the tax law was filled with so many provisions that weren't a matter of revenue collection but expenditures. The answer is an easy one, because it's asked every semester by students in the basic tax course. Why not have the Department of Energy write checks to companies and individuals who are doing things to develop or conserve energy instead of administering the grants through tax refunds? Why not have the Department of Labor reimburse employers who hire members of targeted groups? The answer rests in the Congress' confidence with those other agencies and with the supposed speed with which tax refunds can put money in the taxpayers' hands in contrast to check-writing programs.

I’ve been harping on this problem for decades, and the topic appeared in the early days of this blog. Six years ago, in the frighteningly titled Prof. Maule Goes to Washington, I challenged Congress’s practice of relying on the IRS to do the work of other agencies:

I understand that the Congress, which consistently criticizes the IRS, has a habit of demonstrating its true thoughts about that particular federal agency by putting into the tax law provisions that deal with matters that are within the purview of other federal agencies because the IRS appears to be more capable of administering these programs, but it's time for Congress to demand of the other agencies the same sort of competence that it attributes to the IRS when it turns to the IRS to handle its pet project of the week.

As has always been the case, I rejoice when others step up and corroborate my contentions. That happened last week.

In The IRS Oversight Board Annual Report to Congress 2010, released about a week ago, the IRS Oversight Board reported to the President, the Congress, and taxpayers on the state of the IRS, its accomplishments, its shortcomings, and its challenges. The Board pointed out two weaknesses, namely, the tax gap and archaic information technology systems. It then turned its attention to another concern. The Board’s comment seems familiar:

These two weaknesses are exacerbated by another concern: an under-appreciation of the importance of tax administration to the nation’s economic well-being as evidenced by a willingness to expand the complexity of the tax code with little regard for the impact on taxpayers or the resources needed by the IRS to administer the code. In recent years, the tax administration system has been used to deliver quickly and efficiently a variety of financial benefits to taxpayers during a period of economic turmoil. The IRS has responded well to these challenges, but the result has been to stretch the IRS’ resources thin. Every new tax provision added to the internal revenue code requires both service and enforcement resources for successful implementation.

The Board repeated its reference to “thin” IRS resources when it noted, in yet another familiar comment, the challenges of having the IRS function as the healthcare enforcer. The Board pointed out that failure to fund the IRS exacerbates the risks of turning IRS attention away from “responsible tax administration” and again referred to “IRS resources already stretched thin to administer an increasingly complex tax code.”

An excellent example of the dangers presented by how Congress uses or, more specifically, mis-uses or abuses, the tax law for purposes of gaining political advantage in the vote collection game can be found in its approach to dealing with the problems of economically distressed areas. I am in the early stages of revising a Tax Management portfolio that focuses on this aspect of the tax law. Although subject to change, at the moment I have identified at least forty different tax breaks available to persons, businesses, programs, or activities in any one of at least 14 different types of economically distressed areas. Some breaks are available to one area, some to many areas, and only a handful to all areas. Most of the tax breaks come with expiration dates, most of which are annually extended by a Congress that can hold the extension hostage to the vote collection process. There’s much more leverage available to a legislator when a tax break is on the verge of expiring than there is when a tax break is permanent. Combined with the inability to put relief for economically distressed areas in the hands of the appropriate agencies, the tax legislation game that has polluted the legislative process ever since the leverage twist was identified and put to work threatens the well being of the nation because it imperils the ability of the IRS to collect the revenue. While the IRS is playing multiple grant-making roles, tax returns that should be audited go unaudited. Sometimes I wonder if there aren’t members of Congress who secretly wish for this potential revenue collection failure to come to fruition so that they can impose their “tax only wages under the guise of a flat tax” scheme on America.

The fact that something can be done well and isn’t ought to be a message for all Americans. Perhaps the fact that I’ve been complaining about this for quite some time isn’t sufficiently persuasive. But perhaps the fact that the IRS Oversight Board has said the same thing – though perhaps more tactfully – might have some positive impact on the national tax policy culture. Perhaps. Just perhaps.

Three Alarming Tax-Related Articles

If the bad news about earthquakes, tsunamis, nuclear melt-downs, tornados, and floods aren’t enough, here are three recent articles about less eye-catching, but no less dangerous and alarming economic and tax-related developments:

1. When Changing Energy Suppliers, Check the Details: If you think deregulation of an industry is a wonderful thing for consumers, think again. The article features a woman who “embraced deregulation” of electricity suppliers, was promised a “big discount,” discovered that the quoted low rate turned out not to be so low, calculated her monthly savings at $1.25, and reported, “I’m unhappy.” No kidding. Perhaps that’s why most Pennsylvanians have chosen not to jump on the “deregulation of business is good for the consumer” bandwagon. Those who have been around long enough have seen those bandwagons crash and burn too many times.

2. The Ugly Truth About Infrastructure (and Taxes): Not all truth is pretty, and the status of the nation’s infrastructure qualifies for something worse than the word ugly. Scott Huler, whose On the Grid: A Plot of Land, An Average Neighborhood, and the Systems that Make Our World Work was published a year ago, focuses on the crumbling transportation, energy, utility, and other infrastructure of the nation. He fears that as the infrastructure crumbles, so, too, will crumble the nation, and he expresses concerns, not unlike those I consistently highlight, that Americans are simply unwilling to pay for replacement and upgrading of what their ancestors bequeathed to them, because they have sipped so much of the “no new taxes, no tax increase, goodness, no taxes at all” sound bites being used by politicians to curry favor with voters. The information he provides about infrastructure issues in Japan, Libya, South Korea, and Seattle ought to be taught in the nation’s schools and highlighted on every news channel. He equates the “War on Taxes” with the “War Against Infrastructure.” Consider that, as of 2009, the American Society of Civil Engineer figured the nation to be $2.2 TRILLION behind in maintenance. Serendipitously, late last week I happened upon a History Channel program about infrastructure. This particular episode focused on California. I can’t imagine anyone in San Francisco who watched the program sleeping soundly at night. I can’t imagine anyone living near the two million miles of natural gas pipeline feeling comfortable after learning what happened in the San Bruno catastrophe and understanding how corporate cost-cutting contributed to the death and destruction. Huler claims that he “no longer know[s] how to respond” to the arguments against raising taxes to pay for what we need and use. He said that when he wrote his book he “worked hard not to become a shrieking harpy.” No problem, Scott, I’m sure that in the eyes of the “infrastructure grows on the money tree” believers, I’ve earned the shrieking harpy designation.

3. Gen Xer’s Dim Retirement Prospects: Claiming a better title than “shrieking harpy,” Jack VanDerhai has earned the nickname of “Dr. Doom” because of his “decades-long career of studying the increasingly grim odds of whether Americans can make it through retirement without, to be blunt, going broke.” VanDerhai has concluded the people most at risk of not surviving retirement economically are not current retirees or baby boomers, but Generation X. People in this age group face reduced Social Security and Medicare benefits, the demise of fixed pensions, flat wages, ownership of homes purchased at the top of an artificial market, higher mortgage debt ratios, and horrific investment returns on what little they scraped to save for retirement. Consider these numbers. A person born in 1949 who started investing in a 401(k) equity plan at age 30 (1979), realized a 9.2 percent rate of return as of February 2010, which is post-crash. A person born in 1959 who started investing in a 401(k) equity plan at age 30 (1989), realized a 5.5 percent rate of return as of February 2010. A person born in 1969 who started investing in a 401(k) equity plan at age 30 (1999), realized a 0.3 percent rate of return as of February 2010. Wait? A 0.3 percent rate of return from 1999 through 2010? Hmm, I wonder what economic policies dominated that decade?

Alarming, indeed.