Tax & Business Law Commentary

Whips and Chains?

2007-01-19T11:48:00.000-05:00

The following question was posed on the Maryland State Bar Association's Small and Solo Practice listserv discussion group:

Hello List,

First let me start by saying I hope my question doesn't offend anyone but I wanted to hopefully find someone who could point me in the right direction. I had a potential client call today and ask me to draft a "Domination Contract." I had no idea what that was until the client explained that she has been requested to be a Dominatrix by someone else and she would like me to draft a contract outlining their "do's and don'ts" of their session or meeting I guess. I'm not sure what would really go into a "contract" of this sort.

Is this even legal? I am not sure where to start looking. I was going to try to type in interesting keywords in westlaw to see if anything popped up. If anyone can help me or point me towards a great source I would appreciate it.

Of course, the question that first occurred to me is: Is the "Dominatrix" an independent contractor or an employee? This has obvious income tax and FICA/SECA implications.

My second thought went to the Martin Mull song, some of the lyrics of which are as follows:

"Last night I took you out/And we began to hmmm...."

"Hmmm, hm-hm-hmmmm, hm-hm-hmmmm, hm-hm-hmmmm... pick up the soap... Hmm, hm-hm-hmmmm, hm-hm-hmmmm, hm-hm-hmmmm, ... mayonnaise and rope... Hmm-hmmm-hm-hm, whips and chains.... hmm-hmm-hm-hm-hm, Great Danes... hmm-hm-hm-hm-hm-hm-hmmmm-hmmmm, your wife!"

(Hat tip on the lyrics to Paul Shrug.)

Original Intent on Representing the Unpopular

2007-01-13T11:16:00.000-05:00

In 1770, a prominent Boston lawyer represented the Capt. Thomas Preston and the British soldiers after the Boston Massacre. They were immensely unpopular. This account of that lawyer's recollection of his retention for the defense was posted on October 20, 2006, on the blog, Boston 1775:

The next Morning I think it was [i.e., 6 March 1770], sitting in my Office, near the Steps of the Town house Stairs, Mr. [James] Forrest came in, who was then called the Irish Infant. I had some Acquaintance with him. With tears streaming from his Eyes, he said I am come with a very solemn Message from a very unfortunate Man, Captain Preston in Prison. He wishes for Council, and can get none.

I have waited on Mr. [Josiah] Quincy, who says he will engage if you will give him your Assistance: without it possitively he will not. Even Mr. [Robert] Auchmuty declines unless you will engage. . . .

I had no hesitation in answering that Council ought to be the very last thing that an accused Person should want [i.e., be without] in a free Country. That the Bar ought in my opinion to be independent and impartial at all Times And in every Circumstance. And that Persons whose Lives were at Stake ought to have the Council they preferred: But he must be sensible this would be as important a Cause as ever was tryed in any Court or Country of the World: and that every Lawyer must hold himself responsible not only to his Country, but to the highest and most infallible of all Trybunals for the Part he should Act.

He must therefore expect from me no Art or Address, No Sophistry or Prevarication in such a Cause; nor any thing more than Fact, Evidence and Law would justify. Captain Preston he said requested and desired no more: and that he had such an Opinion, from all he had heard from all Parties of me, that he could chearfully trust his Life with me, upon those Principles.

And said Forrest, as God almighty is my judge I believe him an innocent Man. I replied that must be ascertained by his Tryal, and if he thinks he cannot have a fair Tryal of that Issue without my Assistance, without hesitation he shall have it.

Upon this, Forrest offered me a single Guinea as a retaining fee and I readily accepted it. From first to last I never said a Word about fees, in any of those Cases, and I should have said nothing about them here, if Calumnies and Insinuations had not been propagated that I was tempted by great fees and enormous sums of Money.

Before or after the Tryal, Preston sent me ten Guineas and at the Tryal of the Soldiers afterwards Eight Guineas more, which were all the fees I ever received or were offered to me, and I should not have said any thing on the subject to my Clients if they had never offered me any Thing.

This was all the pecuniary Reward I ever had for fourteen or fifteen days labour, in the most exhausting and fatiguing Causes I ever tried: for hazarding a Popularity very general and very hardly earned: and for incurring a Clamour and popular Suspicions and prejudices, which are not yet worn out and never will be forgotten as long as History of this Period is read.

For the Experience of all my Life has proved to me, that the Memory of Malice is faithfull, and more, it continually adds to its Stock; while that of Kindness and Friendship is not only frail but treacherous. It was immediately bruited abroad that I had engaged for Preston and the Soldiers, and occasioned a great clamour which the Friends of Government delighted to hear, and slyly and secretly fomented with all their Art.

The attorney was, of course, John Adams, second president of the United States.

Compare his actions to the remarks of Charles D. Stimson, the deputy assistant secretary of defense for detainee affairs, reported here.

Housekeeping

2007-01-11T20:42:00.000-05:00

This post is just to clear a problem between Blogger and Bloglines.

Rollout for Maryland Courts Watcher

2007-01-04T22:23:00.000-05:00

We officially rolled out the Maryland Courts Watcher by posting the following announcement on various Maryland State Bar Association listserves:

We are happy to announce the availability of a new free service, Maryland Courts Watcher.

Maryland Courts Watcher posts synopses of every judicial opinion available on the web. That includes the opinions of both of the Courts of Appeal, the United Stated District Court for the District of Maryland, the United States Bankruptcy Court for the District of Maryland, the Circuit Court for Baltimore City, the Business and Technology Courts for Maryland, and the Maryland Tax Court.

All postings include links to the full opinions. Postings are available on the web or via email, RSS, or Atom syndication.

Each posting has labels attached that will enable research into topic areas. Each case also has labels for the judge who authored the principal opinion and any judge who authored a concurring or dissenting opinion. Over time, this will allow users to develop a profile for any particular judge to get a better idea how he or she will approach a particular type of matter. Readers are also able to perform Google searches on the website.

Readers can post comments to any posting. We hope that, in time, this capability will allow the website to become a venue for serious discussion of issues raised by court opinions.

The website for Maryland Courts Watcher is:

http://marylandcourts.blogspot.com/

Finally, we want and need additional editors to help out with the postings. If you want to volunteer, please send an email to mcw[symbol for "at"]taxation-business.com, using the subject line “MCW Volunteer.”

We have posted a more complete description of Maryland Courts Watcher in FAQ fashion here.

Bad News from Finland

2007-01-01T18:24:00.000-05:00

The paper, To Have or Not To Have a Pet for Better Health?, in PLoS-One, reached the following conclusion:

Pet ownership was very lightly associated with poor health in the general working-aged population when using several health and disease indicators. Pet owners had a slightly higher [Body Mass Index] than the rest, which indicates that people having a pet (particularly a dog) could use some exercise.

The following solution was not suggested:

The Tax Foundation Can't Win for Losing

2006-12-30T01:37:00.000-05:00

Even when I somewhat agree with the Tax Foundation, I am somewhat astonished by their cavalier abuse of the facts. Case in point: The recent post Is Maryland Gambling on Gambling to Balance the Budget?

I agree with the Tax Foundation that funding government via a state operated gambling operation is poor tax policy. My primary objection is that the revenue garnered through gaming operations is, in effect, a regressive form of tax. However, I would not say, as the Tax Foundation does (quoting an article from the Lottery Post),that:

The lottery's diminishing contribution to the state budget is one of many reasons why Maryland is facing nearly $8 billion in deficits over the next five years, analysts say.

That's a great point. It is, alas, basically not true. In the last six fiscal years, the gross revenue and net revenue (after expenses) from the lottery to Maryland's treasury were as follows:

Year	Gross Sales	Net Revenue
2001	$1.2 Billion	$407 Million
2002	$1.3 Billion	$443 Million
2003	$1.32 Billion	$445 Million
2004	$1.395 Billion	$458 Million
2005	$1.485 Billion	$477 Million
2006	$1.561 Billion	$501 Million

Source: The Maryland Lottery Agency.

As shown in the above table, the total net revenues over the six year period from the lottery increased by about 25%. Maryland State's expenditures over that period increased by less than 29%, that is, a percentage that is only slightly more than percentage growth of the lottery. Thus, while it is literally true that the lottery's contribution to the state budget has been "diminishing," neither the rate nor amount of decline could be said to materially contribute to a looming $8 billion budgetary shortfall (in a budget that, in FY 2006, was slightly less than $26 billion). (Note: The shortfall is projected over a 5 year period. My back of the envelope estimation tells me that the shortfall will be about 6% of the budget. That's a problem, but hardly a catastrophe.)

Note to The Tax Foundation: Even good arguments are undermined when their proponents substitute truthiness for truth.

Net Neutrality

2006-12-23T12:21:00.000-05:00

Net neutrality explained:

Misleading mumbo jumbo on net neutrality:

If you still can't figure out what net neutrality is all about, follow the Ninja:

America's Pastime

2006-12-14T18:09:00.000-05:00

Apparently the Boston Red Sox will, on their own, cause approximately a 0.1% increase in the U.S. trade deficit in the month of December.

In October, the U.S. trade deficit was $58.9 billion. The $51.11 million that the Red Sox have to pay to the Seibu Lions by December 21 for for negotiating rights to Japanese pitching ace Daisuke Matsuzaka will therefore constitute a measurable portion of the December deficit if the December figure is in approximately in the same range as the October amount.

Of course, the foregoing calculation does not include the bats, gloves, shoes, etc., that the Red Sox and other Major League teams will purchase from offshore suppliers.

Update

A commentator pointed to a discussion in The Hard Times which stated that:

Okay, no one is going to bid $51 million to negotiate with a player just because they think he’s good. Obviously, the Red Sox expect that signing Matsuzaka will give them marketing inroads in Japan, and make them a lot of money in the Far East. How much can they expect to make?

I’ll start off by saying that I have no idea, but we can still try to generate an estimate. There have been two situations in the past similar to this one: The Mariners’ signing of Ichiro Suzuki and the Yankees’ signing of Hideki Matsui. Why not examine how much money they made from that?

Unfortunately, there are no direct numbers on the teams’ revenues in Japan, so the only estimate we can make is going to be based off indirect evidence. Using Forbes reports on team revenues for the past seven years, here is what I found:

* In 2001, Ichiro’s rookie season, the Mariners made $27 million more than they had the previous year. The five teams closest to Seattle in revenues in 2000 increased their income by an average of just $6 million.

* In 2003, Matsui’s rookie season, the Yankees increased their revenues by $8 million. The five teams closest to the Yankees in 2002 revenues upped their earnings by an average of $4 million.

* Between 2000 and 2006, Seattle’s revenues have increased by $67 million. The five teams closest in revenues to Seattle in 2000 have seen their income increase by an average of $54 million.

* Between 2002 and 2006, the Yankees’ revenues have gone up $62 million, versus an average increase of $21 million for the five teams closest to them in revenues in ’02.

If average all of that together, we can estimate that signing a Japanese star player is worth something like $9 million a year. But wait, we’re not done. $9 million in 2001 is not the same as $9 million in 2007. Adjusting for inflation (in baseball, inflation has held at a pretty steady 10% a year), we find that the Red Sox should expect to see their revenues in 2007 to increase by about $14 million should they sign Matsuzaka. That’s a sizeable chunk of change.

In other words, by selling additional products, media rights, etc., back to Japan, the balance of trade flow moves in the other direction, back to the U.S.

I don't know enough about the overall economics of baseball to tell whether the Matsuzaka deal is good or bad. However, I still think that its overall effects on the balance of trade are likely to be negative.

Presence

2006-12-12T18:31:00.000-05:00

The case of Tax Commissioner of West Virginia v. MBNA America Bank, N.A. is a very big deal. In that case, the Supreme Court of West Virginia held that the state could impose a corporate income tax on MBNA even though MBNA had no physical presence in West Virginia.

A state cannot impose a tax on a business engaged in interstate commerce unless, inter alia, the business has a substantial nexus with the state. In the sales tax area, in Quill Corp. v. North Dakota, the U.S. Supreme Court has held that there is such nexus only when the seller of taxable goods or services has a physical presence in the state attempting to impose the tax. The question remains open, however, whether substantial nexus sufficient to support the imposition of income tax requires the physical presence of the taxpayer.

In MBNA, the West Virginia Supreme Court held that the actual physical presence of a taxpayer was not required to allow the state to impose income tax. The money quote is the antithesis of the doctrine of original intent:

[P]rior to concluding, we simply wish to acknowledge the great challenge in applying the Commerce Clause to the ever-evolving practices of the marketplace. James Madison, Benjamin Franklin, and the other Framers at the Constitutional Convention who adopted the Commerce Clause lived in a world that is impossible for people living today to imagine. The Framers' concept of commerce consisted of goods transported in horse-drawn, wooden-wheeled wagons or ships with sails. They lived in a world with no electricity, no indoor plumbing, no automobiles, no paved roads, no airplanes, no telephones, no televisions, no computers, no plastic credit cards, no recorded music, and no iPods. Likewise, it would have been impossible for the Framers to imagine our world. When they fashioned the Commerce Clause, they could not possibly have foreseen the complex and varied ways that commerce is conducted today, especially via the internet and electronic commerce. It would be nonsense to suggest that they could foresee or fathom a time in which a person's telephone call to his or her local credit card company would be routinely answered by a person in Bombay, India, or that a consumer could purchase virtually any product on a computer with the click of a mouse without leaving home. This recognition of the staggering evolution in commerce from the Framers' time up through today suggests to this Court that in applying the Commerce Clause we must eschew rigid and mechanical legal formulas in favor of a fresh application of Commerce Clause principles tempered with healthy doses of fairness and common sense. This is what we have attempted to do herein.

Since I represent clients in this area, I will not offer any editorial comment on the West Virginia opinion. I would note, however, that the Court's holding is diametrically opposite to the holding of an intermediate appellate court that considered the same issue and was presented with essentially the same facts. See J.C. Penney Nat'l Bank v. Johnson, 19 S.W.3d 831 (Tenn.Ct.App. 1999). My guess is that this case will either go to the Supreme Court or it will set off a chain reaction of tax litigation in other states that will ultimately have to be resolved by the Supreme Court.

Hat Tip: The Tax Foundation's Tax Policy Blog which criticizes the MBNA opinion.

Why Bloggers Are Not Enough

2006-12-10T14:52:00.000-05:00

Today, the Baltimore Sun published an article on statutory ground rents, a form of real estate interest little-known outside of the Baltimore area. The thrust of the article was that, as real estate prices in Baltimore City have risen, there has been a dramatic increase in homeowners being ejected from their property due to delinquencies in their payment of ground rents.

I am not certain that the situation is as much of a public policy problem as the article contends. However, the article sheds some light on the continued need for and vitality of newspapers. It also shows how newspapers can produce an important product in the age of cyber information.

As to the first point, the article online omits a sidebar that was presented in the print version of the paper. That sidebar gave some background on the manner as to how the article was prepared. It is obvious that the Sun put substantial resources into the piece. I would ask anyone who contends that blogs could displace newspapers as a primary source of news whether any blog could muster the resources necessary to research and write a similar article.

As to the second point, it is of some interest that the article was designed with web-multimedia in mind. In addition to the text that appeared in the print version, on the web there are two video presentations and two audio presentations. It appears that the Sun understands that it can't limit itself to producing a print product.

Finally, it is worthy of some note that the subject of article is inherently local. At one time, the Sun was truly a national newspaper. That is no longer the case because it can't compete with WaPo, the NYT, the WSJ, the LAT, etc. However, there is still important work to do locally and it's comforting to see that the Sun remains committed to covering local stories in a serious way. Of course, it remains an open question as to whether papers such as the Sun can make money with this more narrow focus.

New Blog In Town

2006-12-09T20:14:00.000-05:00

I am pleased to announce the creation of a new weblog, Maryland Courts Watcher, that I will edit along with a number of other people.

Maryland Courts Watcher will post synopses of all formal opinions issued by the Court of Appeals and Court of Special Appeals of Maryland and synopses of selected opinions from other courts in Maryland. It will not contain any editorial comment, but will link to commentary posted on other blogs.

The blog is designed both to alert readers to new developments in Maryland courts that they may be interested in and to also provide a research tool outside of the commercial services. Thus, all postings can be searched through a Google custom search and each entry has subject tags.

He is the Walrus

2006-12-06T18:32:00.000-05:00

The following headnote is from Judge Charles Moylan's opinion in the case of Nils, LLC v. Antezana:

Confessed Judgment - Purchase of Residential Property - The Provisions for Payment - Partial Defaults of Payment - The Attorneys' Negotiations - The Confessed Judgment Notes - Confessed Judgment - The Allocation of the Burden of Proof - What is a Meritorious Defense? A Question of Law for the Court - A Meritorious Defense to What? - The Antecedent Debt - Section 14-1315 Applies - Late Fees - Of Ships and Shoes and Sealing Wax . . .

(Emphasis added.)

The Front (Climate Not Warming Division)

2006-12-05T22:55:00.000-05:00

Larry Ribstein has been carrying on a virtual one-man jihad against NYT's Gretchen Morgenson. (Start here and just work back.) I have absolutely no intention of getting caught in that crossfire. However, when he takes off as a defender of the "rights of corporate free speech," well, that's a little much.

The occasion was a letter written to Rex Tillerson, the CEO of ExxonMobil by Jay Rockefeller (D. W.Va.) and Olympia Snowe (R. ME). The letter attacked ExxonMobil's past efforts as a leader of the global warming deniers and the Senators urged Tillerson to lead ExxonMobil to:

end its dangerous support of the "deniers" . . . . [and] to guide ExxonMobil to capitalize on its significant resources and prominent industry position to assist this country in taking its appropriate leadership role in promoting the technological innovation necessary to address climate change and in fashioning a truly global solution to what is undeniably a global problem.

Ribstein cheered the WSJ editorial that characterized Rockefeller and Snowe as "bullies." According to Ribstein:

The letter doesn't threaten explicitly. But if a 300 pound bouncer is standing over you and asking you pretty please to stop, no explicit threats are really necessary. These are two prominent senators and, as the WSJ editorial points out, there's any number of things the government can do to a corporation.

A few points:

First, Rockefeller and Snowe are not the "government." They are two senators, one from each side of the aisle. Thus, their actions differ significantly from, for instance, the last six years of Rove-lead shakedown of corporate interests to fund the partisan advantage of the Republican party. (An effort, by the way, that the WSJ editorial board joined in as cheerleader-in-chief.)

Second, ExxonMobil does not attempt to speak to these public issues directly. Rather, it hides behind front groups that it funds lavishly.

Third, ExxonMobil does not fund science. It funds pseudo-science designed to advance its short-term economic interests at the expense of the commonwealth. Between 1998 and 2005, it gave over $2 Million to the Competitive Enterprise Institute ("CEI"), a right-wing think tank. See here. Further, according to Rockefeller and Snowe:

A study to be released in November by an American scientific group will expose ExxonMobil as the primary funder of no fewer than 29 climate change denial front groups in 2004 alone. Besides a shared goal, these groups often featured common staffs and board members. The study will estimate that ExxonMobil has spent more than $19 million since the late 1990s on a strategy of "information laundering," or enabling a small number of professional skeptics working through scientific-sounding organizations to funnel their viewpoints through non-peer-reviewed websites such as Tech Central Station.

It is a false analogy to compare, as the WSJ editorial does, ExxonMobil's and CEI's efforts to those of "the Pew Charitable Trusts, the Sierra Club, [and] Environmental Defense [sic]." These organizations have no predetermined economic interest in taking one side or the other in any scientific dispute. Obviously, that is not the case with respect to ExxonMobil. The recipients of its largess are intended to merely mouth the party-line.

Senators Rockefeller and Snowe have it precisely right:

ExxonMobil and its partners in denial have manufactured controversy, sown doubt, and impeded progress with strategies all-too reminiscent of those used by the tobacco industry for so many years.

And, one could add, all-too reminiscent of those used by the lead mining industry, the asbestos industry, etc.

Let's be candid here: ExxonMobil is not funding the "other side" in some spirited and free scientific debate. Rather, ExxonMobil is engaged, as the Senators say, in a campaign of misinformation designed to support its narrow economic interests.

In an amicus brief in the case of Commonwealth of Massachusetts v.EPA, climate scientists David Battisti, William E. Easterling, Christopher Field, Inez Fung, James E. Hansen, John Harte, Eugenia Kalnay, Daniel Kirk-Davidoff, Pamela A. Matson, James C. McWilliams, Mario J. Molina, Jonathan T. Overpeck, F. Sherwood Rowland, Joellen L. Russell, Scott R. Saleska, Edward Sarachik, John M. Wallace, and Steven C. Wofsy, stated that:

The evidence of . . . changes [such as rising global temperatures, the shifting of plant and animal ranges, the global retreat of glaciers, and the retreat of arctic sea ice, with sea levels rising and oceans becoming more acidic], though attended by the uncertainty or caveats that appropriately accompany scientific knowledge, is nonetheless so compelling that it has crystallized a remarkable consensus within the scientific community: climate warming is happening, and human activities are very likely a significant causal factor. The nature of this consensus may be obscured in a public debate that sometimes equates consensus with unanimity or complete certainty.

To be blunt, large corporate interests are simply too well-heeled to allow them to have free rein in their efforts to influence the public debate, camouflaged by front groups. As we've seen with tobacco, lead, asbestos, auto design, and in so many other cases, the outcome of allowing this "corporate free speech" is all too often massive injury, sickness, and death.

Focused Searching Update, III

2006-11-29T20:35:00.000-05:00

The following blogs have been added to the Tax and Business Law Commentary Google Co-Op search engine:

Professor Bainbridge's Business Association Blog

The Wilmington North Carolina Business Law
and Litigation Attorney Blog

Rubin on Tax

Texas State & Local Tax Law Blog

The Journal of the Business Law Society

Cases and Materials on Business Entities Update

The Tax Foundation's Tax Policy Blog

OMB Watch--Reg Watch

OMB Watch--Budget Blog

Gina's Tax Articles

Taxable Talk

I remain open to suggestions of weblogs and related sites to add to the search engine.

Comment on the 2006 Elections

2006-11-28T22:18:00.000-05:00

There has been a lot of hoo-ha in the media about how the voter shift to the Democrats was not nearly as great as is typically the case in mid-term elections. Just to check, I compared the overall vote for the House of Representatives in 1994 with the vote this year.

In 1994, allegedly a banner year for the Republicans, the Republicans got 51.5% of the popular vote for members of the House compared to 44.7% for the Democrats, a little less than a 7 point spread. See here.

This time out, the percentages were 57.7% for the Democrats and 41.8% for the Republicans, a little less than a 16 point spread. That is, better than double the spread of the Republicans in 1994. See here.

However, the total seats won by each party in the two elections were virtually the same, with the Republicans getting 230 seats in 1994 (and with 1 independent) and the Democrats getting 232 (with no independents) this year. The reason that the heavily Democratic vote did not translate into more seats is, no doubt, a testament to the improvements over the last decade in the art and science of gerrymandering.

Limited Liability and Its Discontents (Gilbert and Sullivan Edition)

2006-11-27T17:57:00.000-05:00

Apparently, critics of limited liability have been around for a long time. From Gilbert and Sullivan's Utopia, Limited, the song Limited Liability:

MR. GOLDBURY.
Some seven men form an Association,
(If possible, all Peers and Baronets)
They start off with a public declaration
To what extent they mean to pay their debts.
That's called their Capital: if they are wary
They will not quote it as a sum immense.
The figure's immaterial--it may vary
From eighteen million down to eighteen pence.
I should put it rather low;
The good sense of doing so
Will be evident at once to any debtor.
When it's left to you to say
What amount you mean to pay,
Why, the lower you can put it at, the better.

CHORUS.
When it's left to you to say,
What amount you mean to pay,
Why, the lower you can put it at, the better.

MR. GOLDBURY.
They then proceed to trade with all who'll trust 'em,
Quite irrespective of their capital
(It's shady, but it's sanctified by custom);
Bank, Railway, Loan, or Panama Canal.
You can't embark on trading too tremendous--
It's strictly fair, and based on common sense--
If you succeed, your profits are stupendous--
And if you fail, pop goes your eighteen pence.
Make the money-spinner spin!
For you only stand to win,
And you'll never with dishonesty be twitted.
For nobody can know,
To a million or so,
To what extent your capital's committed.

CHORUS.
No, nobody can know,
To a million or so,
To what extent your capital's committed.

MR. GOLDBURY.
If you come to grief, and creditors are craving,
(For nothing that is planned by mortal head
Is certain in the Vale of Sorrow-saving
That one's Liability is Limited),--
Do you suppose that signifies perdition?
If so you're but a monetary dunce--
You merely file a Winding-Up Petition,
And start another Company at once!
Though a Rothschild you may be
In your own capacity,
As a Company you've come to utter sorrow--
But the Liquidators say,
"Never mind--you needn't pay,"
So you start another company to-morrow!

CHORUS.
But the Liquidators say,
"Never mind--you needn't pay,"
So you start another company to-morrow!

Hat Tip: David Culpepper

Knaves--Airbrush Edition

2006-11-07T14:09:00.000-05:00

"As a result of Stalin's purges, and later destalinization, many photographs of officials from the periods show extensive airbrushing, often entire people have been removed. The term 'airbrushed out' has come to mean rewriting history to pretend that something was never there."

Just in case you've forgotten what this election is about.

Hat tip: Brainshrub.com and Eric.

An Aside on Employment Numbers

2006-11-04T23:11:00.000-05:00

In a recent post, I commented on two articles in the WSJ, one in the news section and one on the Op-Ed page. The employment numbers used in the Op-Ed piece seemed to me not to be credible. After some investigation, I discovered that the Op-Ed piece used the so-called "household survey" which reported significantly greater employment growth than the "payroll (or establishment) survey."

In yesterday's WSJ, Greg Ip focused on the two surveys and their divergent numbers (Divergent Data Raise Questions About Labor Market's Health). In reviewing the article, Dean Baker comments:

I looked at the data more closely and must come down on the side of the establishment survey. The simple arithmetic looks like this. Social Security tax collections were up 5.35 percent in fiscal year 06 compared to fiscal year 05. The average weekly wage rose by 3.9 percent, which implies job growth of 1.4 percent. Reported job growth in the establishment survey matches this closely, at 1.44 percent. However, we know that the Labor Department will add in 810,000 jobs to its March 2006 number in its benchmarked revision (these additional jobs are wedged in over the prior 12 months). When the data is adjusted for these additional jobs, the establishment survey shows job growth of 1.9 percent for the fiscal year, substantially more rapid growth than is implied by the growth in Social Security tax receipts.

There are complicating factors here -- self-employed workers pay SS taxes, but are not counted in the establishment data, many government workers don't pay into SS -- but these are not likely to change the basic story. It is implausible that the establishment survey is understating job growth, and it may well be overstating it.

Smoke! Smoke! Smoke! (That Cigarette)

2006-11-04T12:09:00.000-05:00

At least as long ago as 1947, it was widely known that cigarette smoking was unhealthy, hence the caption on this post from the title of a famous popular song of that year. Apparently, the people at the Tax Foundation haven't figured out that this represents a public health issue. They oppose an increase in cigarette excise taxes because of a perceived spur to the criminal enterprise of cigarette bootlegging. (And see here.)

As long ago as 1981, the cigarette industry realized that:

Given a prince elasticity of -0.4 for total cigarette sales and -1.2 for teenage smoking participation, a 25 percent increase in the excise tax could be expected to reduce industry sales to about 1.2 percent below what would be expected in the absence of such an increase, and to reduce the number of teenage smokers to 3.5 to. 4.0 percent.

As even the Tax Foundation admits, cigarettes are highly addictive. The ability to quit is related to the age at which one begins smoking--it's easier to quit the later you begin. Although I've seen no specific studies on this, one must assume that price elasticity is even more pronounced among younger teens. Thus, it makes good public health policy to increase the cost of cigarette consumption by increasing excise taxes. Thus, increasing excise taxes will have its greatest impact on those physically most at risk and will have positive effects for years going forward.

The Cato study cited by TF is fairly irrelevant. It deals with cigarette smuggling into New York state and New York City which had high excise taxes relative to the rest of the country. The conclusion, that excise taxes always increase bootlegging, is simply not supportable. The correct conclusion is that excise taxes that are higher than those in jurisdictions that smugglers can easily travel to and from (e.g., North Carolina) can trigger an increase in criminal activity. However, that is not likely to be the case if, for instance, taxes are increased by a majority of all taxing jurisdictions. Moreover, to the extent that high excise taxes, coupled with a variety of other anti-smoking programs, reduce teen smoking, over time the demand (and the profit in smuggling) will decline. In fact, that's exactly what's been happening for a number of years.

Just because a tax (or, for that matter, any enactment) has negative effects is not, in and of itself, a basis for opposing the tax. One has to weigh the negative impact (e.g., smuggling) against the positive effects (e.g., reduction in teen smoking, leading to a long-term, overall reduction, leading to a reduction in cigarette smuggling). TF offers only a one-eye view of cigarette excise taxes.

Finally, in 2003, a California study concluded that "[p]reviously published studies that analyzed data from various time periods between 1950 and 2000 have estimated that 2% to 6% of cigarettes are smuggled within the United States" and that "the tobacco industry exaggerates smuggling claims." Thus, it's not at all clear that any increase in cigarette bootlegging is a major criminal problem.

Focused Searching Update II

2006-11-01T18:42:00.000-05:00

Today, I added four sites to the Google Co-Op search engine.

Two are tax specific, Tax Playa and Andrew Mitchell International Tax Services. (The Andrew Mitchell site has the incredible collection of tax flow charts that Jim Maule, justifiably, raves about.)

The other two, Docuticker and Open CRS Network, have a large amount of research material. While the majority of the material on those sites is not tax or business related, the quality of what can be found there makes it almost imperative that these sites be included in the search engine.

Focused Searching Update

2006-10-31T18:15:00.000-05:00

I've added several more blogs to the Co-Op Search:

California Estate and Business Law Blog
Business Law Prof
Delaware Corporate and Commercial Litigation Blog
Florida Asset Protection Blog
and
Ideoblog (Larry Ribstein)

Again, any suggestions as to additional blogs or websites is welcome.

Focused Searching

2006-10-30T18:45:00.000-05:00

You can now find on the right side of the page a search box below the title "Search Tax & Business Law Commentary Google Co-op Search Engine." This will allow readers to conduct Google searches that are limited to various tax and business blogs and other related sites. Thus far, the search engine is limited to searching the following sites:

TaxProf
ataxingmatter
Death and Taxes
Mauled Again
Roth & Company, P.C.
Center for Tax Studies
Taxalicious
The Tax Foundation
Citizens for Tax Justice
Start Making Sense
Unincorporated Business Law Prof
and of course
Tax and Business Law Commentary

The purpose of the co-op search engine is to allow searches on tax and business law topics where the sites that will be searched are narrowed even before the search is initiated. I will be adding additional sites as time goes on and suggestions are appreciated.

Taking Credit Where No Credit's Due

2006-10-19T21:00:00.000-04:00

On Monday, Maryland Governor Bob Ehrlich's office issued a press release trumpeting "Governor Ehrlich Cuts Unemployment Insurance Taxes by $95 Million--Millions in Reduced Taxes Go to Maryland Employers." In other words, the Governor implied that he engineered a tax decrease.

He didn't.

To understand what actually occured, one has to know a little bit about unemployment insurance and the Maryland Unemployment Insurance Trust ("UIT").

Unemployment insurance is funded by a payroll tax. The tax is earmarked for a fund, the UIT. Financial demands on the UIT increase when unemployment rises and decrease when it falls. During recessionary periods, when unemployment is high, these demands threaten the solvency of the UIT.

In order to avoid a situation where the UIT became exhausted and could not pay unemployment insurance benefits, the General Assembly enacted a supplementary surtax that kicked in whenever the reserves in the UIT fell below a designated level. This determination was made every September 30. If on that date the reserves had fallen below 4.7 percent of the previous year's state-wide taxable wages, the surtax was triggered. The surtax applied to wages paid beginning in January of the following year. Due to sluggish labor market growth, the surtax was in effect for 2004 and 2005.

Maryland's method of funding the UIT had been criticized for a number of years. Among the criticisms was the fact that the surtax was triggered during times when the labor markets were under the greatest pressure. Because the surtax raised the cost of labor, it created a disincentive to hiring and wages at a time when tax incentives should have been pulling in the opposite direction. See here.

In 2003, a special task force was created to revise the way the UIT was funded. As a consequence of that task force's efforts, a comprehensive change in the funding mechanism was enacted by the General Assembly, Ch. 169 Laws of Maryland, 2005. That statute established a single experienced tax rate system to replace the previous experienced rates and flat-rate surcharge system. Six tax rate tables were established. The table used for a particular year now depends on the UIT balance from the preceding September 30 as a percentage of total taxable wages. The rate tables can be found here.

Gov. Ehrlich did not cut taxes on September 30. What actually took place was that the Division of Unemployment Insurance followed the mechanical procedure that had been mandated by Ch. 169 as enacted by the General Assembly in 2005. When it utilized this mandated formula, employers' were required to make unemployment insurance contributions based upon a lower rate table. The change in the formula used was due to the improvement in the labor market as the country came out of the recession: more money flowed into the UIT because of the increase in employment due to the (shallow) recovery and unemployment rates fell slightly, reducing demands on the fund.

Front Page News

2006-10-17T21:42:00.000-04:00

TaxProf takes note of two pieces in today's WSJ. One was an interview, on page 1 (i.e., a news page), of this year's winner of the Nobel Memorial Prize in economics, Columbia University professor Edmund Phelps. The other was an op-ed piece by Brian S. Wesbury, the chief economist at First Trust Advisors L.P. The two pieces clashed, with Prof. Phelps suggesting higher taxes ("[I]t would be a good thing for the federal government to raise taxes and run big surpluses until we have retired the public debt. In the short run the higher tax rates might be unpleasant. But in the long run, with the debt reduced or eliminated, incentives to work or to advance in the world would be enhanced, because after-tax pay rates as a proportion of wealth would be higher.") and Wesbury recommending that we stay the Bush tax cut course.

Presented in this way, it would appear that there are merely two economists who simply reach different conclusions after reviewing the same data. However, further investigation of one portion of the Wesbury piece exposes his essential intellectual dishonesty. Specifically, he states that:

During the 12 months ending in September 2006, the [Bureau of Labor Statistics] household survey reported 2.54 million new jobs. Going back 24 months shows 5.5 million new jobs, an annual average of 2.75 million. This exceeds the booming 1995-2000 average of 2.34 million new jobs per year. The household survey, in contrast with the establishment survey, has consistently signaled a resilient economy. And it continues. In the past two months, the household survey has expanded by 261,000 per month, while the establishment survey rose by an average of just 120,000.

While it is a little wonkish, there are good reasons why economists typically do not use the household survey, but instead rely upon the indice known as the "Employment, Hours, and Earnings from the Current Employment Statistics survey (National)." Barry Ritholtz explains the reason that the household survey, unadjusted, was misleading. His conclusion:

Let's see who has the intellectually honesty to step up to the plate with a big mea culpa. You may assume any of the original advocates of this now totally untenable position [that the unadjusted household survey is more accurate] who adhere to it are little more than partisan hacks, and disregard them as appropriate.

Just so the record is clear, here's the Employment, Hours, and Earnings from the Current Employment Statistics survey (National) on a monthly basis from January, 1992, through September, 2006:

(Click to enlarge.)

Do the math: During the 96 months of the Clinton Administration, the country added 22,635,000 jobs or almost 236,000 jobs a month. By contrast, during the 79 months of the Bush Administration, the country, on a net basis, has added only 3,109,000 jobs, or just a shade under 40,000 jobs a month. Even isolating the most recent 24 months, as Wesbury does, we find that only 4,026,000 jobs have been added or an average of just 167,750 per month. In other words, even when rebounding from a recession, job growth during this Administration is just over 70% of what it was during the Clinton Administration.

(Wesbury also wrongly states that the "the booming 1995-2000 average [was] 2.34 million new jobs per year." In fact during the 60 months from January, 1995 through December 2000, a total of 16,428,000 jobs were created, an average of 273,800 jobs per month or 3,285,600 jobs per year.)

In the end, the Nobel guys tend to shoot straight. They get on the first page of the WSJ. On the other hand, "partisan hacks" are relegated to the ~~knave~~ opinion page.

The Sweet Science?

2006-10-16T22:17:00.000-04:00

The Journal of Law and Policy at Brooklyn Law School has an interesting student note by Joshua A. Stein, Hitting Below the Belt: Florida's Taxation of Pay-Per-Pay Boxing Programming is a Content-Based Violation of the First Amendment. Stein concludes that:

Florida is one of numerous states to authorize a tax specific to telecasts of boxing. As these taxes are specific to a type of television programming, they should be held by courts to be content-based restrictions on speech. However, boxing and other sports have been denied the protections of the First Amendment because they are deemed to be non-expressive. An historical and literary analysis of boxing demonstrates that the sport satisfies the Spence test because boxers intend to express particularized messages which are understood by their audiences. When strict scrutiny is applied to taxes on boxing telecasts, the state's interest in raising revenue is outweighed by boxers'—and their promoters'—freedom of expression.

Stein quotes Norman Mailer at length in an attempt to show that "[a]lthough the expression inherent in boxing cannot be neatly categorized, it is expressive conduct that conveys a specific message that has a substantial likelihood of being understood nonetheless."

Somehow, I can't buy the argument the two guys beating their brains out is an exemplar of "expressive conduct." However, I am sensitive to the argument that (i) there's a potential slipperly slope here and (ii) the power to tax is the power to destroy. For instance, if the state can tax boxing while exempting other sorts of content, what's to stop it from imposing a tax that is so high that it would, in effect, ban any show with any erotic material (however loosely defined) from the cable-ways.

Ultimately, of course, the state's efforts in this regard will fail. As I noted earlier, once the internet pipes get big enough, the broadcasters of internet content will be beyond the reach of state sales tax assessors. Anyone who doesn't think that boxing matches can't be moved offshore simply does not remember "The Thriller In Manilla"

or the "The Rumble in the Jungle."

Hat Tip: DocuTicker

Rollin' (Part II)

2006-10-16T16:18:00.000-04:00

In August, I commented on the creative tax planning efforts of Congressman Gary Miller (R. CA). Representative Miller rolled over the profits from real estate sales not once, but twice, pursuant to the provisions of IRC §1033. He claimed that the properties were sold under threat of condemnation, even though he faced no actual threat of condemnation. To bolster his reporting position, he asked Monrovia, California to provide him with "a letter that talked about eminent domain."

Last week, on similar facts, the Sixth Circuit, in U.S. v. Harris, affirmed a conviction for tax evasion. The pertinent portions of the opinion (which begin on page 77 of the slip opinion) should make for chilling reading by Rep. Miller:

The evidence against Kotula [one of the defendants] on the tax-evasion count is not overwhelming, either in absolute terms or compared to the conspiracy evidence against him. But it is sufficient to support his tax evasion conviction under the very deferential standard for reviewing jury verdicts.

In 1998, Kotula sold his own land to Ashtabula County, Ohio for $425,000. The sale contract recited that Kotula was selling the land to avoid eminent domain. Kotula made a $382,000 profit on the sale, on which he owed federal income tax of $82,000. The parties agree that Kotula did not list the profit on his 1998 federal income tax return.

The government charged that Kotula's failure to report the land-sale gain in that year constituted willful attempted evasion. Kotula's defense is that 26 U.S.C. § 1033 allows a taxpayer to defer gain from a sale made under threat of eminent domain if they use the proceeds to buy replacement property within a certain period of time. As Agent Fisher testified, if the taxpayer meets the requirements, he is not required to report the gain in the first year following the sale.

The government alleges that "several Ashtabula County officials" testified that the land-sale agreement's references to eminent domain were a "sham," but the government fails to point to particular testimony using that word. The government relies on the testimony of current and former county commissioners that the county never suggested that it was considering using eminent domain to take Kotula's land, that it was Kotula alone who insisted on inserting the eminent-domain language, that the commissioners knew eminent domain was unpopular and so would not use it lightly, and that the county had probably not used eminent domain in the twenty years prior to the county's purchase of Kotula's land.

* * * * *

On this record, a reasonable factfinder could find that it was not reasonable to fear eminent domain under the circumstances. With or without such a finding, the factfinder could conclude that Kotula did not actually have a good-faith belief (reasonable or otherwise) that his property was threatened by eminent domain so as to trigger the deferred-reporting provision of IRC §1033.

Incredibly, as near as I can determine, Miller is running unopposed.

Importance of Immigration to Population Growth

2006-10-14T23:51:00.000-04:00

A report by the Pew Hispanic Center, From 200 Million to 300 Million: The Numbers Behind Population Growth, underscores the point that underlay my comment on Thursday. Specifically, the report finds that:

Immigrants and their U.S.-born offspring accounted for 55% of the increase in [U.S.] population [from 200 million to 300 million] since 1966-67. 3 Within this group of 55 million, Latino immigrants and their offspring were by far the largest, representing about 29 million persons, or 53% of the addition due to immigration . . . .

Strikingly, Hispanics constituted only 4.25% of the U.S. population in 1966. In the last 40 years, that figure has grown to 14.9%. The percentage of Americans classified as "White" has fallen from 83.6% to 67% over the same period.

How Many Times Have I Heard That Before?

2006-10-12T21:36:00.000-04:00

From a report, Investigation of Jack Abramoff's Use of Tax-Exempt Organizations, by the Minority Staff of the Senate Finance Committee:

The documents reviewed by the Minority staff raise several issues with respect to [Americans for Tax Reform]’s compliance with current tax laws. As a threshold issue, many of the activities alleged in the e-mails reviewed by the Minority staff indicate that ATR may not be primarily operating to further social welfare purposes, which is a necessary condition of tax-exempt status as a section 501(c)(4) organization. In addition, the documents raise questions whether ATR should have reported income from some of its activities as taxable income. Finally, the e-mails raise questions as to whether insiders at ATR, including [Grover] Norquist, used ATR primarily for their own or Mr. Abramoff’s private benefit. Violations such as these could, under certain circumstances, result in penalties under current law, including excise taxes on officers of ATR, revocation of ATR’s exempt status, and even criminal tax fraud penalties.

Where have we heard this before? Well, here, here, here, and here.

Equal Protection Under State Law: Very Big Deal in America!

2006-10-12T17:08:00.000-04:00

Today, the Maryland Court of Appeals issued an opinion in the case of Ehrlich v. Perez that illustrates that (i) in some cases, rights that we tend to think of as being rooted solely in the U.S. Constitution (in this case, the right to equal protection under law), can also find alternative bases for support in state constitutions and (ii) the Republican Party is doing its best to run headlong off of a demographic cliff.

At issue in the case was a preliminary injunction forcing the state of Maryland to provide medical assistance benefits to resident alien children and pregnant women who immigrated to the United States on or after August 22, 1996. A federal law, The Personal Responsibility and Work Opportunity Reconciliation Act of 1996, generally know as the "Welfare Reform Act," was enacted in 1996. As described by the Court of Appeals:

The [Act] states: "An alien who is a qualified alien (as defined in section 1641 of this title) and who enters the United States on or after August 22, 1996, is not eligible for any Federal means-tested public benefit for a period of 5 years beginning on the date of the alien's entry into the United States with a status within the meaning of the term 'qualified alien.'" 8 U.S.C. §1613(a). Among the provisions of the W elfare Reform Act was the elimination of all benefits for illegal immigrants and other "non-qualified aliens," with a few limited exceptions such as emergency medical care. 8 U.S.C. § 1613. In doing so, Congress divided the two qualified alien categories into two subcategories: (1) qualified aliens who have resided in the U.S. since a time prior to August 22, 1996. . . .Some states were required to provide funding to the first subcategory of qualified aliens. . . . However, a period of five years residency in the U.S. was required for the second subcategory. . . . Congress then authorized the States to enact any law after August 22, 1996, should they choose to compensate this newly designated class of ineligible aliens, provided they use only State funds.

(Some internal citations omitted.)

In 1997, the Maryland General Assembly enacted Md. Ann. Code, Health-General Article §15-103(a)(2)(viii), which provided "comprehensive medical care and other health care services for all legal immigrant children under the age of 18 years and pregnant women who meet [Medicaid] eligibility standards and who arrived in the U.S. on or after August 22, 1996." In 2006, however, Governor Ehrlich cut funding coverage for this part of Medicaid in the budget that he submitted to the General Assembly. (In Maryland, the General Assembly cannot add or increase funding beyond what the Governor has proposed.)

The Circuit Court for Montgomery County issued a preliminary injunction ordering that the state (i) provide Medicaid coverage for all those within the ambit of §15-103(a)(2)(viii) and (ii) reimburse recipients for the benefits that had been denied to them before the date of the order. The injunction was based on the equal protection provisions of Maryland's constitution set forth in Article 24 of Maryland's Declaration of Rights.

On procedural grounds, the Court of Appeals rejected that part of the Circuit Court's order requiring reimbursement of past benefits. The vacation of that part of the order was based solely on the fact that the preliminary injunction remedy is designed to maintain the status quo. An an order that requires payment for benefits provided before the dispute came before the court is equivalent to a judgment in favor of the plaintiffs prior to a complete adjudication of the dispute. However, the Court upheld the injunction insofar as it requires that, while the litigation process is ongoing, the state must continue to provide benefits.

The holding of the case is narrow. If the federal statute had explicitly required that the states deny non-qualified aliens Medicaid benefits, the exclusion would likely have been upheld under the Supremacy Clause. Under those circumstances, the question would have become whether there was a rational basis to conclude that statute furthered the exercise of a particular federal power, namely the power to control immigration. However, because there was no federal mandate prohibiting the states from providing benefits, the more stringent "strict scrutiny" test was applied to determine whether the budgetary exclusion denied the plaintiffs their Equal Protection rights. And, by bottoming its opinion on a provision of the state constitution, the Court of Appeals precluded any Supreme Court review of the Equal Protection question. (Although, various other questions, e.g., a somewhat different "Supremacy Clause" issue raised by the state, could theoretically be appealed to the Supreme Court.)

The opinion comes a day after a story in the Baltimore Sun, Latinos' power in numbers-Naturalized citizens are becoming a political factor in Maryland that demands to be recognized, highlighting the growing political importance of Hispanic voters in Maryland. Those voters will presumably remember that Ehrlich's attempt to cut benefits to pregnant women and children was nothing more than a gratuitous slap at immigrants. As the opinion notes, this budget cut would only achieve "a cost savings of seven million dollars . . . of the four billion dollar budget appropriated for medical assistance health care costs generally."

I suspect that, in the short term, Republicans can mine anti-immigration sentiment to their electoral benefit. In the long run, however, the children and grandchildren of immigrants will remember the nativist enmity stirred up by Republican politicians. That will ultimately crush the party.

Movin' On Up?

2006-10-10T21:05:00.000-04:00

There's been a debate, of sorts, between Grover Norquist's Americans for Tax Reform and the folks over at Citizens for Tax Justice over the question of whether state tax rates cause individuals to migrate from higher tax states. The ATR paper is here and the CTJ argument, linked to three studies of specific states, is on its weblog here.

The ATR analysis is singularly unconvincing. It includes a nifty chart sourced to "Vedder" with no additional information that would allow one to verify the chart's accuracy or to make a separate analysis to determine whether other factors were at work. (Presumably, "Vedder" is Richard Vedder of Ohio University and the Heartland Institute.)

The CTJ web posting cites three studies, from the Iowa Policy Project, New Jersey Policy Perspective, and Policy Matters Ohio, respectively.

The Iowa study was rather narrow in scope. It was designed to address an argument made in support of a particular piece of legislation before the Iowa legislature that would have provided various income tax exemptions to the elderly. The study showed, convincingly I think, that Iowan income tax rates did not cause significant out migration of the elderly from the state. However, the paper did not fully address the more basic question: Do taxes, in general, cause emigration from high to low tax states?

The New Jersey study dealt with the broad question of whether income tax caused net emigration from that state. It concluded:

It is impossible to tell from the IRS data the reasons why people leave or come to a state. However, the numbers for New Jersey would seem to suggest that the regional and national economic situation is an important force, especially in view of the fact that in most years outflow and inflow either rise together or fall together.

But it is equally impossible to interpret the data as in any way showing that changes in New Jersey's income tax rate-up or down-have an impact on whether high income families-or any families-choose to come to the state or to leave it.

One could just as easily, and perhaps more plausibly, conclude that the tax driving people out of New Jersey is the local property tax, since this tax takes a higher percentage of the yearly income of low- and middle-income families than it takes from the wealthiest-so that an increase of even a few hundred dollars is more noticeable to those families than an income tax increase that amounts to a relatively smaller percentage of a wealthy family’s income.

Finally, the Ohio study also limited itself to the affect of income tax on migration and concluded that "migration does not appear to be linked to income tax policy. Policymakers seeking to prevent outward migration should look to policy other than income-tax policy to alter the trend."

Clearly, taxes do have some effect on interstate migration. For instance, I know from my practice that state estate and inheritance taxes will cause some high wealth individuals to relocate. However, it would be virtually impossible to design a study that could isolate and measure the effect that these taxes have on migration. There are likely to be a large number of other factors at work and, more importantly, the number of people affected by these taxes is statistically small.

One of the problems with all of the studies is that there are generally so many factors that bear on an individual's decision to relocate it is virtually impossible to isolate the affect attributable to taxes. For instance, do people move to low tax states to avoid taxes in their state of origin, to enjoy a warmer climate, or to take a job at a non-union factory because work at older, union manufacturers has dried up? And, to the extent that the move is motivated by tax considerations, to what extend are the emigrants fleeing property tax assessments that fund primary and secondary education? If this last factor proves decisive, to what extent are the emigrants really defaulting on their responsibilities (i.e., "The state already paid for my kids' education. The hell with the next generation.")

It is anticipated that Maryland will have a huge increase in population over the next 10 to 15 years caused by the expansion of Aberdeen Proving Grounds, the NSA facility at Fort Meade, and the military's biological research facilities at Fort Detrick. Under these circumstances, unless Maryland's tax system becomes outright confiscatory, there will be little, if any, affect on immigration to the state. The population will increase because there are good, well-paying jobs available.

I think that, in general, similar, non-tax forces are at work causing either immigration to or emigration from various states. With some isolated exceptions (Nevada comes to mind), I think that the amount of taxes imposed on individuals is of little moment in determining emigration or immigration. But, as yet, I have little to go on in reaching that conclusion other than my own intuition.

Taking a Bite at the Apple

2006-10-08T00:21:00.000-04:00

Russ Fox of Taxable Talk reports that New Jersey has extended its sales tax to cover music downloads. Following the links back, you get to this April 13, 2006, story in CNET, The Tax Man Cometh After iTunes. According to CNET, at the time of publication, 14 states and the District of Columbia imposed sales tax on music (and, presumably, software) downloads. New Jersey would be the 16th jurisdiction to do so.

The Supreme Court's holding in Quill v. North Dakota poses a significant hurdle to the states' efforts to impose sales tax on electronic media of any sort. In essence, that opinion requires that there be some significant physical contact with a state before the state can establish sufficient nexus to impose a sales tax. With respect to iTunes, the states probably can effectively impose a sales tax because Apple has sufficent contacts with almost every state to meet the nexus requirements of Quill. However, that is principally because Apple sells and services its computers and MP3 players throughout the country. If Apple were merely in the business of selling the music, it would likely not have a physical presence in any state that imposed sales tax on electronic media. Effectively, the states could not tax these sales.

However, as Apple's relative market share declines (it now controls about two-thirds of the market), the ability of the states to collect tax on the sale of electronic music will also decline since market share will inevitably be gained by companies whose only business is the sale of electronic media over the internet. (Note: Theoretically, the states would lose nothing since consumers who fail to pay sales tax are required to pay use tax. Consumer self-reporting and payment of use tax is, for all intents and purposes, however, non-existent.)

There have been bills introduced in Congress that would overide Quill and allow states to impose sales taxes on internet sales. While such legislation might work with respect to internet sales of tangible property, intangibles, such as software and electronic music downloads, would still be problematical. After all, so long as the servers that provide the downloads are located outside of the U.S., the purchase of downloads would still be sales tax free.

Of course, I once again have a good excuse to post a link to my favorite tax song, "Sales Tax," performed by the Mississippi Sheiks. Since the download is free, it is not subject to sales tax in any state.

Deja Vu All Over Again--WSJ Edition

2006-10-07T13:05:00.000-04:00

Today's WJS editorial page touts the decline in the size of the budget deficit from the amount previously projected. Iit, correctly, attributes the decline of the deficit to increases in tax revenue. (The CBO press release on the deficit number is here.) However, it incorrectly finds that the Bush tax cuts are the underlying cause of the increase in tax revenue.

Jim Maule figured out that the WSJ editorial was baloney three months ago, before it was even published. He said then:

Members of the Administration are touting the revised deficit estimate, and its cause, as a sign that tax cuts are working as intended. Excuse me, but that makes no sense. Without the tax cuts there would be little or no budget deficit. So we're supposed to cheer because the mess isn't quite as bad as it appeared to be? I'd be impressed if the revision showed a budget surplus, because THAT would demonstrate the validity of the "cut taxes, double revenue" nonsense spouted by the "I refuse to pay taxes because I'm special" crowd and the "I cannot pay taxes because I'm selfish" group.

A closer look at the source of the increased tax revenue is most revealing. A significant chunk of it reflects increased corporate taxes, a natural consequence of the huge increase in corporate profits during the past half-year. Most of the rest reflects taxes on high-income taxpayers who have received bonuses. The Washington Post article goes into greater detail on these points. It also explains that taxes on wages are barely increasing, because wages are increasing only slightly. In other words, the tax revenue increases are consistent with the shift of income gains away from the middle class and toward the very top of the income and economic ladders. The rich get richer ....

Making the situation worse are the allegations that the Administration initially overestimated the deficit so that it could return and claim that it deserved kudos for reducing it. That's a ploy not unlike the child who says to a parent, "Would you be upset if I told you I broke the heirloom vase?" only to follow-up with the following comment to the rattled parent, "Well, I didn't. It's just that the picture window is broken." There's one word to describe this approach: manipulative.

The CBO report explicitly notes that:

Steady growth in corporate profits probably explains most of [the increase in tax revenues in September, 2006 from those in September, 2005], although some of it likely stems from settlements of past years’ taxes and a recent change in tax law that required large firms to accelerate some payments from 2007 into 2006.

Paul Krugman also pinpoints a different cause for the growth in corporate profits (behind Times Select Paywall), than that offered by the WSJ:

[A]fter-tax corporate profits have more than doubled, because workers' productivity is up, but their wages aren’t — and because companies have dealt with rising health insurance premiums by denying insurance to ever more workers.

This, of course, would also explain another "surprise" the WSJ editorial focuses on--the fact that the top 1% of all income earners account for 37% of revenue receipts from the individual income tax.

Angry Bear also anticipated the WSJ editorial when he published this chart from the CBO's August, 2006, estimates and made the following comments:

(Click to enlarge.)

But look at the on-budget deficit for 2006. It shows a small improvement over 2005, and then the CBO projects the on-budget deficit to worsen in fiscal 2007.

But compare 2006 to the earlier CBO estimates - 2006 is a complete disaster. And the bad news is another bubble is bursting right now (the housing bubble), and IMO the CBO estimates are once again ignoring the budget implications of that bursting bubble.

So when the Bush Administration touts their budget progress in the coming weeks, remember where we were just a few years ago. And remember where the budget deficit is likely to go. They call that progress?

Well, the WSJ editorial board certainly does.

Hat Tip: TaxProf

Premier Kissov

2006-10-07T00:17:00.000-04:00

The BBC is reporting that CBS's Sixty Minutes will report this weekend that a "US no-fly list used to try to prevent terror attacks [created after 9-11] includes the names of 14 of the long-dead 11 September hijackers." However:

[T]he names of the 11 British suspects recently accused of a plot to blow up airliners flying to the US were not included on the list.

Cathy Berrick, director of Homeland Security investigations for the General Accounting Office told CBS that this was due to concerns that the list could end up in the wrong hands.

"The government doesn't want that information outside the government," she said.

As Dr. Strangelove once pointed out, some things have to be made public in order to work:

Yes, but the... whole point of the doomsday machine... is lost... if you keep it a secret! Why didn't you tell the world, eh?

Thing are not nearly as bleak as they may first seem, however. I have obtained a photograph of one of the people on the list, Robert Johnson:

Be on the lookout!

Hat Tip: beSpacific

Ok. Now back to work.

Grab and Leave

2006-10-06T17:55:00.000-04:00

This post has nothing to do with (now former) Congressman Mark Foley. Rather, it deals with the conclusions of a report, When Knowledge Is an Asset: Explaining the Organizational Structure of Large Law Firms, by James B. Rebitzer and Lowell J. Taylor. They conclude that:

From the property rights perspective, large law firms are poorly suited to sustaining employment relationships because they have no enforceable means of controlling the firm's key knowledge asset—client relationships. The up-or-out partnership systems that have evolved over time in these firms offer an awkward but workable resolution to this problem. By restricting partnership size to maximize surplus per partner and by making senior attorneys residual claimants, law firms limit the opportunity for sub-groups of partners to grab and leave with the firm's clients. This action, however, creates additional demand for inexperienced associates who serve as (imperfect) substitutes for their more experienced counterparts. The result is that more associates are hired than can be promoted into a stable partnership. Those associates who do not succeed outgoing partners will be dismissed before they acquire sufficient client knowledge to themselves pose a threat of grabbing and leaving. That law firms find it worthwhile to commit to the costly practice of firing qualified attorneys in order to retain control over client relationships points to the general importance of control over assets in more conventional employment relationships.

The authors study available data to determine whether the data can justify alternative theories, such as the "dual incentive" theory. "According to this [theory], law firms create incentives for associates to invest in firm specific skills by promising a valuable promotion to some or all of the associates who undertake the investments. It is difficult, however, for outsiders to monitor whether the associates have actually met the firm's requirements. This gives the employer an incentive to cheat the associate by denying promotion even when the associate has performed as the firm desires. Since the employees anticipate cheating by the firm, no investments in firm specific human capital are made."

Ultimately, they reject the dual incentive theory because the alternative "grab and leave" "model predicts that large law firms, with long-standing relationships to important corporate clients, would implement a kind of legal production technology that would keep non-partners at arms-length from clients." The authors' examination of the increasing amount of time attorneys spend on client contact as they move up the seniority ladder leads them to conclude that the grab and leave model is in operation at large firms.

Hat Tip: Docuticker.

Housekeeping Update

2006-10-05T21:32:00.000-04:00

I have deleted the Bloglet subscription box and terminated this weblog as a covered weblog under Bloglet. I imported all Bloglet subscribers, except those whose subscriptions were anonymous, into FeedBlitz.

My understanding is that Bloglet's performance was spotty at best and, in any event, does not deliver the postings with HTML format as does FeedBlitz.

Will I Know It When I See It?

2006-10-04T22:24:00.000-04:00

One would think that most fundamental questions in tax law were settled. For instance, when is an organization a partnership for tax purposes? Unfortunately, that is not always (or even often) the case.

Brad Borden of Washburn University School of Law will publish The Federal Definition of Tax Partnership in an upcoming issue of the Houston Law Review. The paper is now posted on SSRN. As Borden explains in the abstract:

[C]ourts, Treasury, and the IRS generally have not considered the purposes of partnership tax law in the more than 150 instances they have interpreted and applied the definition of tax partnership. As a result, those efforts have produced ten separate tests for defining tax partnership, perpetuating the definition's uncertainty. This Article identifies and evaluates each of those tests and recommends abandoning tests that do not incorporate the purposes of partnership tax law and consolidating the remaining tests. Based on that consolidation, the Article proposes a new definition of tax partnership. The proposed definition incorporates the purposes of partnership tax law, and, because partnership tax law was intended to govern substantive-law partnerships, it includes some aspects of the substantive-law definition. Nonetheless, by using tax-specific terminology and relying on the purposes of partnership tax law, the proposal clarifies the definition of tax partnership and moves away from the substantive-law definition.

The simple definition:

A tax partnership is two or more persons, at least one of whom provides significant services, who have (or will have) common gross income.

It probably comes as a great surprise to non-tax practitioners, but the question of whether an arrangement is or is not a partnership for tax purposes arises fairly often. While obviously borne in academe where Borden currently resides, the article provides useful guidance to work-a-day practitioners.

Blackwhite

2006-10-03T00:52:00.000-04:00

From the WSJ:

Republicans also deserve credit for financing the war, which is more than many Democrats say they'll do if they run Capitol Hill. The extension for two more years, through 2010, of the 15% rate on dividends and capital gains will also help sustain the economic growth that is throwing off record revenues to pay for the war even as the budget deficit declines.

Let me get this straight: The Republicans financed the Iraq War by failing to finance the Iraq War?

From the Center on Budget and Policy Priorities, we find this graph which exposes the WSJ's editorial bull:

As with almost all Republican argument today, Orwell is the best reference:

"The key-word here is blackwhite. Like so many Newspeak words, this word has two mutually contradictory meanings. Applied to an opponent, it means the habit of impudently claiming that black is white, in contradiction of the plain facts."

Hat Tip: Brendan Nyhan.

Looking for a One-Arm Economist

2006-10-02T23:19:00.000-04:00

A recent CRS report, Running Deficits: Positives and Pitfalls, makes two points about federal budgetary deficits. Maybe.

First, deficits paid by younger generational cohorts to finance benefits for older generations may be justified. Thus:

Some shifting of resources to older generations . . . can be justified on the basis of equity. To the extent that technological change leads to greater prosperity over time, future generations will have access to higher standards of living. To the extent that population growth increases the size of the economy, the burden of financing pay-as-you-go retirement systems is reduced. If some of those gains are shifted from younger to older generations, then incomes and levels of well-being would be more equal among generations. Furthermore, a fiscal policy that shifts some resources from younger to older generations can raise living standards of all following generations by transferring a portion of the benefits of future economic growth into the present.

Or, perhaps not:

The possibility of raising standards of living by shifting resources from younger to older generations has its limits. The example above relies on the assumption that the policy continues indefinitely into the future. With a finite ending point this policy would be unsustainable because some young cohorts near that end point would be made worse off and would be unwilling to give up resources.

On this point, the report's conclusion takes an "on the one hand, on the other hand" approach:

Despite the projected magnitude of these intergenerational transfers [Social Security and Medicare, particularly Part D], younger generations might not be worse off than their parents if economic grows at a sufficiently swift pace.

These generational transfers are largely driven by the growth in the number of beneficiaries of entitlement programs relative to the work force, as well as by rapid increases in health care costs. The possibility that some future generation may eliminate fiscal policies that it perceives will lower its standard of living introduces political risk into social insurance programs funded by a pay-as-you-go mechanism. If a generation anticipates that a younger generation will stop contributing to a pay-as-you-go social insurance program, then it may decide to end the program itself. A generation whose descendants are unwilling to finance its benefits would have little to gain, apart from altruistic impulses, by continuing its contributions.

However, when it comes to the question of permanent structural deficits, the report has only one arm:

A government that runs deficits and is unwilling to raise taxes or cut spending faces three choices. First, domestic borrowing can be increased at the cost of crowding out domestic investment. Second, a government can borrow from foreign investors and governments. Borrowing from the rest of the world prevents deficits from crowding out investment. That is, foreign investors can provide financial resources now in exchange for future interest payments and profits. As foreign investors accumulate larger portfolios of stocks, bonds and other assets, the flow of interest payments, dividends and repatriated profits abroad increases as well. Third, a central government can print money to reduce the real value of debt denominated in domestic currency.

All three options have unpleasant consequences. Over time, each can seriously damage national economies. Simple supply and demand theory implies that a smaller supply of savings for private investment will lead to higher interest rates and lower growth in private capital stocks. Lower stocks of private capital threaten economic growth, and slower economic growth translates into lower average living standards in the future. Borrowing from the rest of the world permits higher levels of investment and faster growth at the cost of sending a higher fraction of earnings abroad. If foreigners lend capital by purchasing stocks and bonds rather than by building auto plants, for example, they may decide suddenly someday to take their investments elsewhere. This could strain domestic and international financial systems, thus constricting firms' and households' access to capital. Finally, inflation caused by printing money distorts the flow of information generated by the price system and disrupts financial markets. Investors, if they wish to avoid capital losses in real terms, demand higher interest rates when they see signs of inflation. A major reduction in the real value of the federal debt would require a significant acceleration in inflation. Few economists believe that the restrictive monetary policies needed to squeeze rapid inflation out of an economy would not require substantial economic disruption, at least in the short run.

On the other hand, reducing government deficits can improve economic performance in at least three ways. First, paying off government debt increases the supply of investment funds available for domestic investment. Second, paying off government debt held by foreign governments or investors reduces the amount of interest payments going abroad. Alternatively, paying off debt held by domestic investors gives them the opportunity to rebalance their portfolios by buying foreign assets, which offsets some of the flow of dividends and profits going abroad, or by buying domestic assets that otherwise would have been bought by foreign investors. Third, scaling down the federal debt decreases the temptation to reduce its real value by printing money, lessening the possibility of a major acceleration in inflation. Finally, most economists believe reducing government borrowing lowers interest rates, which in turn have positive effects on investment and growth.

(BTW, talk about samizdat. I had to call my Congressman's office for a copy of the report. It was faxed to me, which explains the poor reproduction quality. As soon as I get a better copy, I will scan it and replace the fax version.)

Ungrateful Deadweights

2006-09-29T19:51:00.000-04:00

The Tax Foundation takes, ah, dead aim at the issue of tax expenditures and is somewhat off target. That is, the criticism does score some points, but does not hit the bull's-eye.

The TF discussion was triggered by the appearance in public web access of a CRS report, Tax Expenditures: Trends and Critiques. (Why CRS reports remain a sort of public policy samizdat is beyond me. The report in question had actually been posted by TaxProf two weeks ago, but only this week became widely available via Open CRS. But that's a rant for another day.) Tax expenditures are "those revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability."

A good deal of the Tax Foundation's criticism is well founded. For instance, the posting states that:

Because tax preferences are less visible to voters than direct spending programs, they reduce the transparency of the nation's fiscal system. That's bad policy because—as we've learned from recent debate about problems with congressional "earmarking" — lack of fiscal transparency inevitably promotes wasteful spending, shielding ineffective programs from the cleansing power of public scrutiny and budgetary daylight.

Recently, Linda Beale commented on a hearing held by:

[T]he Subcommittee on Federal Financial Management, Government Information, and International Security of the Senate Committee on Homeland Security and Governmental Affairs. . . . The hearing was titled "Deconstructing the Tax Code: Uncollected Taxes and Issues of Transparency." The hearing was "to examine uncollected taxes and issues of transparency relating to deconstructing the tax code, focusing on the 2006 updated estimate of the tax gap by the IRS, examine IRS efforts to close the tax gap as well as legislative solutions to increase taxpayer compliance, and explore the transparency of the tax code."

(Link omitted.)

She concludes by saying that:

Any discussion of tax expenditures should result in greater transparency, not to the misleading ploys evident in the FY 2005 budget [where the reduction of tax rates on dividends from 35% to 15% was not defined by the Bush Administration as a tax expenditure]. Further, Congress should take care that discussions of tax expenditures do not act merely as an entree to renewed discussion of further revenue reductions rather than a genuine effort to make relevant tax information more accessible to ordinary Americans.

It is here that the Tax Foundation comments miss the mark. Their posting states that:

[E]very additional tax expenditure carves out a portion of the nation's income tax base, forcing up tax rates to compensate. And as any economist will testify, higher marginal tax rates aren't bad simply because they make taxpayers "pay more." They're bad because they reduce the efficiency of the complex web of plans, contracts and relationships we call "the economy."

Economists teach that the "deadweight losses" of taxes—that is, the pure economic waste that occurs as a side-effect of every tax—rise as the square of the tax rate. Here's what that means. If tax expenditures erode half the nation's tax base, and tax rates are doubled to raise the same revenue, the economic costs of the tax system don't simply double as well. They rise by four times in those markets that remain in the tax base.

(Some links omitted and emphasis added.)

The first paragraph in the TF posting is completely correct. The second paragraph is not.

The first link that I have left in goes to a Wikipedia entry that merely defines and discusses the concept of "deadweight loss." The second link goes to a Wikipedia entry that discusses the "Economics of Taxing a Good." But, in dealing with the question of whether or not to increase or decrease income taxes it is simply wrong to assume that all taxes create the same deadweight effect. Brad DeLong addressed this issue in January, 2005:

Now there are two analytically distinct claims there at the end of the first paragraph I quote, the first of which--for which I have a good deal of sympathy--is that our system of taxing income from capital has in all likelihood been very costly in terms of deadweight losses imposed on the economy when measured against the revenue raised and the progressivity gained

The second claim, however, is the problem. The second claim is the old supply-side b.s.: that the growth the tax cuts will unleash means that the tax cuts would more than pay for themselves.

If I were writing about that second claim, I would not say that "most economists typically find this line of argument questionable." I would say that an overwhelming majority of economists find this claim ludicrous.

All taxes have some deadweight effect. But to assume that the deadweight effect of all taxes is the square of the tax rate in all cases is to fall into the fallacy that all tax cuts will pay for themselves.

Finally, an examination of two charts in the CRS report are particularly revealing with respect to who benefits from tax expenditures, a point that the TF ignores. Chart 4, below, shows various various tax expenditures and, for each, shows a measure of progressivity, the Suits index. (The Suits progressivity index varies between — 1 (completely regressive) to +1 (completely progressive). The Suits index is negative if the benefits from the program are received predominantly by families in the upper part of the income distribution.)

(Click to enlarge.)

In other words, the tax expenditures shown are, as a group, not particularly progressive and, in some cases, are downright regressive. In contrast, direct expenditures are fairly progressive:

(Click to enlarge.)

Taxes are not an unalloyed good. They have undesireable economic side-effects. However, they are, as Justice Holmes reminded us, the price we pay for civilization. The key is not to oppose all taxes, but to design a tax system that maximizes the benefits to the entire society. Part of that design requires that there be progressivity in the tax system, a requirement that the TF consistently ignores.

Penny Saved, Penny Earned Department

2006-09-25T23:34:00.000-04:00

A study from the Employee Benefit Research Institute, Retirement Security in the United States--Current Sources, Future Prospects, and Likely Outcomes of Current Trends, points out that:

In 1990, the projected 75-year actuarial balance for the Old-Age, Survivors, and Disability Insurance (OASDI) program was –0.91 percent of taxable OASDI payroll, meaning that the OASDI or Social Security tax would need to be increased by 0.91 percentage points to achieve actuarial balance over the next 75 years from 1990. This 75-year deficit grew to more than 2 percent of taxable payroll before improving to just under 2 percent by 2005.

In other words, if, in 1990, we had kicked up the FICA tax withheld from employees by less than a half percent and increased the employer share (which, yes, I know, really comes out of the pockets of the employees) by an identical amount, the system would have been guaranteed to be solvent until 2065. Since we've waited 16+ years to take any action (and are likely to wait a good deal longer), the tax needed to assure solvency has more than doubled.

The news gets even grimmer when one realizes that Social Security is now scheduled to pay fewer bucks for the bang:

On top of the projected deficit, the amount of preretirement income a worker can expect at retirement from Social Security at specific ages of commencing benefits is going to decline due to the scheduled increases in the normal retirement age. For those age 65 in 2005 and starting to receiving benefits in that year and having made the equivalent of the average wage index over the course of their working career, the replacement rate of income just prior to turning age 65 from Social Security is 42.2 percent. For those turning age 65 in 2025 with the same earnings, the expected replacement rate is 36.3 percent. The replacement rates from Social Security are lower for higher earners and higher for lower earners.

Of course, THAT'S THE GOOD NEWS! The bad news is that:

The Medicare Hospital Insurance Trust Fund is estimated to be facing an actuarial balance of –3.09 percent of taxable payroll, which is a significant increase from the projected balance in 2002 of –2.02 percent. This means that the payroll tax for Medicare would need to be increased by 3.09 percentage points—or benefits would have to be cut by an equivalent amount—in order for the revenues to match expenses for the program over the next 75 years. This level of tax increase would more than double the current payroll tax rate for Medicare.

The projected growth in these expenditures could present serious issues for the federal and state governments. According to a Congressional Budget Office (CBO) study, depending on the spending path of expenditures for Medicaid and Medicare, these expenditures could amount to from 5.3 percent of gross domestic product (GDP) to 21.9 percent of GDP by 2050. For comparison, Social Security expenditures are projected to account for between 6.3 percent to 6.6 percent of GDP by 2050 under the same sending path assumptions.

Hat Tip: Docuticker.

The Once and Future Tax

2006-09-25T21:57:00.000-04:00

Kelly at Talking Taxes has some interesting observations about the extension of sales taxes to services. She (he?) points out:

Taxes on services can have a "layering" effect, with several layers of tax being added to the cost of goods or services by the time they are acquired by the end consumer.

Some types of businesses (e.g., newer or smaller companies) could be put at a competitive disadvantage because they have to rely on outsourced service providers, while older and larger companies can rely on in-house (and, thus, sales tax exempt) staff to provide the same services.

There may be a movement of service providers to states that do not tax their services.

To me, this last factor deals a fatal blow to any attempt to tax any services other than those that, by the nature of the service, always have a physical nexus to state where the consumer of the service is located.

Currently, with respect to sales taxes applicable to goods sold to businesses, attempts to make a jurisdictional end-run around the tax are blunted by the application of use taxes. Thus, the business consumer, if it does not pay sales tax, becomes potentially liable to pay a use tax. As a consequence, state tax collectors can usually collect the tax from the seller or the purchaser. (Use taxes are, theoretically at least, also applicable to individual consumer purchases. As a practical matter, however, there is little or no enforcement in this area.)

More importantly, however, the jurisdictional issue throws into question the possible theoretical utility of a national sales tax, the value added tax. One of the allures of value added taxes is that they offer the promise of tamping down domestic consumption, while simultaneously increasing the ability of American businesses to sell abroad. (As in Europe, the VAT would only be applicable to goods that are ultimately sold in the U.S. Thus, it operates as a sort of tariff, with U.S. residents paying more than foreign consumers for goods subject to the VAT.)

Any attempt to impose a VAT-like tax on services turns this policy goal on its head, since service providers in the U.S. would be at a relative disadvantage to foreign service providers when attempting to sell services to U.S. customers. By way of example, neither a VAT nor its state cousin, the sales tax, could be imposed on accounting services provided from Bangalore. The policy hurdles are especially tricky here, since any VAT on services would hobble precisely those sorts of high value services that nations want in order for their economies to remain on the cutting edge.

Steal This Election?

2006-09-24T19:15:00.000-04:00

Voting in Maryland's recent primary election was a mess. My sense is that the mess was caused primarily by a lack of trained personnel. That is, the problems were not rooted in any deliberate attempt to subvert the election. Rather, the local boards of election did not perform their jobs competently and did not have sufficient competent voting judges at the polling places.

However, there still remains an issue whether electronic voting machines can be intentionally rigged to change the election results. The Center for Information Technology Policy of Princeton University has studied the Diebold AccuVote-TS Voting Machine, the machine used in Maryland. The Center has produced the following video summary:

Needless to say, Diebold has taken issue with the study. The authors of the study have issued a point by point response to Diebold's defense. In another posting, one of the study's authors had this additional comment:

[O]ne of the lessons of our study is that even one dishonest election worker can cause big trouble. So the relevant question is not whether the average election worker is honest, but whether a would-be villain can get a job as an election worker.

The answer to that question is almost certainly "yes." Election workers are in short supply in most places, so any competent adult who volunteers is likely to get the job. And every election worker I've talked to has had private access to a voting machine for more than a minute — enough time to inject the kind of vote-stealing software we demonstrated.

As always with computer security, we don't just worry that things will go wrong on their own. What really vexes us is that our adversary is trying to make things go wrong. If a single election worker can corrupt an elections, then the bad guys will become election workers. Without the necessary safeguards, the many honest election workers won't be able to stop them.

In the 2000 presidential election, because of the so-called "butterfly ballots," 2000 to 2400 of the Buchanan votes were almost surely Gore supporters who mistakenly punched their ballot for Buchanan. Adding these votes to Al Gore's totals would have changed the outcome of the election. Ironically, it was the 2000 debacle that has lead to the accelerated development and use of electronic voting machines.

I happen to believe that some form of electronic voting is necessary. However, I also believe that any system of electronic voting must have sufficient redundancy and safeguards built in to assure that elections are not corrupted. I am less than confident that the current Diebold machines are up to the task.

Hat Tip: Robert Ferraro.

Contracts, the Rule Against Perpetuities, and Legal Malpractice

2006-09-18T22:34:00.000-04:00

An interesting opinion handed down by the Maryland Court of Special Appeals on Friday raises questions concerning the parameters of an attorney's duty of care in drafting a contract.

The case, Cattail Associates, Inc. v. Sass, involved a contract to purchase two undeveloped parcels of real estate that the purchaser intended to develop. The contract specifically provided that closing was to occur after governmental approval of a subdivision of the properties.

Standing alone, the provision with respect to closing constitutes a violation of the Rule Against Perpetuities under Maryland law. That is, because the contract contained no time limit within which subdivision approval must be granted, there was no assurance that the purchaser's interest in the properties "must vest, if at all, not later than twenty-one years after some life in being at the creation of the interest." As a consequence, without more, the contract would not be enforceable.

However, the contract at issue had an addendum that contained a "savings provision." That is, one section of the addendum provided that:

The parties to this contract intend that it will be binding and legally valid upon them. In order to preclude any application of the Rule Against Perpetuities which would otherwise invalidate and nullify this contract, the parties agree that this contract shall expire, unless otherwise previously terminated, on the last day of the time period legally permitted by the Rule Against Perpetuities in the State of Maryland, in which case all deposits shall be promptly returned to the Buyer.

Of course, even this provision was somewhat problematical since it was unclear who the measuring life or lives were intended to be. The Court interpreted the provision broadly, however, and stated that "the clear implication is that the sellers as a class should be considered the measuring lives."

I suppose that all's well that ends well, but I have a further question: Should all sales contracts have Rule Against Perpetuities savings provisions? If so, is it now malpractice in Maryland to draft a contract without such a provision? And, if it's not now malpractice in Maryland to draft a contract without a savings provision, when, if ever, does the requisite standard crystalize sufficiently that, if the savings provision is missing, the attorney's duty of due care has been breached?

This afternoon, right after reading Cattail Associates, I was reviewing a contract for the sale of a restaurant. Closing was to occur within a certain period after approval of the transfer of the liquor license. One of the changes that I suggested be made to the contract was to add a Rule Against Perpetuities savings provision.

What Have I Wrought?

2006-09-14T20:33:00.000-04:00

Beginning in the late 80's, I participated in efforts to promote LLCs. As part of that effort, I chaired the committee that drafted Maryland's LLC Act.

The Maryland LLC Act is among the most opaque in the nation with respect to the identities of the LLC's owners. There is no requirement that there be a public record in this state of the names of either the owners or actual operators of an LLC.

While I continue to favor the general principal of opacity with respect to LLCs, I also favor transparency in campaign contributions and campaign contribution limits. An article in The Annapolis Capital shows that these goals may be at war with each other. According to the article:

Developers are pouring tens of thousands of dollars into the county executive race by using a loophole in Maryland campaign law that allows them to avoid contribution limits while donating virtually anonymously, an analysis by The Capital shows. In a race that's been dominated by concerns about the scale and pace of growth, voters in Tuesday's primary election will have a hard time figuring out just who's been bankrolling many candidates.

The analysis of campaign finance reports filed with the state Board of Elections found at least 84 instances of developers using Limited Liability Companies to give more than $40,000 to county executive candidates.

A legal hybrid between a corporation and a partnership, LLCs are often formed by developers when starting a new project.

It's very hard to track their owners because the state doesn't require LLCs to disclose ownership. And many LLCs have vague names, such as Owings Mills III LLC and Sigma 45 LLC.

LLCs have to be registered with the state. But information on file with the state Department of Assessments and Taxation often contains few clues about LLC owners, instead listing a "resident agent" who may have littleor nothing to do with the ownership.

* * * * *

Under state law, political donors can give up to $4,000 to an individual candidate or $10,000 to all candidates or fund-raising entities - political action committees, for example - over a four-year election cycle.

Business accounts and LLCs are subject to the same limits. So business or LLC owners can give up to $10,000 over a four-year election cycle in their own names, plus another $10,000 in their companies' names.

As a result, a developer can give $10,000, then give another $10,000 through his LLC and not have it count against his limit. He can do the same with his second LLC, his third and so on.

The article mentions a bill, HB 585, that was introduced in last year's General Assembly session that passed the House but died in the Senate. The bill, if enacted, would have aggregated campaign contributions by affiliated entities.

Assuming that one is in favor of campaign finance limits, HB 585 makes sense. It is narrowly focused on the issue of campaign finance and does not unnecessarily destroy the default rule of the Maryland LLC Act that LLCs be able to conduct their affairs in private.

Lest there be any confusion, the Maryland LLC Act merely does not mandate automatic public disclosure. There is nothing in the statute that blocks disclosure where there is a compelling reason for disclosure. Thus, discovery in the course of litigation can be used to compel disclosure of an LLC's ownership structure. I believe that limiting campaign contributions provides another compelling reason to mandate disclosure, a goal that can be reached by the limited means suggested in last year's HB 585.

Hat Tip: Unincorporated Business Law Prof.

Outsourcing

2006-09-13T07:53:00.000-04:00

Linda Beale has a great post explaining why outsourcing of tax collections is bad public policy. She focuses on the practical--outsourcing will, net/net, reduce overall governmental revenues. However, it seems to me that she misses one important point.

The goal of those who favor outsourcing will be advanced by outsourcing--the goal is to reduce governmental revenues. That's why over the last decade the budget for IRS's auditing and collection activities have been systematically reduced.

As I've noted before, the hobbling of IRS's audit and collection functions not only has a direct effect, that is, less audits and less resources devoted to collection lead to less revenue raised, but there's an indirect effect as well. That is, people have additional incentives to play "Audit Roulette," since the likelihood that they will be caught is radically diminished. As a result, taxpayers are less likely to correctly report and pay their tax obligations.

To some extent, of course, the shortfall caused by fewer resourses being devoted to enforcement is offset by increased computerization. As a result, it's simply more difficult to hide income. And, with the growth of the alternative minimum tax, the income tax has at its upper levels essentialy become flat, with fewer significant abilities to decrease one's income tax via aggressive use of deductions.

However, don't be fooled by those attempting to cut the IRS budget and who support outsourcing collections. Their goal is not greater efficiency, but less.

Don't Tell Linda Tripp About This

2006-09-11T23:47:00.000-04:00

Via David Pogue's NYT Blog I learned about free teleconference hosting at LiveOffice (which, as Pogue notes, is not to be confused with Microsoft's Office Live). By merely registering, you can obtain a permanent telephone number that allows you to set up teleconferences for free without having to make any prior reservations. The only catch is that the number is a long distance number and all of the participants have to pay long distance rates to participate. However, since most of us are on plans that provide either large blocks of toll-free time or low rates for long distance calling, this would seem to be a minimal burden.

It was not until I used the service, however, that I learned that it allows the conferences to be recorded for free. However, mindful of the criminal charges brought against Linda ("With Friends Like Her, You Sure As Hell Don't Need Enemies") Tripp, I intend to make certain that I always inform the participants that the conference is being recorded.

The Art of the Deal

2006-09-08T18:15:00.000-04:00

How come my negotiations on behalf of clients don't go nearly this well?

Cool Running Mon, Nu?

2006-09-07T20:01:00.000-04:00

I never cease to be amazed at the wealth of resources on the web. In preparation for the hearings before the Senate Committee on Finance, the staff of the Joint Committee on Taxation released a background paper on Present Law and Background Relating to Executive Compensation.

The hearings were directed toward the supposed cause and effect relationship between the $1 Million cap on executive compensation imposed by IRC Section 162(m) and the stock option backdating scandal. The argument in favor of the repeal of Section 162(m) goes like this: Section 162(m) imposes a penalty tax on executive compensation in excess of $1 Million a year, except compensation that is "performance-based." This has caused a growth in such performance-based compensation mechanisms as stock options which, in turn, have lead to such abuses as backdating of the options.

While I have some doubt as to the wisdom of Section 162(m), the option backdating scandal hardly provides a basis for repeal of the section any more than Bonnie and Clyde provided a justification for outlawing banks. (Although, I suppose that argument would have been a good excuse for a catchy slogan: "Unless banks are outlawed, only outlaws will have banks.")

The report, however, is a gem from a teaching perspective. In 45 concise pages, it presents a useable outline of the various types of deferred compensation arrangements and how they work. I have lectured on the topic, but I had not previously seen such a readable summary.

And the title of this posting? It's derived from the report's discussion of rabbi trusts. Rabbi trusts are deferred compensation arrangements where money or stock is placed in an irrevocable trust rather than being paid to the employee. The compensaton is deferred because (i) the employee cannot draw upon the assets in the trust at will and (ii) the assets in the trust remain subject to the claims of the creditors of the employer in the event of the employer's bankruptcy. (The arrangement got its name because the first letter ruling approving its use was sought by a synagogue for its key employee.)

Even though a rabbi trust has to be subject to the claims of the employer's creditors to allow the compensation to the employee to be deferred, planners have sought to minimize the risk that creditors will actually seize the assets in the trust by organizing the trust under the laws of a foreign jurisdiction. Funds placed in such trusts are now no longer deferred due to the enactment of IRC Section 409A in 2004. However, footnote 33 of the report notes that offshore rabbi trusts have been referred to as a "Rastafarian" rabbi trusts. Somehow, I can't picture Bob Marley wearing tallit.

How Knaves Fool Fools

2006-09-03T10:30:00.000-04:00

The weekend WSJ has an editorial, Incomes and Politics: Comparing the Current Decade to the Sainted 1990s, that, when read closely, demonstrates one method used by knaves to fool fools.

The overarching thesis of the editorial is that, thanks to massive tax cuts, we're doing fine, thank you. The editorial goes so far as to contend that the tax cuts have actually made the tax code more progressive:

[T]he new data show that the bottom 50% of Americans in income--U.S. households with an income below the median of $44,389--paid a smaller share of total income taxes in 2004 (3.3%) than in Bill Clinton's last year in office (3.9%). That 3.3% is the lowest share of total income taxes paid by the bottom half of earners in at least 30 years, and probably ever. The majority of American families with an income below $40,000 pay no income tax at all today, and many of them also get a welfare subsidy from the Earned Income Tax Credit that effectively offsets much of what they pay in payroll taxes.

By contrast, Americans with an income in the top 1% paid 36.9% of all federal income taxes in 2004, down slightly from 37.4% at what was the height of the dot-com boom in 2000. But the top 5% and 10% of earners saw an increase in their tax share over that same period, with the top 5%'s share rising to 57.1% in 2004 from 56.5% in 2000. If this isn't the definition of a highly "progressive," a k a redistributionist, tax code, we don't know what is.

Emphasis added.

Apparently, the WSJ doesn't know what a progressive tax code is. Let me explain: It's a tax code that, when all taxes are factored in, is progressive. That is, the more one makes in income, the larger percentage of that income is paid in taxes. The key phrase is "when all taxes are factored in." Look carefully at the WSJ quote above. It focuses solely on income taxes.

Back in April, I had a post, Fools and Knaves, Wall Street Journal Edition. Since the WJS is pushing the same baloney now that it was peddling then, let me offer the quote contained in my previous posting from a study, authored by Michael Strudler and Tom Petska of the IRS and Ryan Petska of Ernst and Young:

[S]ince 1997, with continuation of the 39.6-percent rate but with a lowering of the maximum tax rate on capital gains, the redistributive effect again declined. It appears that the new tax laws will continue this trend. Analysis of panel data shows that these trends are not quite as great as seen by looking at annual cross-section data, but the trends cited above are still apparent.

The WSJ editorial is based upon an IRS report that has not yet been released, but which the WSJ has had an "early look at." I will update and offer additional comments when the report becomes publicly available.

Hat Tip: TaxProf.

An Additional Comment:

The WSJ editorial has the following chart, which TaxProf reproduces:

Note the title of the table on the bottom: "Percentage share of federal taxes and total income, 2004." (Emphasis added.)

Wrong, wrong, wrong.

To the extent that I understand the editorial, based upon a report that's not yet publicly available, the chart shows the distributional burden only of income taxes, not all federal taxes. In other words, the knaves have now even fooled themselves into believing their baloney.

Freeloaders

2006-08-28T16:16:00.000-04:00

Two recent opinions illustrate the problems that America's mobility poses states and localities in raising tax revenue.

In Antzis v. Comptroller, the Maryland Tax Court addressed the question of whether a tax, levied on the Maryland income of non-Maryland residents, was constitutional. The facts, as set forth by the Court, are as follows:

Petitioners are three married couples that reside in Pennsylvania and file joint nonresident Maryland income tax returns. The returns are filed because in each case the husband is a partner in a multi-state law firm with Maryland and Pennsylvania operations. The partnership apportions its income among the states in which it does business, and this creates Maryland taxable income for each Petitioner pursuant to §10-210 [of the Maryland Tax-General Article]. There also exists a withholding obligation for the partnership under §10-102.1 [of the Maryland Tax-General Article]. These taxes are not in dispute.

In 2004, the General Assembly of Maryland enacted a special tax applicable to non-residents. The tax requires non-residents to pay income tax equal to the state rate (4.75%) imposed by §10-105 [of the Maryland Tax-General Article], "plus an amount equal to the lowest county income tax rate set by any Maryland county in accordance with §10-106.1 of [of the Maryland Tax-General Article]." . . . Petitioners did not pay the amount required by §10-106.1 and were assessed accordingly. Petitioners' contention is that the tax imposed by §10-106.1 is unconstitutional.

Maryland income taxes on both residents and non-residents can be described as follows. The resident taxpayers’ payment is split between two separate taxes, namely the state income tax portion that goes into the General Fund of Maryland, and a local tax portion that goes to the taxpayer’s county of residence, or to Baltimore City in the case of a city resident. The local tax revenues are used to fund local services. By contrast, the non-resident taxpayers' tax consists of the state income tax portion at the same rate paid by residents, plus the special non-resident tax, both of which go into the General Fund. Non-residents pay no local income tax because they have no local county of residence. As stated earlier, residents do not pay the special non-resident tax prescribed by §10-106.1.

Petitioners contend that imposing the special non-resident tax exclusively on nonresidents, coupled with the differences in how the tax revenue is allocated, equates to discrimination against the non-resident in violation of both the United States Constitution and the Maryland Constitution and Declaration of Rights. To support these contentions, the Petitioners assert that the state income tax and the local income tax are different taxes and cannot be combined to determine whether residents and non-residents are being taxed equally.

The taxpayers principally relied upon Fulton Corp. v. Faulkner, 516 U.S. 325 (1996), contending that the Maryland statute expressly discriminates against nonresidents by levying a tax on nonresident income which has no direct corollary with respect to residents. Among the arguments that they raised was that "the special tax compensates for nothing, and cannot be 'fairly related to the services provided by the State [which benefit interstate commerce].'"

In one paragraph, the Tax Court succinctly put that argument to bed:

To fully explore these contrasting points-of-view, this Court questioned counsel as to whether a nonresident taxpayer gains any direct or indirect benefit from local services being provided by a Maryland county or by Baltimore City. Such local services traditionally include police and fire protection, waste disposal, water and sewer services, and the myriad of other local governmental activities on behalf of people within each local jurisdiction. It was conceded that such local benefits do, in fact, accrue both directly and indirectly to nonresidents while they are present or doing business in a jurisdiction. Obviously, both residents and nonresident receive these local governmental benefits by mere virtue of their physical presence within a jurisdiction, either in person or as part of a business entity doing business within the jurisdiction. It seems perfectly reasonable, therefore, for the State to seek compensation for these services from non-residents through the tax system. Although there is no direct mechanism to allocate the special non-resident tax revenue to a particular county, the General Fund of Maryland exists to provide funding for the benefit of all Maryland counties and Baltimore City, selectively, indirectly, to all persons or entities physically situate or doing business within its local borders.

Emphasis added.

In other words, there's no free lunch when it comes to municipal services.

In District of Columbia v. Bender, the precise legal issue was different, but the overriding tax policy issue was the same. There, owners of valuable commercial real estate in the District of Columbia sought to avoid paying taxes on income generated by those properties. The specific question before the Court was whether the tax statute violated the Home Rule Act, but the same basic principle was at stake: Whether income that is generated as a direct consequence of municipal services can be tax to fund those services. Here too, the Court sustained the taxing authority.

There was a time when most commercial activity could be readily identified to a particular physical situs. To a growing degree, that is no longer the case. Capital, both human and economic, can be put to work in one locale but managed a substantial distance away. The underlying tax policy question is whether the governmental authorities who create and maintain the public infrastructure that supports the economic activities in a specific locale can be funded by taxing income that will, if not immediately taxed, be "exported" out of the locality.

Ain't Necessarily So

2006-08-27T20:11:00.000-04:00

Estate-Tax Plans Get Trickier in the weekend WSJ suggests that estate planning has become immeasurably complex because, as currently drafted, the estate tax is scheduled to disappear in 2010 and then bounce back again, at higher rates, in 2011. The article focuses on the problems inherent in measuring how much life insurance estates, particularly modest estates, will need as part of an estate plan.

The article is needlessly alarmist.

No one, least of all me, has a perfect crystal ball when it comes to predicting what Congress will do. But it's virtually a slam-dunk, sure bet that the scheduled reversion of the estate tax to the 55% rates and $1M lifetime credit of 1997 will never take place. It is only a shade less likely that the lifetime credit will, after its increase to $3.5 million, be reduced. Thus, the only real uncertainties are:

Can any compromise be enacted early enough to avoid the zero estate tax in 2010? Let me suggest that this issue causes only a limited degree of planning uncertainty, since few clients are focusing their planning efforts around the fact that 2010 will be their year of demise. If no compromise is enacted by 2010 and your client dies in that year, it only means that his or her heirs hit the Estate Tax Lottery Jackpot. If that is the case, it is unlikely that any tax practitioner will have to answer to an unhappy client for failing to correctly predict the state of the law three and a half years in the future.

Will the estate tax rates be higher than they are currently? At best, this is a minimal factor in the estate tax planning for most clients, since any increase in rates is likely to be more than offset by a hefty increase in the lifetime credit and by other, new, planning devices built into any compromise.

How high will the lifetime credit go? Again, this would seem to create only a limited degree of planning uncertainty for most clients. After all, if we assume that the $3.5 million credit is, as a practical matter, a floor for any compromise, then the only families exposed to any estate tax after a compromise is reached are those with family wealth well in excess of $7 million. My suspicion is that relatively few readers of even the WSJ fall into this category.

A more interesting question is why the article was written in the first place. Let's try to guess.

The current estate tax law provides a huge subsidy to the life insurance industry. Virtually any change in the law will dramatically reduce the market for such insurance. Hmmm.

Of the 16 paragraphs in the article, 14 discuss the use of life insurance in estate planning that has, as its principal goal, tax minimization. Could it be that the article was nothing more than the fruit of efforts by insurance industry flacks attempting to sow panic among the wealthy in order to get in a few last licks?

Nahhh.

Hat Tip: TaxProf

Murphy's Law?

2006-08-23T00:11:00.000-04:00

Much of what passes for conservative political thought these days is nothing more than rationalizations attempting to justify policies that favor the rich and economically entrenched. It is therefore refreshing to find a judicial opinion that actually applies conservative principles.

Yesterday, in the case of Murphy v. IRS, the U.S. District Court for the District of Columbia (per Ginsburg, C.J.) determined that, as a matter of Constitutional law, "compensation for a non-physical personal injury is not income under the Sixteenth Amendment if . . . it is unrelated to lost wages or earnings."

The taxpayer had "filed a complaint with the Department of Labor alleging that her former employer . . . in violation of various whistle-blower statues, had 'blacklisted' her and provided unfavorable references to potential employers after she had complained to state authorities of environmental hazards . . . ." The Secretary of Labor found in favor of the taxpayer and the case was remanded to an administrative law judge for a determination of the amount of compensatory damages to which she was entitled.

The taxpayer:

submitted evidence that she had suffered both mental and physical injuries as a result of the . . . .blacklisting . . . . A physician testified [that the taxpayer] had sustained "somatic" and "emotional" injuries. One such injury was "bruxism," or teeth grinding often associated with stress, which may cause permanent tooth damage. Upon finding [that the taxpayer] had also suffered from other "physical manifestations of stress" including "anxiety attacks, shortness of breath, and dizziness," the ALJ recommended compensatory damages totaling $70,000, of which $45,000 was for "emotional distress or mental anguish," and $25,000 was for "injury to professional reputation" from having been blacklisted. None of the award was for lost wages or diminished earning capacity.

IRC Section 104(a) provides that "gross income [under IRC Section 61] does not include the amount of any damages (other than punitive damages) received ... on account of personal physical injuries or physical sickness." Since 1996 it has further provided that, for purposes of this exclusion, "emotional distress shall not be treated as a physical injury or physical sickness." The taxpayer had contended that the award was not taxable because she had suffered physical injury (e.g., the bruxism). However, that argument was rejected by the Court which stated that:

[The taxpayer] no doubt suffered from certain physical manifestations of emotional distress, but the record clearly indicates [that she was] awarded . . . compensation only "for mental pain and anguish" and "for injury to professional reputation."

The Court then turned to the argument that makes this case remarkable. Specifically, is IRC Section 104(a)(2), which does not permit the award to be excluded from income, constitutional? The Court held that it was not.

In its analysis, the Court extensively reviewed the history of the Sixteenth Amendment. Ultimately, it agreed with the taxpayer's contention that:

a damage award for personal injuries-- including nonphysical injuries -- is not income but simply a return of capital -- "human capital," as it were. See Gary S. Becker, Human Capital (1st ed. 1964); Gary S. Becker, "The Economic Way of Looking at Life," 43-45 (Nobel Lecture, Dec. 9, 1992).

In a footnote, the Court remarked:

[The taxpayer's point] is that as with compensation for a harm to one's financial or physical capital, the payment of compensation for the diminution of a personal attribute, such as reputation, is but a restoration of the status quo ante, analogous to a "restoration of capital," [Commissioner v.] Glenshaw Glass, 348 U.S. [426 (1955)] at 432 n.8; in neither context does the payment result in a "gain" or "accession[] to wealth," id. at 430-31.

In Commissioner v. Banks, the Supreme Court determined that when a litigant's recovery constitutes income, the litigant's income includes the portion of the recovery paid to the attorney as a contingent fee. As a practical matter, any legal fee paid in the course of a lawsuit except one for personal injury will, under IRC Section 104, generally get added back into income when computing the claimant's liability for alternative minimum tax. Since such fees are not deductible for alternative minimum tax purposes, they are, in essence, not deductible at all. See my comments here made before Banks was handed down.

The decision in Murphy re-establishes balance to the equation, at least in those situations where the award sought is for "personal injury." (This would not include, however, awards for economic injuries such as lost wages, etc. In my previous comments on Banks, I pointed out some of the practical problems that employees face in attempting to use attorneys or other paid agents in negotiating contracts or other compensation awards.)

Murphy is a conservative opinion in the traditional sense of the word "conservative." It is doubtful whether a "conservative court" in the post-20th Century meaning of the term (the Fourth Circuit, for instance) would have reached the same conclusion as did the D.C. Circuit.

Income and Wealth Inequality

2006-08-21T11:31:00.000-04:00

Brad DeLong has a good summary of the various positions in the debate over whether the growing inequality of income and wealth is determined by governmental policies, including tax policies, or whether it is primarily an outgrowth of other factors such as technology and the globalization of labor markets. It's fairly lengthy as blog postings go, but well worth reading since DeLong is relatively even-handed in describing the various opposing points of view.

And This Is Bad Because . . . ?

2006-08-18T21:47:00.000-04:00

In his NYT column today, Wages, Wealth and Politics, (both the column and the follow-up on his related weblog are behind the Times Select subscription wall), Paul Krugman discussed the rapidly growing gap in income and wealth between the really wealthy and the rest of us, drawing a causal connection between our politics and our economy:

[S]ince 1980 the U.S. political scene has been dominated by a conservative movement firmly committed to the view that what’s good for the rich is good for America. Sure enough, the rich have seen their incomes soar, while working Americans have seen few if any gains.

In the blog that he maintains in conjunction with his column, Krugman expanded on that theme:

There are real questions about just how closely supply and demand determine wages; the labor market isn't just like the market for wheat. Also, there's a lot of evidence that unions have a large effect on the wages of non-union workers, too. When you're in an economy in which about a third of private-sector workers are unionized, as was true of the United States when I was growing up, even non-union employers tread carefully, for fear of giving their workers a strong incentive to organize. When you're in an economy where unions have been largely banished from the private sector, as is the case now, things are very different.

Of course, there are bright spots. Government workers, who, by dint of being voters, have some drag with their paymasters, have seen their incomes rise over time. Rather than embracing this as good news, in an op-ed piece in WaPo last Sunday, Chris Edwards, tax director at the Cato Institute, was critical of the growth in federal wages:

The Bureau of Economic Analysis released data this month showing that the average compensation for the 1.8 million federal civilian workers in 2005 was $106,579 -- exactly twice the average compensation paid in the U.S. private sector: $53,289. If you consider wages without benefits, the average federal civilian worker earned $71,114, 62 percent more than the average private-sector worker, who made $43,917.

* * * * *

To get spending under control, Congress should consider trimming overly generous benefit packages and freezing federal wages for a few years.

His comments were echoed by the Tax Foundation's Andrew Chamberlain.

I suspect that there's a good deal wrong with employee management in the federal government. But to say that the principal problem is that federal employees are making too much money relative to employees in the private sector is crazy. After all, one of the major social problems we face is that private sector employees are taking it on the chops. Which is to say that the principal problem we face is that private sector employees are not making enough. The solution to that problem is not to institute policies with respect to federal employees similar to those that have undermined the economic well-being of private sector employees.

Full Disclosure: The woman with whom I sleep with is a federal employee.

Where Does Grover Norquist Stand On This One?

2006-08-16T19:11:00.000-04:00

I try not to republish without any comment material that's appeared on other weblogs. I'll make an exception for this video that was published in TaxProf, for which further comment is superfluous:

More on Rosie Scenario

2006-08-14T21:06:00.000-04:00

Late last month, I commented on the report by the Treasury, A Dynamic Analysis of Permanent Extension of the President's Tax Relief. At the time, I said:

The report, apparently authored by noted government economist Rosie Scenario, states that its projections will only be achieved if there is "an offsetting change in government revenues or spending." In other words, there will be significant budget deficits as a result of the tax cuts unless we cut government services.

A just released memorandum by Jane Gravelle of the CRS commenting on the Treasury report states that:

The fact that revenues must be made up by spending cuts clearly acknowledges that the tax cuts do not pay for themselves. But what is the magnitude? According to CBO projections, individual income taxes would be 8.4% of GDP in FY 2009 and 9.8% in FY2012, suggesting that the tax cuts are about 1.4% of GDP. For the base case reported above, output increases by 0.5% in the short run and 0.7% in the long run. In the tax reform study, Treasury indicated the marginal tax rate on labor income was 24% and the marginal rate on capital income 14%. Using an overall rate of 20%, the offsetting revenue gain from induced economic effects would be 0.1% of output, or 7% of revenue loss in the next five years.

Stated more succinctly, notwithstanding the baloney dished out by the Republicans to the effect that tax cuts will generate more government revenue, the additional revenue will only be equal to 7% of the revenue lost from the tax cuts. In other words, to paraphrase Merle Travis (by way of Tennessee Ernie Ford), Republican tax cuts make most of us just another day older and deeper in debt.

Hat Tip: TaxProf.

Rollin'

2006-08-13T16:51:00.000-04:00

IRC Section 1033 allows a taxpayer two years to reinvest the proceeds of a sale of property sold under "condemnation or threat or imminence thereof" without having to recognize any gain on the initial sale. However, there has to be an actual threat of condemnation. As the Tax Court said in Rainer Co., Inc. v. Commissioner, 61 T.C. 68 (1973):

It is a well-known fact that local governments possess the power to condemn property for use in public projects. Accordingly, if mere knowledge that a local government entity possessed the power to condemn an owner's property was sufficient evidence of a threat of condemnation, then few sales of land to the public would fail to qualify under section 1033.

This is a lesson that seems to have been lost on U.S. Rep. Gary Miller (R. CA). As reported today in the LAT (free registration required), Rep. Miller rolled over the profits from real estate sales not once, but twice, even though he faced no actual threat of condemnation of any of the properties involved.

In 2002, he "sold 165 acres to the city of Monrovia [and] made a profit of more than $10 million." But "Monrovia officials say that Miller sold the land willingly and that they didn't threaten to force him to sell." While Miller claims that the sale was made under threat of condemnation, that was simply not possible since "the city could not have used eminent domain to purchase Miller's property, because it was acquiring the undeveloped hillside land for a wilderness preserve using state funding that specifically prohibited forced sales." Indeed, it appears quite clear that Miller was chasing the city to purchase the property, not the other way around:

A videotape of a February 2000 City Council meeting, packed with people pushing the city to protect the hillside, shows Miller pleading with city officials four times to buy his land.

"Why don't you buy my property? I've asked you repeatedly," Miller said.

Apparently, Miller is a bit of a one-trick pony, since:

[T]wo years after the Monrovia sale, [Miller] raced to beat his extended deadline of Dec. 31, 2004, for reinvesting the profits. On Dec. 28, he reinvested some of the profits by purchasing 10 lots for about $5 million near the expanded 210 Freeway in Fontana, a building in Fontana for $1.3 million and five acres in Rancho Cucamonga worth about $2 million. He bought the properties from Lewis Operating Corp., a major Inland Empire developer and one of Miller's largest campaign contributors.

Miller took an exemption again when he sold the 10 lots to the city of Fontana in 2005 and again when he sold the building to Fontana this year, claiming both were compulsory sales.

But records and interviews in Fontana show that those sales were not compulsory.

It appears that Miller worked hard, but unsuccessfully, to "paper" the second set of transactions to make it appear as if he was selling under threat of condemnation:

To bolster his case that the sale was forced, Miller also asked the city for "a letter that talked about eminent domain," said Ray Bragg, the city's redevelopment director.

Ultimately, Miller received a letter signed by City Manager Kenneth R. Hunt, that notes that the "redevelopment plan for this project area does not currently authorize the use of eminent domain."

Clark Alsop, the lead attorney representing the jurisdiction, stated that:

"It's pretty clear to me that the city cannot make a representation to the IRS that this is property being taken under the threat of eminent domain and therefore this person deserves a tax break."

And, of course, the taxpayer involved should not make a representation, under penalties of perjury, that income from the proceeds of a sale is subject to Section 1033 when that's not the case. Congressman Miller apparently did this not once, but twice.

Followup

I subsequently did some further research on Rep. Miller. It appears that I was unfair to him when I labeled him a "one-trick pony." According to The Hill, Rep. Miller is currently being investigated for violations of House ethics rules for borrowing $7.5 Million from "a campaign contributor and business partner . . . which he used to purchase real estate from" the business partner's company.

Drugged

2006-08-12T09:20:00.000-04:00

There's a good post on the Tax Analysts site, Economic Analysis: Drug Firms Move Profits to Save Billions, by Martin A. Sullivan.

Moving profits from the United States to low-tax jurisdictions is the way prosperous U.S. pharmaceutical companies keep their taxes low. And that domestic-to-foreign shift has clearly accelerated in recent years. By Tax Analysts' calculations, in 1999 foreign profits accounted for 39.2 percent of worldwide profits of large U.S. drug companies. By 2005 that percentage had jumped to 69.9 percent.

* * * * *

When one affiliate of a multinational corporation makes a sale or loan to another affiliate, profits are shifted. When the terms of the transactions are set so that affiliates in low-tax countries get the better deals, the low-tax affiliates get larger shares of the profits and the multinational group reduces its overall income tax burden.

Pharmaceutical companies own a lot of marketing intangibles and patents that are developed in one or just a few locations and then used worldwide. Determining fair terms for interaffiliate transactions involving intangible assets involves a great deal of subjective judgment, so those determinations are a constant source of conflict between drug companies and the IRS.

The data strongly suggest the IRS is losing the battle.

How much is the IRS losing? Determining where profits belong is never a clear-cut call, but profits generally track the location of value-creating economic activity. Sales and long-term assets, segmented by geographic location, are two measures of economic activity that are available from company annual reports. As shown in Figure 3 (on page 474), foreign assets on average accounted for 41 percent of worldwide assets and foreign sales accounted for 44 percent of worldwide assets from 2003 to 2005. If we use those measures as profit indicators, foreign profits should be roughly 43 percent of the worldwide total instead of the actual figure of 66 percent. The difference — 23 percent — is the amount of worldwide profit that arguably should be reassigned to the United States.

The nine largest drug companies had total pretax profits of $42.6 billion in 2005. If 23 percent of that number, or $9.8 billion, were shifted back to the United States and taxed at an average rate of 30 percent, the treasury would take in an additional $2.9 billion — in just one year, from just nine companies.

One of the principal drivers behind escalating health care costs is the rapidly rising cost of prescription drugs that are protected by patents. I happen to believe that patent protection is necessary to encourage investment in new drugs. According to this report in thestreet.com, "The pharmaceutical industry is a far riskier investment than the broad market as a whole, as defined by its distribution of returns since the Dec. 29, 2000, inception of the current S&P Pharmaceutical index." Taking away patent protection would throttle the industry, meaning that the development of new medicines would be dramatically slowed.

Presumably, the use of the tax dodges described by Sullivan have resulted in an increase in the stock price of pharmaceuticals. The economic question, that I cannot answer, is whether this has resulted in greater investment in new drug development.

In a sense, the question raised by Sullivan's report is a specialized version of a question posed in another Tax Analyst report by Joseph J. Thorndike, What's a New Democrat to Do?:

[T]he fundamental issue of tax policy in a global economy [is] the future of progressive taxation in a world of mobile capital. Taxes on capital income have long been regarded as a vital component of tax fairness. But in recent decades, experts have begun to question whether capital income should be taxed at all. Even more striking, some economists have suggested that taxes on capital income can't be made to work, at least not over the long term.

Library Card

2006-08-11T08:05:00.000-04:00

There's a great search site, WorldCat, that will locate libraries in which particular books and other publications can be found. Thus, if you type in "Robert Ercole," you will find 36 publications authored by Mr. Ercole or someone with a similar name (such as Robert d Ercole, the author of Les Risques naturels potentiels liés aux lahars d'origine volcano-glaciaire: cas de la région du Cotopaxi (Equateur)).

The "real" Mr. Ercole is one of the co-authors of Maryland Limited Liability Company Forms and Practice Manual. You will discover that this work can be found in 8 fine libraries around the country.

Search "Stuart Levine"? Apparently there are a great number of scholars with that name. They have published such varied works as The American Indian Today, The Short Fiction of Edgar Allan Poe, and The Monday-Wednesday-Friday Girl: and Other Stories. And, of course, you will also find that he I am one of the authors of Maryland Limited Liability Company Forms and Practice Manual.

In addition to searching by the name of author, you can also search by subject or title.

Hat Tip: Kevin Drum

Am I Dead or Am I In Miami?

2006-08-08T17:53:00.000-04:00

Last year, I commented on the case of Maloof v. Commissioner after the Tax Court had rendered its opinion. The case raised the question of whether a shareholder's guarantees of an S corporation's loans could be used by the shareholder to increase his basis for using S corporation losses. The Tax Court held that loan guarantees could not be used to increase basis.

Last week, the 6th Circuit Court of Appeals handed down the decision on Maloof's appeal. As expected, it upheld the Tax Court on all points. The decision underlines the substantive point that I made last year that:

LLCs classified as partnerships or as disregarded entities have benefits over S corporations. Were [Maloof's] company an LLC classified as a partnership or a disregarded entity, [Maloof] would have obtained the benefits he sought.

In addition to discussing the main issue, I also focused on one of the peripheral arguments raised by the taxpayer: That the Tax Court should have applied the decisional law of the 11th Circuit since the taxpayer lived there with his mother, rather than the 6th Circuit, where the taxpayer's wife lived. I thought that the argument was frivolous and I said, "Note to Counsel: Your client's name is 'Maloof' not 'Oedipus.'"

Oddly, Maloof continued to press the question of his residency and thus the proper appellate court to entertain the appeal. The appeals court made short work of the argument:

Maloof, finally, argues that because he lived in Florida at the time he filed his petition in tax court, Eleventh Circuit precedent should control this appeal. See 26 U.S.C. § 7482(b)(1)(A) ("[Decisions of the United States tax court] may be reviewed by the United States court of appeals for the circuit in which is located . . . the legal residence of the petitioner."). That he volitionally filed this challenge to the Tax Court's decision in the Sixth Circuit, not the Eleventh Circuit, makes this something of a bewildering argument. . . . But the argument is of no moment anyway. . . . Maloof cannot show that the application of Eleventh Circuit precedent would make any difference to the outcome of this appeal.

Final Note to Counsel: Florida is hot and has alligators and palm trees. Ohio is not as hot and has no such fauna or flora.

Good Writing

2006-08-07T21:25:00.000-04:00

David Brunori writes a column, The Politics of State Taxation, for TaxAnalysts. His most recent column has great commentary on the Maryland Wal-Mart bill, the BAT nexus tax legislation, the proposal in Ohio to cut state capital gains taxes, and various state proposals to tax rental cars.

The column has a "Quote of the Week" feature, but for my money the best quote is Brunori's:

As reported in several major newspapers, a study has found that people will try to avoid taxes on rental cars. Enterprise Rent-A-Car, the nation's second-largest rental-car company, commissioned two well-known scholars to study the effects of taxes on the business. Bill Gale of the Brookings Institution and Kim Rueben of the Urban Institute looked at local car rental taxes across the United States.

Gale and Rueben found that many renters went out of their way to rent cars in jurisdictions with lower or no car rental taxes. I could have told Enterprise that and saved it whatever it paid Gale and Rueben. Eighty local governments in 38 states have car rental taxes. Politicians like the tax because they think it will be exported to nonresident visitors. But half of all car rentals are by people who live in or near the jurisdiction. As Gale and Rueben found, those people will shop around and avoid the tax. Local governments can't effectively or efficiently tax mobile tax bases. This study is just one more piece of evidence.

Some More Clarity

2006-08-07T08:20:00.000-04:00

An article in today's NYT illustrates with even greater clarity that Gov. Jon Corzine was not speaking in favor of supply-side economics in his comments to a New Jersey newspaper. The article relates how in many states the growth in the tax burden represented by the property tax has outstripped the growth of individual income. The Times quotes Corzine as follows:

"It is all too clear to everyone: The property tax burden is simply overwhelming our citizens and their economic well-being," Gov. Jon S. Corzine of New Jersey said to the State Legislature on July 28 as it gathered for the special session. "Our citizens pay through the roof for a tax that is imposed without any regard to income or ability to pay."

Of course, the ability of any state, particularly geographically small states such as New Jersey, to shift the tax burden to the more well-off is limited because the well-off can more easily "take a walk" and move to lower tax states.

What Corzine Said

2006-08-05T10:28:00.000-04:00

The Tax Foundation's Tax Policy Blog had an interesting headline, Corzine Denies He's a Supply-Sider, But.... The premise of the post was that Governor Jon Corzine of New Jersey had made pro-supply-sider comments while denying that he was a supply-sider. William Ahern, who authored the post, either did not read the newspaper article in which Corzine was quoted or failed to understand his comments.

In the article, Corzine Opposes Any Increase in State Income Tax, in the Courier Post Online, Corzine stated that:

he believed the income tax rates were so high that they were near the point where they could be cut, which in turn might spur economic growth and bring more money into the state's coffers.

"I have a . . . view that you could almost lower taxes on income and generate revenue," Corzine told the Asbury Park Press editorial board.

Ahern interprets this as support for the theory of supply-side economics, the idea that you can raise government revenue by cutting taxes. This theory is allegedly illustrated by the ~~Laugher~~ Laffer Curve.

As I noted here, the wealthy have a greater ability to minimize their taxes by picking an appropriate state for their domicile. That was the point that Corzine was focusing on, not some subtle support for supply-side nonsense. The article makes this clear:

Reports have said New Jersey has lost residents and jobs in high-paying sectors in recent years. Some experts argue the state's taxes and high cost of living are to blame.

Corzine indicated Thursday that he was looking at that issue. He said New Jersey's income taxes made the state "less attractive" than Connecticut, and put it at a "competitive disadvantage" to Pennsylvania and Delaware.

In other words, Corzine was examining the question of whether Jersey's tax rates were driving businesses and wealthy individuals into near-by states, not whether lower taxes would spur economic growth resulting in higher state revenues.

One can debate the merits of supply-side theory. But one should not cherry-pick partial quotes from elected officials (or anyone else for that matter) that seem to support the theory when it is clear from their full comments that no such support was intended or implied.

Death of a Trojan Horse

2006-08-04T07:25:00.000-04:00

In case you haven't heard, the attempt to gut the estate tax has failed. Details of the vote in the Senate are here.

The money quote from the NYT:

"The bottom line is, we bet on the wrong horses," said Senator Charles E. Grassley, Republican of Iowa and chairman of the Finance Committee.

Hot Tip

2006-08-03T20:26:00.000-04:00

In what now seems to be the increasingly unlikely event that the Estate Tax Gutting and Minimum Wage Undermine Act of 2006 passes, there is a great way to attempt to assure that service personnel actually benefit from any tip that you might want to bestow for quality service.

The bill would reduce the minimum wage for any person who receives tips in an amount equal to the tips received. How much does an employer know the amount of the tip?

One way is to count the tips, if a tip jar is used, or tally them, if tips are paid via credit card. If, however, the service provider receives the tip directly in cash, the employer basically relies on self-reporting.

While my suggested solution relies on some self-interested dishonesty on the part of the employee and it's not a good thing to encourage dishonesty, I somehow think it's justified here.

If there's a tip jar, hand the tip directly to the server. If you use a credit card, put down a 10% tip on the card. Then give the employee another 10% in cash. (Why not give the entire tip in cash? The employer will always assume that some tip was given and will likely assume at least a 10% tip, if not more.)

The boss will think you're a schnorrer, but the server will think you're a hero.

Tax Sham Update

2006-08-02T08:14:00.000-04:00

The statement of Senator Carl Levin at the Permanent Subcommittee on Investigations Hearing: Tax Haven Abuses: The Enablers, The Tools & Secrecy succinctly summarizes the case studies in sham detailed in the report, the Wyly case study and the POINT case study. According to Levin's summary, "[E]ach scheme relied on a key deception made possible by tax haven secrecy."

In the Wyly case:

The key deception . . . is the Wyly claim that the 58 offshore trusts and corporations were independent. Under U.S. law, the tax on the income of a truly independent trust is paid by the trustees. But if a U.S. person controls the trust's assets and investments, then the trust's income is generally taxable to that person.

The claim that the offshore trusts were independent of the Wylys is contradicted by overwhelming evidence. This is not a case where the Wylys handed over their stock options and awaited the annuity payments, while independent trustees operated the trusts. Instead, for thirteen years, the Wylys and their representatives continually told the trusts what to do – when to exercise the stock options, when to sell the shares, and what to do with the money. The Wylys conveyed their directions through so-called "trust protectors," individuals selected by the Wylys, who worked for the Wylys, and who were empowered to fire any offshore trustee. The protectors transmitted the Wyly directions to the offshore trustees who consistently carried them out.

* * * * *

When the offshore entities opened securities accounts at Bank of America and were asked to name their beneficial owners as required by new U.S. anti-money laundering laws, they refused to do so, claiming again they were independent. Bank of America allowed the accounts to operate without getting the information required by law.

In the POINT case:

[A] phony Isle of Man corporation sold stock it didn't own to another phony Isle of Man corporation for money it didn't have. The fake stock was lent back with fake cash as security for repayment of the loan, and the fake loss on the stock price was transferred out to offset real gains. No real economic activity took place, but one critical thing happened – a $9 billion paper portfolio was created. This paper portfolio originated with Jackstones and Barnville, shell operations with no employees, no offices, and paid-in capital of £2 – that’s about $5 each.

The final step in the POINT scheme was for Barnville to sell the paper losses to wealthy individuals, including Haim Saban and Robert Wood Johnson IV. These clients used the paper losses to offset real capital gains. Mr. Saban used POINT to offset about $1.5 billion in capital gains; Mr. Johnson offset about $143 million. Together, the fees they paid to Quellos, the lawyers, the bankers, and others totaled about $75 million. One more proof that this sordid tale was used to concoct tax losses is the fact that the greater the paper loss generated for a client, the greater the fees charged by Quellos.

The POINT tax shelter included transactions to create the appearance of a complex investment with real economic substance. In reality, the transactions were expertly designed to remove all risk, using circular transactions that cancelled out or were unwound. A 5-year warrant, for example, which was included in the transactions to produce the illusion of a profit potential, was always terminated before any profits were realized. In a transaction involving Mr. Saban, an $800 million loan and stock purchase were added to provide a patina of economic substance, but the way the transaction was structured, it could not realize a profit in comparison to the transaction's fees and other costs. For example, the cost of a collar that capped possible profits at 8% of the total investment reduced a $130 million profit to $13 million, which was then dwarfed by fees totaling $53 million.

* * * * *

The key deception in POINT was the fake offshore portfolio that generated fake stock losses sold to partnerships with a false business purpose. The end result was $2 billion in real and taxable capital gains that were supposedly erased.

Senator Levin was particularly incensed at the lawyers, accountants, and bankers who participated in the frauds:

Each participant essentially told the Subcommittee: "I was only responsible for my little piece of this. I didn't know the other parts. It's not my fault."

* * * * *

Could it be true that the banks and brokers and lawyers who participated in POINT didn't know what they were involved with? Or is it that they didn't want to know?

Hmmm. Did Senator Levin question this lawyer for the taxpayers?

More Valuable Than Money

2006-08-01T18:15:00.000-04:00

"A good reputation is more valuable than money." Publilius Syrus

This week, in a memorandum decision, Lehrer v. Commissioner, the Tax Court dealt with the question of whether taxpayers could be relieved of penalties for substantial understatements of income tax because they had reasonable cause for, and acted in good faith with respect to, the understatements. The taxpayers argued that they reasonably relied on their tax preparer and therefore the accuracy-related penalties under IRC Section 6662 did not apply.

The Tax Court opinion noted that:

Reasonable cause has been found when a taxpayer selects a competent tax adviser, supplies the adviser with all relevant information, and consistent with ordinary business care and prudence, relies on the adviser's professional judgment as to the taxpayer’s tax obligations. . . . To establish reasonable cause, the taxpayer must prove by a preponderance of the evidence that: (1) The adviser was a competent professional who had sufficient expertise to justify the taxpayer's reliance on him or her, (2) the taxpayer provided necessary and accurate information to the adviser, and (3) the taxpayer relied in good faith on the adviser's judgment.

(Citations omitted.)

The Tax Court rejected the taxpayers' reasonable cause argument on two bases.

First, it found that:

[The taxpayers] hired [the return preparer] after a relative's recommendation and a few telephone conversations in which [the preparer] cited some Code provisions. [The taxpayers] introduced no evidence regarding [the preparer's] credentials or his experience in preparing tax returns. [The preparer] was not called as a witness at trial. In short, [the taxpayers] failed to introduce any credible evidence that [the preparer] was a competent tax adviser with sufficient expertise to justify their reliance.

Second, the Court also concluded that the taxpayers failed to demonstrate that they relied in good faith on the tax preparer's advice:

We find that [the taxpayers] failed to perform the due diligence that a reasonably prudent person would perform before hiring an income tax return preparer. [They] did little to investigate [the preparer's] qualifications before hiring him. [They] did not determine whether [the preparer] was a CPA or had relevant education and experience.

* * * * *

We cannot excuse a taxpayer who makes little or no effort to discern whether the person the taxpayer has chosen to prepare a return is competent to give tax advice.

Of course, there are taxpayers who are more discerning. Today, the United States Senate Permanent Subcommittee on Investigations issued a staff report entitled Tax Haven Abuses: The Enablers, The Tools and Secrecy. The report has gained a fair amount of public attention. See the NYT article, Tax Cheats Called Out of Control, and the WaPo article, Tax Shelters Saved Billionaires A Bundle.

In one case, a major law firm, Byran Cave, received fees of $1.3 Million. Lawyers from that firm:

[P]rovided tax opinions with respect to the strategy for [Haim] Saban [the client] and helped draft the factual representations on which the opinion was based, as well as transactional documents to help implement the strategy. The legal opinions prepared by Bryan Cave were based on extensive factual representation statements signed by various persons, including Mr. Saban. However, according to Mr. Saban, he did not read these statements before signing them. Further, after having now read some of the representations, Mr. Saban told the Subcommittee he could not have attested to the facts if he had read them at the time and that some of the representations were completely inaccurate. . . .[T]he attorney for Bryan Cave was not aware of the nature of [certain critically important] underlying transactions . . . .

All too neat. All too perfect.

The client relies on the reputation of the law firm to avoid the imposition of penalties. For $1.3 Million, he can presumably present a facially better case than the Lehrers.

The law firm, in turn, invokes the Sargent Schultz defense.

Willful blindness all around.

Cynic

2006-07-29T23:51:00.000-04:00

Before this week, even I did not fully appreciate the lack of character of the Republican Party. Their attempt to pass their bill to slash taxes on the estates of multi-millionaires by attaching it to a long overdue increase in the minimum wage is simply breathtaking in its cyncism.

According to an analysis by the Center for Budget and Policy Priorities, the bill would put an average of $1,200 a year into the hands of 6.6 Million people. In other words, there would be a total economic benefit to the lowest economic classes in this country of just short of $8 Billion a year. The gutting of the estate tax, however, would put $1.4 Million a year into the hands of 8,200 people. That is, the richest of the rich would receive a benefit of just short of $10 Billion a year.

One thing that the CBPP missed is that the radical reduction of the estate tax is that it's the gift that keeps on giving. That is, the change in the minimum wage has to be periodically updated to keep pace with inflation. By way of example, since September 1997, the purchasing power of the minimum wage has deteriorated by 20%. Thus, the increase in the minimum wage is not nearly as much of an increase as it is a clawback to where it once was.

On the other hand, the reduction of the estate tax will always keep up with inflation, since no matter how wealthy the wealthy get, their savings from the changes in the bill will always keep pace.

I Wish I Had Said That

2006-07-27T14:57:00.000-04:00

In her discussion on the Bush Treasury Department's report, A Dynamic Analysis of Permanent Extension of the President's Tax Relief, Linda Beale says that:

Bush, of course, is convinced that dynamic analysis is the way to go. His budget proposal for 2007 proposed establishing a Treasury Division on Dynamic Analysis. I wonder if the 147 or so people laid off from the estate tax audit team will move over to Dynamic Analysis to figure out how to paint rosy scenarios for the way eliminating the estate tax on multimillionaires will cause the economy to take off in a new spurt of growth?

The report, apparently authored by noted government economist Rosie Scenario, states that its projections will only be achieved if there is "an offsetting change in government revenues or spending." In other words, there will be significant budget deficits as a result of the tax cuts unless we cut government services. As I pointed out previously, it is mathematically impossible to balance the budget based on cuts in non-military, discretionary spending. This means that the economic benefits of the Bush tax cuts can only be realized if the cuts are made up by subsequent tax increases.

Got that now?

No Room at the Court

2006-07-25T18:17:00.000-04:00

Tax disputes arise in different ways. The taxing authority can challenge a position a taxpayer takes on a return or a taxpayer can file an amended return, in effect, challenging a position he or she had previously taken. If the taxing authority fails to honor the position on the amended return, the taxpayer can generally sue for a refund.

In Billings v. Commissioner, handed down by the Tax Court today, the dispute arose in a slightly different manner.

Mr. Billings learned that his wife had embezzled money in 1999. He filed an amended joint return with his wife for that year and requested innocent spouse relief from the Tax Court. The type of petition that he filed is known as a:

"nondeficiency stand-alone" petition--"nondeficiency" because the IRS accepted his amended return as filed and asserted no deficiency against him, and "stand-alone" because his claim for innocent spouse relief was made under section 6015 and not as part of a deficiency action or in response to an IRS decision to begin collecting his tax debt through liens or levies.

In a previous case, Ewing v. Commissioner, 118 T.C. 494 (2002), the Tax Court had agreed that it had jurisdiction to hear such cases. However, the decision in Ewing was reversed by the Ninth Circuit (439 F.3d 1009 (9th Cir. 2006)) and the Ninth Circuit's position has been adopted by the Eighth Circuit (Bartman v. Commissioner, 446 F.3d 785, 787 (8th Cir. 2006)).

Today, the Tax Court threw in the towel and agreed that it lacked jurisdiction. The opinion, however, was merely a plurality opinion, with a separate concurrence and three dissenting opinions. (See the summary at TaxProf.)

The irony is that the issue may ultimately be nothing more than a footnote since a bill, S. 3523, has been introduced by Senators Feinstein and Kyl. The bill would allow nondeficiency stand-alone petitions to be filed "with respect to liability for taxes which are unpaid after the date of the enactment" of the Act. In other words, the only individuals who will not be able to file nondeficiency stand-alone petitions are Billings, Ewing, Bartmann, and anyone whose nondeficiency stand-alone petition is currently pending and with respect to which a decision is rendered prior to the date of passage of the bill.

What advice to clients: Hurry up and wait (until S. 3523 passes).

Hat tip to TaxProf for the links to Ewing I, Ewing II, and Bartman.

Second Thoughts: Upon reflection, I think that the last sentence of my analysis is incorrect. It is based on the assumption that the doctrine of res judicata would bar Billings, et al., whose nondeficiency stand-alone petitions either are or would be dismissed for lack of jurisdiction prior to the passage of S. 3523, from refiling after its passage. I now believe that they could refile. After all, the first dismissal was due to a lack of jurisdiction which, by virtue of S. 3523, will be cured retroactively. Presumably, their cases would fall within the class of cases that S. 3523 would allow since their cases would be filed "with respect to liability for taxes which are unpaid."

Runaway Taxes

2006-07-25T08:39:00.000-04:00

TaxProf has a good summary of resources and commentary on H.R. 1956, the bill now pending in the House that would gut the ability of the states to tax corporate income. See my previous comments here.

Among the material that can be found there is a link to the National Governors' Association's report, Impact of H.R. 1956, Business Activity Tax Simplification Act of 2005, on States. According to the report, in 2007 alone, the states would collectively lose almost $8 Billion in revenue. By way of example, Maryland would lose $106.4 Million, representing 26.8% of its corporate income tax revenue. The CBO reports more modest, but still significant, revenue losses of a billion dollars in the first year of enactment, growing to $3 Billion annually by 2011.

H.R. 1956 is a bad bill. Perhaps worse than the substance of the bill is its dishonesty, being cast as a "tax simplification" measure.

Don't be fooled.

As Honest As The Day Is Long

2006-07-23T15:27:00.000-04:00

In Casablanca, Rick fixes the roulette game to allow a young Bulgarian refugee to win enough money to buy an exist visa. His croupier, Carl, is challenged by another customer who was watching:

Customer: Say, are you sure this place is honest?

Carl (fervently): Honest! As honest as the day is long!

Only fools will believe the Bush Administration's explanation for eliminating over half of the lawyers in the IRS who audit estate and gift tax returns. The story is reported by the NYT here.

Bush Administration ~~apologist~~ spokesman Kevin Brown "dismissed as preposterous any suggestion that the I.R.S. was soft on rich tax cheats. He said that the money saved by eliminating the estate tax lawyers would be used to hire revenue agents to audit income tax returns, especially those from people making over $1 million."

Right. The Bush Administration is as honest as the day is long.

First, according to the article, citing the aforesaid Brown as the source, "estate tax lawyers are the most productive tax law enforcement personnel at the I.R.S. . . . For each hour they work, they find an average of $2,200 of taxes that people owe the government." While Brown argues that:

[C]areful analysis showed that the I.R.S. was auditing enough returns to catch cheats and that 10 percent of the estate audits brought in 80 percent of the additional taxes. He said that auditing a greater percentage of gift and estate tax returns would not be worthwhile because "the next case is not a lucrative case" and likely to be of relatively little value.

This may be technically true, but it is also irrelevant. After all, it only follows that one can gut the enforcement staff without any diminution in audit revenue if one is assured that the remaining staff will only focus on those estates that owe taxes. In reality, this is not likely to be the case, since it is not certain before an audit is conducted whether or not any tax is due.

To illustrate this point, assume that every police speed trap picks up one speeder for every 100 cars that pass by. Assume further that there are 100 speed traps and each picks up 1 speeder (i.e., 100 total speeders).

Using Brown's logic, we could reduce the number of speed traps by 99% since only 1 in 100 drivers are actually exceeding the speed limit. Of course, what actually will occur is that the last remaining speed trap will only pick up 1 speeder, since that speed trap's percentage is still only 1 in a hundred. Thus, the reduction in the total number of law enforcement personnel causes a similar reduction in the number of speeders apprehended.

Second, as a practical matter, the loss will be even greater than the percentage reduction in enforcement since the reduction in audits will embolden those who want to "game" the tax system. Assume that drivers knew that the number of speed traps had been dramatically reduced. Over time, because they would have a lower incentive to monitor their speed, we could expect that there would be a greater number of speeders on the road. The same thing happens in tax law.

In fact, practitioners actually refer to this behavior as "audit roulette." Specifically, taxpayers willingly take positions that they know the IRS can probably successfully challenge because (i) they may not get audited at all or (ii) even if audited, they can settle the case for less than 100 cents on the dollar. This tendency is especially pronounced in estate planning with taxpayers taking positions using aggressive property valuation appraisals.

Any practitioner in the area knows that John Hruska, an IRS estate tax lawyer in New York who is active in the National Treasury Employees Union, which represents IRS workers, is correct when he says that "This [the gutting of the estate tax audit division] is not a game the poor will win, but the rich will."

Some readers of this blog have taken exception to my constant reference to the Bush Administration's tax policy makers as "knaves." Only fools would take exception now.

Relatively Flat

2006-07-22T09:40:00.000-04:00

I've long contended that the U.S. tax system, taken as a whole, is relatively flat and not very progressive. The Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution, has just issued various analyses of S. 3626, Senator Landrieu's "compromise" estate tax bill. Within the specific analysis of the bill, there are these two charts:

(Click to enlarge image. Original can be found here.)

The second chart shows the current distributional effect of all federal taxes. The average federal tax rate is 21.2%. Individuals in the $75-100,000 economic class have an average tax rate of 23.2%. Wealthy individuals, those making between half a million and a million dollars, have an average tax rate of 25.9%. Significantly, if you really start to hit it big and jump into the over $1 Million a year class, your average rate actually falls to 25%. This is not terribly progressive. Of course, when blended with state taxes, that are generally regressive, the system, as a whole, is even less progressive than shown in the table.

Under the Landrieu proposal (the first chart), the average tax rate for individuals in the $75-100,000 economic class would fall by 0.1%. Wealthy individuals, those making between half a million and a million dollars, will see their average tax rate fall by eight times that amount. The rate for those in the over $1 Million a year class would fall by a "mere" 0.4%. Of course, individuals making less than $75,000 a year get no tax benefit under the bill. Thus, the Landrieu proposal further reduces overall progressivity.

Of course, these two charts don't tell the whole story. Since the estate tax cuts will increase the federal deficit, there will be a continuing trend away from progressivity by, for instance, attempting to reduce Social Security benefits and throwing the costs of various programs onto the states. (Given the tax competition between states, this will only accelerate the trend toward regressivity. Wealthy individuals are more mobile, thus can more easily arrange to avoid having their income taxed by states that attempt to inject progressivity into their tax systems.)

Hat tip: TaxProf.

Visitors

2006-07-21T06:59:00.000-04:00

From time to time, I check on the paths of readers of this blog to see where they're from. This morning, a reader came in from India via an Alta Vista search.

The significance of this is that it has been widely reported that the Indian government had blocked access to a large number of blogs, including Blogger and Typepad based blogs. See this story on Boing Boing on July 17. The blocking may have been somewhat more selective than originally reported. According to this story in the WSJ online on July 19:

Several telecom operators confirmed there were more than 15 sites they were directed to block. Close to a third of the sites were home to blogs, the personalized Web logs that have become popular in India, just as they have in other parts of the world. Among the Web sites blocked are parts of Blogger and GeoCities. Included on a list seen by The Wall Street Journal are sites that showcase views of an Islamic holy man, conservative Hindus, and Dalits, the low caste in India pejoratively referred to as untouchables.

(Emphasis added.)

Either all parts of Blogger were not blocked or the blocks have been substantially lifted.

Walmart Is Smiling

2006-07-19T17:17:00.000-04:00

Judge J. Frederick Motz of the United States District Court for the District of Maryland, has sustained Walmart's challenge to the Maryland Fair Share Health Care Fund Act. His opinion in the case of Retail Industry Leaders Association v. Fielder holds that the Act is preempted by ERISA. In reaching his decision, Judge Motz ruled that the industry trade association, rather than Walmart itself, had standing to bring the action.

In a nutshell, the Act imposed a "tax" on non-governmental firms doing business in Maryland that have 10,000 or more employees. The tax was in the amount of 8% of the firm's payroll in Maryland, but would be reduced dollar for dollar to the extent that the firm expends funds for employees for "health insurance costs." The Act defines "health insurance costs" to mean "the amount paid by [the] employer to provide health care or health insurance to employees in [Maryland] to the extent the costs may be deductible by [the] employer under federal tax law."

The class of employers potentially affected by the Act was small:

There are four non-governmental employers of 10,000 or more people in Maryland: Johns Hopkins University . . . , Northrop Grumman Corp. . . . , Giant Food Inc. . . . , and Wal-Mart. When enacting the law, the Maryland General Assembly anticipated that only Wal-Mart would be affected by the Act's spending requirement.

The important issue raised by the case are not those limited questions of standing, preemption, or the equal protection that were actually addressed by the Court. Rather, the principal issue is whether we can stop the continued erosion of the availability of affordable health insurance.

The Act was ham-handed. It singled out one company, although admittedly one that has a limited "likeability factor" because of its reputation for brutal cost cutting that inflicts pain upon both its employees and its suppliers. The Act was passed solely to make it appear as if the legislature was actively addressing the health insurance issue, when, in fact, the legislature was simply avoiding any creative attempt to grapple with the problem.

My sense is that there are "bad guys" in the health care debate. Insurance companies, for instance, have so much invested in the current system that they will move heaven and earth to oppose real reform. However, health care reform should be designed to accomplish its legitimate goal: the establishment of a system that provides broadly available and affordable heath care for all Americans. If some bad guys may get injured in the process, so be it. But the process should not be directed toward punishing businesses that we simply do not like.

Law Office Technology On the Cheap

2006-07-18T18:20:00.000-04:00

In June, I gave a presentation at the Maryland State Bar Association's annual presentation on how to start a solo practice. The presentation, Technology for the Solo Practitioner or How Can You Be Two Places at Once When You're Not Anywhere at All, should be of interest to a much wider audience.

My thesis is that extremely inexpensive technology as the use of scanners, pdf, Internet fax services, etc., not only allows paper dependent businesses (e.g., law firms, accounting firms, etc.) to go paper-less easily and cheaply, but that quite spectacular overall efficiencies and cost reductions will result when they do so. What is baffling to me is why there has not been greater adoption of these methods.

Certainly, it is not because the core programs are so difficult to master. After all, the use of word processing was quickly and broadly adopted even though in the early days one had to be quite technologically savvy to use word processing programs successfully. And, of course, computers were constantly freezing up and crashing.

In contrast, the conversion to a paper-less office requires nothing more than a slight extension of existing skill-sets. Presumably, in most offices, the basic foundation, involving the use of email, the creation of standard document filing and nomenclature, is already in place. Moreover, the base technology, the personal computer, is far more stable than it was even five years ago, much less fifteen years ago.

I don't know the answer as to why there has not been a more rapid movement to paper-less small and medium-sized offices. I only know that the impediment is neither the cost nor the availability of appropriate technology.

War Against the States

2006-07-13T19:22:00.000-04:00

One of the more contentious issues in state tax is that of nexus. That is, whether the activities of a business have a sufficient connection with any particular state to allow the state to either impose income tax on the business' activities or force the business to collect sales tax on sales to residents of the state. Two bills before Congress are apparently attempting to use the guise of tax simplification to weaken the ability of states to tax corporate income.

According to a CRS report, State Corporate Income Taxes: A Description and Analysis, the proposed legislation, H.R. 1956 and S. 2721,:

is intended to further modify the state taxation of businesses engaged in interstate commerce.The legislation would impose new regulations on how states impose taxes on multistate businesses, through (1) imposing uniformity on the time component of nexus determination and (2) expanding the definition of goods and services subject to the nexus rules. The legislation would not directly address the complexity of the state corporate income tax structure — in particular, the various apportionment formulas (and allocation rules). . . .

Many economists and other researchers who analyze state corporate income taxes agree that the critical issue with the current state corporate income tax structure is the variability in the allocation and apportionment of corporate income from state to state. The current mosaic of state corporate income tax rules creates economic inefficiencies for the following reasons: (1) relatively high compliance costs, (2) increased opportunities for tax planning by businesses, and (3) potential gaps and overlaps in taxation. The new regulations as proposed in H.R. 1956 and S. 2721, would exacerbate the underlying inefficiencies because the threshold for business —the 21-day rule, higher than currently exists in most states — would increase opportunities for tax planning leading to more "nowhere income." In addition, expanding the number of transactions that are covered by P.L. 86-272 [a previous federal enactment "simplifying" the nexus question] would have expanded the opportunities for tax planning and thus tax avoidance and possibly evasion.

In other words, the proposed legislation is a wolf in sheep's clothing.

One criticism of the report. On page 18, it refers to "de minimus [sic]" standards. Mrs. Sheff would not be pleased.

A Penny Cut Is a Penny Spent

2006-07-12T21:56:00.000-04:00

Yesterday, President Bush crowed about how his tax cuts somehow generated more revenue for the Federal government. David Wessel of the WSJ succinctly deflated this fantasy:

Do Tax Cuts Pay for Themselves?

Not if you read the fine print in the new White House midsession review of budget trends. "While difficult to estimate precisely," Treasury long-run analyses of the effects of President Bush's tax cuts "may ultimately" raise total national output of goods and services by 0.7%.

So is that enough to pay for the tax cuts, even after allowing them to work their economic magic over the next 10 years? The Center for Budget Policies and Priorities, a Washington think tank and advocacy group that is distinctly unfriendly to Bush fiscal policies, says it isn't. "A 0.7 percent increase in the economic output that the Congressional Budget Office has projected for 2016 would represent an additional $146 billion [in gross domestic product]," it says. "If new revenues equaled as much as 20% of the additional output, the increase in revenues resulting from making the tax cuts permanent (assuming Treasury's best-case assumptions) would be $29 billion."

That's a lot of money. But how does it compare to the size of the president's tax cuts? The congressional Joint Committee on Taxation, using conventional analyses, says making the president’s tax cuts permanent would reduce federal revenues in 2016 by $314 billion. That is more than 10 times what the Treasury analysis suggests tax cuts would generate by prompting more hours of work, more savings and investment and more efficient use of resources.

(Link in the original.)

There's a recent CRS report out that concludes that even when tax cuts are targeted to incentivize savings, the net result is to reduce national savings. The report, Savings Incentives: What May Work, What May Not, finds that:

Most of the government incentives to save come through the tax system. For FY2006, these tax incentives are estimated to cost the U.S. Treasury $125.6 billion in forgone tax revenues — almost 40% of the estimated FY2006 budget deficit. The tax incentives primarily benefit higher-income families because they (1) are more likely to save, and (2) face higher marginal tax rates and thus benefit more from sheltering income from taxation. The tax incentives, however, appear to be relatively ineffective in inducing new saving — many of the families benefitting from the tax incentives likely shifted funds from other saving accounts into the tax-preferred accounts. Consequently, public saving is lower because of the forgone tax revenues due to the tax incentives while personal saving may be only slightly increased at best. In designing pro-saving policies, it is important to consider the aggregate effects of the policies on all components of national savings, both public and private.

The Bush Administration and the President's Advisory Panel on Federal Tax Reform have advocated expanding tax incentives as the primary policy to encourage saving. Personal saving has been shown to be fairly unresponsive to tax incentives, however, and they may substantially decrease public saving (that is, increase the budget deficit). The long-term net effect on national saving is likely negative.

(Emphasis added.)

Of course, all government incentives designed to encourage savings are not created equal. The types of savings that the Bush Administration favors are particularly pernicious:

Both the Bush Administration proposal and the President's Advisory Panel plan shift savings incentives from the front-loaded form to the back-loaded form. Most of the arguments regarding increasing private saving, however, apply to front-loaded savings plans. Back-loaded plans or Roth IRAs eliminate (1) the immediate reward to retirement saving (the tax deduction), and (2) the need to save for future tax liabilities. Consequently, shifting from front-loaded to back-loaded savings approaches may reduce personal savings. In addition, the long-term revenue loss from these proposals could be substantial thus leading to a large reduction in public saving. The result of these savings proposals could be a large reduction in national saving and a reduction in economic growth.

(Footnote omitted, emphasis supplied.)

The bottom line is that Bush Administration tax policies are making us, collectively, poorer. No amount of puffery by the Knave-In-Chief can change this reality.

The National Review Needs a Tax Lawyer

2006-07-11T20:57:00.000-04:00

Postings have been light lately due to the press of work, but I could not let this one go by. It proves that it is possible to be both a knave AND a fool.

In a pro-estate tax repeal ~~editorial~~ screed, the NRO accused the Joint Committee of Taxation of ignoring the revenue effects that the proposed estate tax repeal bill would have by repealing the step-up basis rules. Thus, according to the NRO:

The JCT reported that repealing the death tax would cost the federal government $281 billion in revenue over the first five years. But that number doesn’t include the effects of a provision in the bill to eliminate the exemption that heirs currently receive from paying capital-gains taxes on the assets they inherit.

There's only one problem with the NRO's argument--that's not what the repeal bill would do.

The JCT explanation of the repeal bill can be found here. On pages 6-7 of the explanation, the JCT tells how under current law, there will be a very limited modification of the step-up basis rules in 2010. This modification, which will only be effective for one year, would effectively limit the step-up in basis for decedents dying in 2010 to $1.3 million. In other words, for one year the step-up basis rules are modified in a way that will increase income tax revenues. However, after that one year, the current statue's provisions sunset and the step-up in basis rules, unmodified, are reinstituted.

Even this limited one-year modification of the step-up basis rule would be repealed under the proposed estate tax repeal bill. As the JCT explains on page 16:

The provision also repeals the modified carryover basis rules that, under EGTRRA [which is to say, current law], would apply for purposes of determining basis in property acquired from a decedent who dies in 2010. Under the provision, a recipient of property acquired from a decedent who dies after December 31, 2009, generally will receive date-of-death fair market value basis under the basis rules in effect under present law with respect to decedents dying prior to 2010.

In other words, the NRO is simply wrong both as to what the law is and also what it would be if the estate tax repeal bill is enacted. Contrary to the NRO's analysis, there would be no positive revenue effect due to the repeal of the basis step-up rules. In fact, in 2010, the only year in which the basis step-up rules are currently scheduled to be modified, the repeal bill repeals the modification, essentially reducing, rather than increasing, any additional income tax revenue that would offset the losses from the repeal of the estate tax. Since, under current law, there will be no estate tax in 2010, the repeal bill triggers a net revenue loss in 2010.

Before the NRO accuses the JCT of bad faith, it should at least read and attempt to understand the provisions of the bill.

Hat Tip: TaxProf.

Slight Correction: The above analysis was not of the full estate tax repeal proposal, but was of the "Permanent Estate Tax Relief Act of 2006" (a.k.a., "Estate Tax Repeal Lite"). This bill would not completely repeal the estate tax, but would simply gut it. It is the current bill that Frist is trying to push through the Senate.

The criticism of the NRO stands, however, since it was the JCT's revenue loss estimates for this bill that the NRO wrongly attacked.

The IRS Is Under Water

2006-06-28T18:40:00.000-04:00

The following is a slightly edited version of an email from an attorney with the IRS in its National Office that I received via a tax-related listserve:

Friends, I thought I would enlist your help since you are the current section or committee leaders of some of our most interested bar groups and likely to have the most comprehensive e-mail mailing lists of those who would find this useful. Please pass this information around among your groups.

As you may know, the main IRS building was heavily flooded on Sunday and has been closed since. It will be a while until electric power comes on and we are invited back in to work. Before too long, attorneys should be able to get in to retrieve documents.

Our phone system works and individual attorneys can check their voice mail. Our e-mail server came up today but, as of now, only attorneys with Blackberries have access to our network. . . . By next week, we hope to get some access for the rest of our lawyers -- a few desktops on our intranet to share. Our other computer applications are not yet available, including saved work.

We will try to figure out how to get things done while away from our offices. There will be a few challenges and we hope people will bear with us. . . .

Thanks in advance for your cooperation and patience.

Bag Men

2006-06-25T17:45:00.000-04:00

According to Wikipedia:

A bag man (or bagman) is a person designated to collect money in a protection racket. Originally the term only applied to Mafia members collecting for mob bosses, but the term later spread to use in corrupt police precincts where a foot patrolman was the designated "bagman" to pick up and deliver bribes from the local mob(s) to the precinct captain. In many cases, the bagman receives a percentage of the money collected.

* * * * *

In many cases, the bagman acts as "insulation" to protect higher-ups from exposure or direct prosecution.

It is clear from the report of the Senate Committee on Indian Affairs (the McCain Report) and today's story in the Washington Post that Grover Norquist, Ralph Reed, and Amy Moritz Ridenour were all using their respective non-profit organizations to prevent public disclosure of the lobbying efforts of Jack Abramoff. Marcus S. Owens, a tax lawyer at Caplin & Drysdale and a former Internal Revenue Service official, was quoted in the WaPo article as saying that, "It's not a tax-exempt activity to act as a bag man for Jack Abramoff." However, that's exactly what happened, with the various entities controlled by Norquist, Reed, and Ridenour laundering money from Abramoff and his clients, raking off a "commission" for themselves in the process.

Paul Kiel of TPM Muckraker suggests that Norquist and Reed (and, presumably, Ridenour as well, although her case is somewhat more complex), do not face any potential criminal charges. He states that:

The worst that could happen to Norquist, according to [Melanie Sloan, a former federal prosecutor and the Executive Director of Citizens for Responsibility and Ethics in Washington], would be for the IRS to crack down on ATR. His group would lose its 501(c)3 status. That would result in hefty fines, and his donors would be mighty upset, since their contributions would suddenly become taxable. One of the pillars of the modern conservative movement would be disgraced. Pretty bad. But there's not really a criminal case to make against Norquist. No jail time.

Of course, as I previously noted, in Norquist's case, the lion's share of the money to his operation came through his 501(c)(4) entity, not his 501(c)(3) foundation. Thus, the loss of tax exempt status would not have a major affect on his donors.

I am not nearly as pessimistic as Kiel or Sloan. After all, the improper use of the 501(c)(4) and 501(c)(3) organizations was not incidental, it was part of their basic fabric. Thus, the improper tax reporting was not some minor foot fault, it was intentionally false. And, the returns filed by these organizations are executed under penalties of perjury.

I know little about the requirements concerning lobbying disclosures, but apparently there is no criminal penalty associated with filing a false lobbying report with Congress. See here:

PENALTIES. Whoever knowingly fails: (1) to correct a defective filing within 60 days after notice of such a defect by the Secretary of the Senate or the Clerk of the House; or (2) to comply with any other provision of the Act, may be subject to a civil fine of not more than $50,000.

I have to believe that there must be some criminal sanction triggered by operating a wide conspiracy to hide this information from public disclosure.

Update

Kiel has updated his previous post.

It would appear that if there's a will, there's a way to prosecute Grover Norquist.

* * * * *

We at TPMm have some current and former federal prosecutors in our readership, who wrote in to disagree with Sloan's analysis.

One, who currently works in the Justice Department, wrote in to say that any material false statement by Norquist in his filing documents with the IRS would be a felony.

And here's another reader, a former federal prosecutor:

If Norquist was running ATR as you describe (or as the Senate report describes), it's virtually inconceivable that he was doing so completely on his own. But if he had even a tacit agreement with at least one other person to make ATR appear eligible for 501(c)(3) status when in fact it was not, then he and that other person conspired to impede the lawful functions of the Internal Revenue Service, which is known to federal prosecutors (like myself, once) as a "Klein conspiracy." It gets you up to five years in prison under section 371 of Title 18 of the United States Code.

Now that's more like it.

Cheap Dates?

2006-06-21T20:47:00.000-04:00

Kleinrock has reported that:

To sweeten the pot [with respect to passage of the "Permanent Estate Tax Relief Act of 2006"], [Ways and Means Chairman Bill] Thomas added language to his bill that creates a new 60 percent deduction for qualified timber capital gains. This deduction alleviates the tax treatment of timber gains under current law (which is based upon the legal form of ownership of the underlying timber assets). The provision is effective for qualifying gains recognized from the date of enactment through calendar year 2008. The measure is sure to entice Democratic Senators like Patty Murray (D-WA) and Maria Cantwell (D-WA) whose constituents would benefit from such a provision.

Emphasis added.

The staff of the Joint Committee on Taxation today issued an estimate of the revenue loss that the bill would cause. Over ten years, the estimate for the revenue loss from the estate tax portion of the bill is $279 Billion. The estimated revenue loss for the change in tax treatment of timber gains is only $940 Million. (Note: The revenue loss numbers for the change in tax treatment of timber gains from 2006 through 2016 is greater than $940 Million, but the losses for 2006 through 2008 are already part of the law, but the tax break "sunsets" after 2008. Thus, the net effect of the change which removes the sunset provision is the $940 Million.)

Somehow, this brings to mind the old joke where the question is raised: "Just what kinda girl do you think I am." and the punchline is: "We just established that, now we're only negotiating over the price."

Hat Tip on the Joint Committee Report to TaxProf.

Racing to the Bottom

2006-06-17T11:02:00.000-04:00

The article, Interstate Competition and State Death Taxes: A Modern Crisis in Historical Perspective, 33 Pepp. L. Rev. 835 (2006), by Jeffrey A. Cooper, discusses the difficulties that states have in imposing various estate and inheritance taxes.

Prior to 1924, various states, lead by Florida, began to compete to attract wealthy residents by repealing various taxes that triggered upon death. In that year:

Congress amended the Internal Revenue Code to allow a taxpayer's federal estate a dollar-for-dollar credit for all or a portion of the state death taxes paid by that estate. In 1926, in response to demands from state leaders, Congress increased the maximum amount of this "state death tax credit" to eighty percent of the federal estate tax otherwise payable under the 1926 rate tables.

(All quotes have footnotes omitted.)

In due course, all of the states enacted at least a "pick-up" tax. That is, a tax equal to the maximum allowable Federal estate tax credit.

However, beginning in 2001, the Federal estate tax credit was phased out over a four year period. Cooper describes what happened next:

The state death tax uniformity of the late twentieth century is now but a memory. Interstate competition to attract wealthy residents begins anew.

* * * * *

The popular media has fanned the flames of this renewed interstate competition. One need not read past the headlines to figure out the advice being dispensed. Readers of Forbes have been encouraged to say, "Florida or Bust." Wall Street Journal subscribers have been educated on "A Reason to Relocate." In states with death taxes, local newspapers warn of a pending exodus of wealth. A front-page article in Crain's New York Business decried that retirees are simply "fleeing New York" in response to its state death tax. The Connecticut Law Tribune titled its editorial about the new Connecticut death tax "A 'Run Away' Tax," predicting state residents would run away to Florida in response.

This media pressure has both molded public opinion and helped shape the agenda for the field of estate planning. Helping taxpayers choose their state of domicile has become a fundamental element of modern estate planning practice. Domicile considerations have become so paramount that at least one author has suggested that lawyers in states with death taxes may have an ethical duty to discuss with estate planning clients the virtues of moving out of state.

Amid this backdrop, state leaders seem to be presented with a choice: lose your state death taxes or lose your wealthy residents. A past generation of state leaders faced a similar conflict and confronted a similar decision. Presented with the choice of losing state residents or abandoning state death taxes, they were prepared to choose the latter. The Congress of 1926 preempted that decision. The Congress of 2006 seems unlikely to take similar action.

As such, state leaders of 2006 may have no political choice but to finish what their predecessors started. Looking out across the new death tax landscape after EGTRRA, modern state leaders may consider it futile to compete with Florida and the other death tax havens. They may simply decide that state death tax revenues come at too high a political cost and turn elsewhere for needed tax dollars.

As I have pointed out numerous times here, while the Federal income tax is slightly progressive, state taxes tend to be regressive. (The best analysis is found in Who Pays? A Distributional Analysis of the Tax Systems In All 50 States by the Institute on Taxation and Economic Policy.) That problem has become more pronounced as the Federal tax regime has become flatter with fewer state tax-related deductions. Moreover, since some otherwise deductible taxes (e.g., state income taxes) are subject to the alternative minimum tax, wealthy taxpayers are presented with even greater incentives to leave states which rely on moderately progressive income taxes (e.g., New York, Maryland) and move to states that rely heavily on regressive sales taxes (e.g., Florida).

While directed only at the effect that decoupling has with respect to state estate and inheritance taxes, Cooper's conclusion could just as well apply to many of the recent changes in tax policy at the Federal level that have had a deleterious affect on the ability of states to levy taxes:

State leaders will abandon this traditional source of revenue in favor of others. Burdens will shift. Some taxpayers will lose while others will gain.

Let there be no question: The rich will gain. Moderate income and poor taxpayers will lose. And the public services offered by states and localities (including education) will dramatically decline.

Hat Tip: TaxProf

W Is Not TR

2006-06-17T00:57:00.000-04:00

Thinking of taking a vacation at a national park this summer? This report, What Visitors to America's National Parks Will Experience During Summer 2006, by the Coalition of National Park Service Retirees may give you second thoughts:

Despite "happy talk" assurances from political appointees at the Department of the Interior and National Park Service (NPS), all is not well this summer in America's national parks. A Coalition of National Park Service Retirees (CNPSR) analysis of the status of 37 national parks – including 17 surveyed in detail by the Coalition -- finds widespread evidence of major problems that will be evident this summer – including decreased safety for visitors, longer emergency response times, endangerment of protected resources, and dirtier and less well-maintained parks – and only grow worse in the coming years.

* * * * *

Key findings of the CNPSR survey include the following:

Visitors and resources at national parks will be put at greater risk this summer than in the past due to extensive full-time emergency and law enforcement staff cuts.

Most surveyed parks will have fewer law enforcement rangers on the job this summer to protect park visitors and park resources.

Visitors to parks this summer will see evidence of deteriorating park operations resulting from reduced preventative maintenance, in terms of scheduled custodial checks, roadside litter pickup, and upkeep for grounds and buildings.

Widespread cuts in seasonal hires will mean future or lower-quality visitor services, interpretive services, resource protection and maintenance. [Emphasis in the original.]

Widespread cuts are putting the parks in an almost purely "reactive" posture, falling far short of the law and Congressional intent to protect the resources for future generations.

The park maintenance backlog has increased rather than been reduced, as promised.

NPS budget shifts are taking place largely at the expense of leaving key staff positions unfilled.

Some people are not happy:

Hat tip: Docuticker.

The Strength of Hercules

2006-06-13T17:13:00.000-04:00

I follow a policy of not commenting on cases that either I or my firm are or have handled. However, that policy does not extend to commenting on cases that rely on cases that either I or my firm are or have handled. Science Applications International Corp. v. Comptroller, handed down by the Maryland Tax Court on May 11 falls into this category.

The holding in Science Applications was primarily based on the holding of the Court of Appeals of Maryland in Hercules Inc. v. Comptroller, 351 Md. 101(1998) where I represented the taxpayer. The opinion in Science Applications indicates that the Comptroller's Office either does not or is incapable of understanding the basic Constitutional principles concerning a state's ability to tax companies conducting interstate business.

The principles can be stated simply: A state can only tax economic activities that take place within its borders. However, a state can utilize a formula to tax a portion of a unified business conducted in more than one state so long as the formula reasonably reflects the actual business being conducted in the state attempting to levy the tax. Two or more entities may be aggregated into a single business for state tax purposes if there is an "operational connection" between their business activities.

Science Applications International Corporation had operations in Maryland. However, it also was the parent corporation that owned Network Solutions, Inc. Network Solutions operated independently of its parent. According to the findings of fact:

[Network Solutions] was managed independent of and separate from [Science Applications]. Approximately 5 of the 385 [Network Solutions] employees . . . came from [Science Applications]. [Network Solutions] hired a separate management team from outside [Science Applications], including technical, sales and marketing personnel. [Network Solutions] had a separate Board of Directors. [Network Solutions] had its own Human Resources Director and made its own decisions as to whom to hire and fire. Its first post-acquisition CEO was recruited through a national search campaign.

Based on these facts, it would seem beyond question that, as interpreted by the Court of Appeals in Hercules, there was no operational tie between Network Solutions and Science Applications. The Comptroller apparently argued, much as it had in Hercules, that statements in the parent's annual reports and the parent's financial statements supported a finding that there was an operational connection between the two businesses.

Apparently, the Comptroller hasn't figured out that the "operational function" test means that there have to be facts which show an active flow of "operational value" between two businesses before their respective incomes can be aggregated for state income tax purposes. That test requires that the the direction and control exercised by the parent to the subsidiary has to be greater than that which is exercised by any member of the board of directors of a company. In fact, as the name of the test would seem to indicate, the operations of the parent and the subsidiary have to be intertwined.

My understanding is that the Comptroller is not appealing this decision. However, I also understand that the Comptroller is going to refuse to pay interest on the refund due to Science Applications. Since I am currently involved in litigation on a similar issue, I will not comment on the Comptroller's obstinance or cramped reading of the statute that requires that interest be paid on tax refunds.

Lies, Damn Lies, and the JEC

2006-06-12T08:32:00.000-04:00

Today, Kleinrock reported that the estate tax repeal effort may not be dead. Specifically, it reported that "Senate Majority Leader Bill Frist (R-TN) [whose brother's family will benefit to the tune of a half a billion dollars from estate tax repeal--ed.] is looking for a legislative vehicle in which to attach his initiative [to repeal the estate tax] and get it through Congress. Currently, the top candidate is the pension reform bill."

Also today, TaxProf had links to two position papers on the estate tax.

The first was Neil H. Buchanan's paper The JEC’s Estate Tax Report: Myths and Legends, 111 Tax Notes 1133 (6/5/06). In that paper, Buchanan takes on the oft-repeated baloney of the JEC that the estate tax threatens small businesses. He shatters the argument, concluding:

[T]he closest thing that the JEC has to a credible source regarding the "burdens" of the estate tax cannot rule out the possibility that heirs are able to pay estate taxes if they want to hold onto the family business. The economists who wrote the study even suggest that business owners might not care enough to do all they can to keep the business in the family. The latter possibility means that, even if we do someday find evidence of businesses that were "busted up" by the estate tax, we cannot be sure that was even a bad result from the standpoint of the decedent.

Buchanan notes three other arguments that the JEC frequently drags out in support of repeal. One of those is that the estate tax has reduced the stock of capital in the country by approximately $847 million. He characterizes this argument as being "highly suspect."

Lo' and behold, TaxProf also links to a new missive from the JEC, Reconsidering the True Revenue Yield of the Estate Tax. In that report, the JEC contends that "[a] study from the U.S. Treasury Department found that "estate taxes have a dampening effect on the reported size of taxable estates," reducing reported estate sizes by 14 percent." The report itself does not provide any citation or link to the study, but a quick Google search located it here. The study, literally, reaches the precise conclusion that the JEC reports, but that conclusion does not apply to the current estate tax. Why?

By its terms, the study "explored the effects of estate taxation on bequests using time series data for the period 1948 through 2000." Thus, the percentage of estates subject to the estate tax was significantly higher than it is today.

Furthermore, the report explicitly denies the its conclusion supports the implication that the JEC would read into it, namely that wealth is being diminished as a result of the estate tax. Thus, the report states, "As with much of the work on the taxable income elasticity, it is not clear whether this measures the effects on saving and wealth accumulation, or reflects tax avoidance." (Emphasis added.)

Buchanan notes that JEC reports have a "cover page, with the title of the report above an American eagle seal and [JEC Chair Jim] Saxton's name." Too bad they lack any intellectual honesty.

And the Winner Is . . .

2006-06-08T21:46:00.000-04:00

In the category "Dumbest Rationale In Support of Any Policy Argument From a Supposedly Intelligent Media Outlet" goes to (here I fumble with the envelope), the WSJ Editorial Board who make this argument in support of repeal of the estate tax:

[T]he best thing gay activists could do for themselves at the federal level would be to support repeal of the death tax, since under current law gay couples often lack inheritance rights.

Wrong. The best thing that gay activists could do is argue that the provisions of IRC Section 2056(a) (unlimited spousal bequests) should be extended to gay and lesbian unions.

Just a Wild Ass Guess?

2006-06-07T23:00:00.000-04:00

Before the Bush Administration again begins to push a program to "reform" (read "gut") Social Security, you should read the report just issued by the CBO, Projections of Net Migration to the United States. It shows that the estimates of the solvency of the Social Security trust fund are based upon assumptions that, in the dry words of the report, "are subject to a high degree of uncertainty."

Estimates of immigration trends are necessary components in determining the future size of the Social Security trust fund, since:

higher rates of immigration improve the [Social Security] system's solvency, at least for a time—because the immigrant population is disproportionately composed of people of prime working ages, with relatively small percentages of children and the elderly. However, outlays are also affected: those immigrants will eventually retire and become eligible to collect Social Security benefits.

Both the Social Security Administration and the Census Bureau make such estimates. The estimates vary significantly. In 2003,

[a] Technical Panel on Assumptions and Methods was appointed by the Social Security Advisory Board to review the trustees' methodology and key demographic and economic assumptions used to project the future financial status of the system’s trust funds, including assumptions about immigration.

With respect to immigration, the Technical Panel's estimates were strikingly at variance with the estimates of both the Social Security trustees and the Census Bureau. The following chart dramatically illustrates the differences:

(Click chart for larger image.)

You will note that the trustees' estimates are, in the near term, the lowest estimates of the three. This contributed to their recent finding that the trust fund would be depleted earlier than previously estimated. If the Technical Panel's estimates are correct (or, more appropriately, closer to correct), we have more time to deal with structural problems in the system than the trustees' estimates would lead us to conclude. And remember, the estimates as to immigration are only one set of assumptions that go into the final estimate of system solvency. Thus, any single report by the trustees has to be taken with a large heaping of salt because the various assumptions upon which the trustees' conclusions are based "are subject to a high degree of uncertainty."

Estate Tax Commentary Update

2006-06-05T18:52:00.000-04:00

Jim Maule summarizes a plan he previously outlined for repealing the estate tax in exchange for the income taxation of unrealized appreciation in the decedent's propert. The original plan is set forth here. His summary is set forth here. At the end of the summary, he sets forth the most concise and compelling reasons to oppose the current efforts to abolish the estate tax:

The debate over the estate tax, and the various proposals, including mine, plays out against a backdrop that is very disconcerting, and if it isn't, it ought to be. Most advocates of estate tax repeal refuse to accept the idea of taxing unrealized appreciation at death. They want a system that taxes investment income at low or zero income tax rates and to the extent accumulated, escapes estate taxation. Likewise, they want growth in investment assets to escape taxation. Whatever wonderful arguments can be paraded out in favor of exempting investment income from taxation, the upshot is that the burden of paying for government shifts to wage earners. That shift has already started. Considering the decline in real wages, the payment of low wages to undocumented workers, and the difficulty for wage earners to accumulate sufficient post-taxation discretionary income to move into the investor class, the ability of the nation to sustain itself by seeking all necessary revenue from wage earners is at risk. Many who reply that the solution is to cut government spending are among the first to object when a specific government expenditure is nominated for termination.

There's an undercurrent to the taxation debate that transcends taxation. It goes to the heart of whether this country will continue to have a middle-class, one of the significant indicia of genuine freedom and democracy, or whether it will atrophy into another of the "many ruled by a few" arrangements that have dominated human history. This question is even more provocative when one considers the ways in which the few have made their way into the elite. Though it is important that discussion of these issues be done in a manner that permits the entire citizenry to understand what is at stake, I have serious doubts that it will. The rhetoric accompanying the small estate tax repeal slice of the much larger question about what sort of nation we are, want to be, and will be, reinforces my doubts.

(Emphasis added.)

Linda Beale takes on the WSJ op-ed of Nobel Laureate Edward C. Prescott (which can be found here by subscription only). Astonishingly, Prescott does little more than restate the standard arguments in favor of repeal which have repeatedly been shown to be factually false (e.g., there will be no impact on charitable contributions, the tax hits hardest on small, entreprenuerial businesses, the cost of compliance is roughly equal to the revenue raised, the tax is levied on income that has already been taxed, etc.). (Aside: When a Nobel Prizewinner relies on arguments that, in the main, are well-known to be factually untrue, shouldn't a recall of the Prize be in order?) All of Prescott's empty empirical arguments, however, are nothing more than garnish around his quasi-religious philosophical argument that:

[W]e can only grip the neck of our vibrant economic goose so tightly before it eventually dies and quits laying those golden eggs. And many of those golden eggs come in the form of capital that allows descendents to keep family businesses intact, or to begin new businesses that fuel our economy.

Beale cuts through the foliage and states:

The analogy is colorful, but off target. We are not gripping the neck of our goose at all tightly--we have in fact one of the lowest tax burdens of any of the developed world. Further, estate taxation doesn't prevent descendents from keeping the family business intact--with current exemption levels at $2 million for individuals and $4 million for couples, few businesses are threatened with the tax. While the heirs may diversify their investment and continue to make good as ongoing entrepreneurs, there would likely be room for more entrepreneurial activity without those dynastic families.

Prescott's conception of fairness shortchanges the important function of the estate tax to level the playing field at least somewhat for children born into poverty compared to the richest few. This redistributive function is important, and it should not be disregarded.

In a very real way the fight over the estate tax transcends the details, pro and con. At the bottom, Maule and Beale get it right: It's about about what sort of nation we are, want to be, and will be.

The State of the Estate (Tax)

2006-06-03T22:45:00.000-04:00

This report from the Center on Budget and Policy Priorities makes it clear that most Americans would receive no benefit from the repeal of the estate tax. Since 2000, the "lifetime credit amount" (the amount of wealth that can be transferred over one's life without the imposition of any estate tax) has risen from $675,000 per individual ($1.3 Million per married couple) to $2 Million per individual ($4 Million per married couple) today. It is scheduled to rise to $3.5 Million per individual ($7 Million per married couple) by 2009.

As a consequence of this change, the percentage of decedents' estates that are subject to estate tax has fallen dramatically as this graph shows:

The CBPP also reports that the small business/small farm poster children constantly trotted out by the pro-repeal forces really has no current basis in fact:

The Congressional Budget Office estimates that, had the 2006 exemption level of $2 million ($4 million per couple) been in place in 2000, the number of taxable farm estates would have dropped by more than 90 percent, and the number of taxable family-owned businesses by almost three-quarters. At an exemption level of $3.5 million ($7 million per couple), as will exist in 2009, fewer than 100 family businesses and only 65 farm estates would have paid any estate tax.

(Emphasis added.)

And, among this rather elite group, it is unlikely that any would have to sell the family farm:

The CBO considered the question of whether the estate tax forces family farms and businesses to be sold. CBO found that of the few farm and small business estates that would owe any estate tax, the vast majority would have sufficient liquid assets (such as bank accounts, stocks, bonds, and insurance) to pay the tax without having to touch the farm or business. For instance, at a $3.5 million exemption level ($7 million per couple), only 13 farms would have faced such a liquidity constraint. Furthermore, those farm and business estates facing liquidity problems would likely have other options available to them — such as spreading their estate tax payments over a 14-year period — that would allow them to pay the tax without having to sell off any of the farm or business assets.

Of course, there are real victims of the estate tax. The Bush Cabinet for example. And let's not forget the family of Bill Frist.

Still Keeping My End of the Bargain

2006-06-02T22:28:00.000-04:00

In the Spring of 1966, I was flunking Latin at Baltimore City College. My teacher, the legendary Mildred Sheff, offered me a deal: She would pass me with a "D" if I promised never to take Latin again. I am proud to say that I have kept my end of the bargain for almost 40 years. (I am also happy to report that I recently saw Mrs. Sheff, now in her 90's, at the supermarket and she's still quite energetic. )

I don't think that it's a violation of the terms of the deal to report on a new website that collects opinions given by the Maryland Attorney General's Office to the various clerks of the court. The site is here. One of the opinions, dated August 2, 2002, by Julia Andrew, delves deeply into Latin scholarship as follows:

Over the past several months, I have received inquiries from a couple of your offices regarding the meaning of the initials "sct" appearing at the top of the formerly-used form of marriage application/license/certificate of marriage. A copy of the old form is enclosed. Apparently, persons in interest needing a foreign language translation of their marriage certificate have inquired about the meaning of the abbreviation.

I have determined that "sct" stands for "scilicet," although it is an improper abbreviation. Knowing that some official documents, such as wills, use to commence with the formal greeting: "Know All Ye Men By These Presents" and recollecting from my high school Latin studies that "scire" means "to know,"I did a bit of checking in Black's Law Dictionary, 7th ed., under "scire" and variations thereof and found the following:

scilicet (sil-a-set or -sit). [fk. Latin scire licet "that you may know"] That is to say; namely; . . . .
Abbr. sc.; scil. ; (erroneously) ss.

Black's Law Dictionary, 7th ed., p. 1347. Now it is more common to see "to wit," which also means "That is to say; namely." See Black's Law Dictionary, 7th ed., p. 1498.

Please do not hesitate to contact me if you have any questions concerning these matters.

I do not consider my publication of this information a breach of contract. I think (and hope) that Mrs. Sheff concurs.

I Try To Be Fair

2006-06-02T08:34:00.000-04:00

Even when disagreeing with other commentators, I try to fairly describe their arguments. One part of that process is to, whenever possible, link to their comments.

Yesterday, the Tax Foundation's Tax Policy Blog had a report on a CRS study, "Flat Tax Proposals and Fundamental Tax Reform: An Overview." Tax Policy Blog then presented what purported to be the summary of the CRS study as set forth in the study. However, the excerpt was not complete and was edited to make it appear that the CRS study agreed with the Tax Foundation's basic tax policy recommendations. That is not the case as the study itself states:

Should the tax base be income or consumption? Is one inherently superior to the other? How do they stack up in terms of simplicity, fairness, and efficiency —the three standards by which tax systems are generally assessed? There appears to be insufficient theoretical or empirical evidence to conclude that a consumption-based tax is inherently superior to an income-based tax or vice versa.

One issue associated with the choice of a tax base is equity — how the tax burden will be distributed across income classes and different types of taxpayers. For example, a tax is "progressive" if tax paid as a percentage of income increases as income rises. Although some types of consumption taxes can be designed to achieve any desired level of progressivity with respect to consumption alone, their progressivity with respect to income could only be approximated. Also, a consumption tax would involve a redistribution of the tax burden by age group, with the young and old generally bearing more of the total tax burden than those in their prime earning years. And the transition from an income-based tax to a consumption-based tax would have the potential for creating windfall gains for some taxpayers and losses for others.

A definitive assessment cannot be made of the effects of taxing consumption on either economic efficiency or the aggregate level of savings. Although the current tax system's distortions of the relative attractiveness of present and future consumption (saving) would be eliminated, to raise the same amount of tax revenue, a consumption-based tax would require an increase in marginal tax rates (since consumption is smaller than income). This action, in turn, would increase the current system's distortion between the attractiveness of market (e.g., purchased products) and nonmarket activities (e.g. leisure). The net effect on overall economic efficiency cannot be ascertained theoretically. In addition, economic theory indicates a consumption tax would not necessarily produce an increase in saving. The increase in after tax income might reduce saving, while the increase in the return to saving may increase it; the net result is uncertain.

A positive aspect of a consumption-based tax is the ease with which the individual and corporate tax systems could be integrated. In addition, the problems introduced by separate provisions for capital gains, attempts to distinguish between real and nominal income, and depreciation procedures would essentially be eliminated. It is doubtful, however, that a consumption-based tax would have much effect on the complexities introduced into the system to promote specific social and economic goals. Many of the same factors that influenced the design of the current income tax system would exert the same influences on the final design of a consumption tax.

Whether one prefers income or consumption, one tax rate or multiple tax rates, a critical point to remember is that the benefits to be derived from tax revision would result from defining the tax base more comprehensively than it is under current law. A tax with a base that is comprehensively defined would prove more equitable and efficient than a tax with a less comprehensively defined base.

(Footnote omitted, emphasis added.)

In other words, the study concludes that the Tax Foundation's hobbyhorse can't run.

It's a Very Simple Game?

2006-05-08T14:00:00.000-04:00

The late Baltimore sports commentator Charley Eckman used to say "It's a very simple game." Apparently, that's not necessarily the case.

A recent study, "Scattering of a Baseball by a Bat," concludes:

A ball can be hit faster if it is projected without spin but it can be hit farther if it is projected with backspin. Measurements are presented in this paper of the tradeoff between speed and spin for a baseball impacting a baseball bat. The results are inconsistent with a collision model in which the ball rolls off the bat and instead imply tangential compliance in the ball, the bat, or both. If the results are extrapolated to the higher speeds that are typical of the game of baseball, they suggest that a curveball can be hit with greater backspin than a fastball, but by an amount that is less than would be the case in the absence of tangential compliance.

Theoretically, then, if you can hit a curve ball, it will travel further than a similarly hit fastball. This presumably increases the likelihood of the batter hitting a home run. However, a hit fastball will move with greater speed. One would think that this would thus increase the number of hits "through the hole" in the infield. However, the authors warn:

These results will have implications for the issue of whether an optimally hit curveball will travel farther than an optimally hit fastball. To investigate this in detail requires a calculation of the trajectory of a hit baseball . . . . Such a calculation requires knowledge of the lift and drag forces on a spinning baseball. However, given the current controversy about these forces, further speculation on this issue is beyond the scope of the present work.

Hat Tip: ResourceShelf's DocuTicker.

Tradesport and Taxes

2006-05-03T23:28:00.000-04:00

This evening, I noticed that shares of "Republican Party Candidate to Win the 2006 Maryland Governor [sic] Race" are now trading at 39 on Tradesport. I immediately began thinking.

I know a few Republicans whom I can goad into putting down bets on Gov. Ehrlich to win at even money.

If, for every $100 I bet with Republicans on Gov. Ehrlich to lose, I buy $80 in Tradesport contracts for "Republican Party Candidate to Win," I am guaranteed in all events to win $20. That's because if Ehrlich loses, I win $100 from a Republican, but lose my $80 in Tradesport contracts. Conversely, if Ehrlich wins, I lose $100 to a Republican, but I get back roughly $200, or a net of $120, from my Tradesport contracts.

So why haven't I quit my day job?

Well, first there's the obvious difficulty of locating, then investing in, and then enforcing a lot of barroom bets. As a practical matter, this is fairly hard work.

But there's a tax problem.

If Ehrlich loses, I'm ok. While I've lost $80 in Tradesport contracts, I will get back $100 of cash which I will likely not report as income. After all, friendly bettors don't generally turn out 1099's or W-2G's and I'm not that honest.

However, if Ehrlich wins, I get a net of $120 which is going to be reported to the IRS by Tradesport. Assuming that my marginal tax rate, both federal and state, is about 40%, I only net out $52 on the Tradesport side of the transaction. Since I've lost $100 in the barroom, I'm down a net $48. Theoretically, of course, I could attempt to deduct the $100 I lost in the barroom against my Tradesport "winnings," claiming that both were a form of wagering. There are obvious record keeping and proof problems involved in this, however, which are likely to be insurmountable.

Moreover, it's not clear that "investing" in a Tradesport contract is technically gambling. In that case, my $120 in Tradesport "winnings" is simply a short term capital gain that cannot be offset by my $100 gambling loss.

I think that I'll keep my day job.

DeLay Legal Fee Update

2006-05-03T08:30:00.000-04:00

Raw Story is reporting that Tom DeLay's legal bills in 2006 now top $400,000.

Not to worry.

According to OpenSecrets.org, as of March 31, 2006, DeLay's campaign committee had cash on hand of $1,450,959. As previously reported here, he can spend all of that on his legal defense. Of course, according to reports filed on February 15, upon which I based my last report, DeLay only had $1.3 million cash on hand. And, according to the Raw Story report, the $400,000 in legal fees paid by DeLay this year also include $110,000 from his campaign fund.

In essence, DeLay's campaign fund has become a $1.56 million legal defense fund.

The Nineteenth Family

2006-04-25T23:11:00.000-04:00

Via TaxProf, there are links to a terrific report by Public Citizen and United for a Fair Economy on the 18 incredibly rich families that are providing the financial muscle behind the ongoing efforts to repeal the estate tax. In addition to describing the ways in which these families have mounted their campaign, the report also sets forth a comprehensive listing of and rebuttal to the principal lies of the campaign (Foes Have Misled the Public About the Cost and Reach of the Estate Tax; Foes Have Misled Public About Harm to Family Farms and Small Businesses; Groups Have Lied About the Cost to Collect the Tax; More Fables: The Double Tax; The Estate Tax Is Misleadingly Characterized as a Tax on Hard Work).

However, the report missed one important family that has lead the way in storming the ramparts of the estate tax--The Frists.

While perhaps not providing as much financial muscle as the 18 families listed in the report, Little Brother Doctor Senator Bill has been the point man in the Senate for estate tax repeal. While the Senator's net worth is a measly $15-45 million, Big Brother Tom and his family, according to Forbes, have a net worth of $1.7 Billion. Tom's current holdings in HCA, Inc., alone, (5,563,198 shares) are worth, as of close of business on April 25, 2006, almost $252 Million.

I won't bother to undertake as precise an estimate of the tax savings the Frist family would enjoy if the estate tax were repealed, but it's safe to say that it's well (very, very well) north of $200 Million.

It must be nice to have ~~relatives~~ friends in high places.

Knaves Environmental Style

2006-04-24T01:15:00.000-04:00

I don't often comment on environmental issues here. The reason is that I feel that I lack the necessary competence with respect to the basic science issues involved. I can't possibly bring to bear the level of expertise as, say, the contributors to RealClimate.

But financial numbers are another story. After all, over my almost thirty years in practice I've had to review more than my share of financial reports and business tax returns. Thus, I try to delve into financial information in order shed light on the lies dished out by knaves. There is now a case in point dealing with the politics of the environment.

The Republican controlled House Committee on Resources has just put up a website on Earth Day titled "myth-information." It's an outrage. But, rather than rant, I decided to look at some of the alleged "information" offered by the ~~knaves~~ Committee. Specifically, I examined the claim the Committee makes on the website that:

Money is flowing to conservation in unprecedented amounts... But much of it is not actually used to protect the environment. Instead, it is siphoned off to pay for bureaucratic overhead and fund raising, including expensive direct-mail and telemarketing consultants.

The Committee offers as evidence the "fact" that various environmental organizations have "4.9 billion dollars in net assets" yet spend "almost zero dollars for the environment." This charge is allegedly backed up by a chart showing the income and net assets of 29 environmental organizations.

First, let's examine the source of the "4.9 billion dollars in net assets." Of that amount, $3.1 billion is in the coffers of the Nature Conservancy. What the hell are they doing with all that money anyway?

Well, to find out, one has to take a look at the Nature Conservancy's financial reports. Unlike, say, Grover Norquist's Americans for Tax Reform, the Nature Conservancy actually publishes its financials on its website. Of course, some knowledge about how the Conservancy works might be important. In examining its website, we learn that:

In the United States, The Nature Conservancy uses land acquisition as a principal tool of its conservation effort. The Conservancy helps to protect approximately 15 million acres in the United States.

Additionally, the Conservancy acquires conservation easements. It's website explains that:

A conservation easement is a restriction placed on a piece of property to protect its associated resources. The easement is either voluntarily donated or sold by the landowner and constitutes a legally binding agreement that limits certain types of uses or prevents development from taking place on the land in perpetuity while the land remains in private hands. Conservation easements protect land for future generations while allowing owners to retain many private property rights and to live on and use their land, at the same time potentially providing them with tax benefits.

Now, take a look at the Conservancy's 2005 financial statement. You will find that $2.47 billion of the Conservancy's assets are either in "conservation lands" or "conservation easements." Another $1.2 billion are in "endowment investments" or "planned giving investments." There's another $568+ million in "investments held for conservation projects." In other words, the bulk of the Nature Conservancy's assets are held for and used to advance its environmental efforts. In fact, 82% of all funds donated to the Nature Conservancy go directly to conservation programs. See here.

Close examination of the financial statements of the organizations on the Committee's list with next two largest net worths, The Conservation Fund (net worth of $282 million) and the Trust for Public Land (net worth of $225 million) show that their assets are also primarily devoted to their conservation efforts. (For The Conservation Fund's financials, see here. For the financials of the Trust for Public Land, see here.)

Income? The Committee shows that the 29 organizations listed had income of $1.831 billion dollars. Of that amount, $761 million was income of the Nature Conservancy (that is, more than 41.5% of the total) and, as shown above, most of that went to operations, not lobbying or fundraising. Similar analyses of the income and expenses of other organizations that rank high on the Committee's net income list, the Trust for Public Land and the World Wildlife Federation for instance, also show that most of their income goes to their operations. (The WWF's financials are here.)

The Committee's website is nothing more than propaganda. Worse, it's false. Worse yet, it directly slanders organizations that have long demonstrated their devotion to conservation and environmental preservation.

There is some good news, however. Josh Marshall has named Committee Chair Richard Pombo as one of the Congressman who may possibly be indicted in the Abramoff investigation. Can't happen too soon.

Results on the Estate Tax

2006-04-23T17:37:00.000-04:00

RESULTS describes itself as "a nonprofit grassroots advocacy organization, committed to creating the political will to end hunger and the worst aspects of poverty." On April 18, it held a press conference concerning the attempts to repeal the estate tax. A transcript of that conference is available here and an mp3 recording is available here.

Former IRS Commissioner Sheldon Cohen offered some of the most pointed remarks:

[A] lot of the confusion in proposed repeal is setting up straw men and then knocking them down. Much of the argument says, well, this is double-taxation; you get taxed on the income, and then you get taxed on it again. Ninety percent – over 90 percent of the value of estates has never been taxed. That is, it’s generally appreciation that's occurred.

Also I think most of us forget that the so-called death tax, which is really an estate tax, occurs at the end of life. So it's been deferred for 50, 60, 70 years of work. So if you discounted it by the fact that it's paid at the end of life, instead of installments during the period of time which accumulated – the wealth is accumulated, you'd get a much lower number.

Progressive taxation – that is, the higher your income, the higher the rate of tax – has been with us since the very beginning. Teddy Roosevelt was in favor of this kind of taxation. This is not particular party or group. We each have our own points of view, depending on where we sit. But progressive tax has been with us right from the beginning. The question is always, "How much progression?" And that's a legitimate argument.

The real impact on small business is almost nil. As Mr. Carlson indicated, the impact on small family farms is virtually nil. The impact on small family businesses is virtually nil because the tax law now has exemptions for family farms and for family business that are slightly larger than the general exemption. And they also allow for longer payout, so that – in my practice – I’ve been practicing law for a little over 50 years – I have never seen a family business that was sold because of the estate tax. They are sold, because the kids don’t want to manage the business, the kids are off just being doctors or lawyers and don't want to go back into the farm, or don't want to go back into the family manufacturing business. That occurs all the time. But it isn't because of the estate tax that the business is sold.

Nobody's talked about – and the (charity, or very charity) of mentioning this – what an important element here – is that the estate tax, as well as the income tax, are an encouragement for charity. That is, since we have deductions in beneficial gifts to charity, we're (all) encouraged to give to worthy causes. Nobody knows for sure how much is going to be lost when, as and if these – either the income tax were to be pushed down in rates, or the – or the estate tax were to disappear. But if that were to be the case, there are estimates that go to 13-plus billion up to 20 billion. I’m not an economist; I don't want to project those numbers.

I do know that it does affect people's behavior. People give a little more to charity because there is tax benefit. We saw that the President and the Vice President both took advantage of large charitable deductions at the end of last year. That was just announced this last week, when they filed their returns.

So it’s an important element. And I think it's been missing from the discussion. And it will be missing, because the charities can't say it out loud. They can't say it because their donors might get offended.

(Emphasis supplied in all cases.)

Another participant in the press conference, Robert Carlson, made this point:

The present estate tax only affects about 300 farm estates per year. That's less than one percent of all farm estates. And those are Department of Agriculture numbers.

What is most dangerous about the proposal to end the estate tax, however, is that with its ending – which would only affect, again, less than one percent of farm estates – we would have imposed the capital gains on gains in farm estates, and that would affect many more people. So there would be a net – there would be a net loss; there would be many more losers than gainers among the farm community and family farms and ranchers, if the estate tax were to be eliminated.

(Emphasis added.)

In other words, as I have pointed out before, the repeal will actually impose additional tax burdens on most small estates, including smaller family businesses and farms.

Finally, Adam Hughes, of OMBWatch, noted that Senator Kyl's suggested "compromise" was no compromise at all:

That proposal would cost between 81 and 84 percent of full repeal. And what we're talking about there is around 770 billion added to the debt over the first 10 years.

Dick Cheney Speaks Out In Favor of the Estate Tax

2006-04-18T13:45:00.000-04:00

Ok, the title is simply untrue. But Dick Cheney's recently released income tax return does present a strong argument for the retention of the estate tax.

Ordinarily, the ability of an individual to reduce his or her income taxes through charitable deductions is limited to a certain percentage of the individual's income. In reaction to Hurricane Katrina, those rules were suspended with respect to charitable contributions made between September 27, 2005, and the end of that year. As a consequence, in 2005, Cheney was able to satisfy various pledges that he had made to charitable organizations that would otherwise had taken years to fulfill. Citizens for Tax Justice discusses Cheney's strategy here.

The CTJ report also claims that Cheney reduced his 2005 taxes by almost $1.1 Million due to the Bush tax cuts. CTJ does not explain how it made that determination. If it used the post-Katrina suspension of charitable deduction limitations in their calculation, its conclusion is simply not justified. The reason that Cheney had such high charitable deductions is that the tax law provided him with a strong incentive to cash in his Halliburton stock options and contribute them to charity in 2005. Absent the temporary suspension of the limitations on deducting charitable contributions, the contributions would inevitably have been made, but at a much later date. While taken as a whole, the charities to which Cheney directed his contributions received a Katrina-related benefit by getting their money now, not later, the Cheneys' total income tax bill, over time, would likely have been about the same.

Nevertheless, this brings us to the estate tax. As presently formulated, the estate tax generally falls on the estates of the wealthy and, most heavily, on the estates of the very wealthy. Within the estate tax are provisions that strongly encourage charitable giving. Some of these allow wealthy contributors to "double dip." Thus, in Cheney's case, he received a charitable contribution that wiped out any tax on the income on his stock options. (As reported by the Washington Post, "[t]he options largely were from Halliburton Co. . . . [with] [s]maller amounts came from companies for which [Cheney and his wife] had been board members, including Electronic Data Systems, Procter & Gamble, Lockheed Martin and Anadarko Petroleum Corp.") Furthermore, the net proceeds that Cheney would have realized had he exercised the options and taken those proceeds into income are also effectively taken out of his estate for estate tax purposes. Assuming that these proceeds would have been taxed in his estate at a fairly high marginal rate, one can reasonably conclude that the economic cost to him and his wife of each dollar of these charitable contributions was significantly less than fifty cents because of the tax savings provisions they were able to utilize.

As a practical matter, the Cheneys' contributions illustrate that tax incentives do work to "create" charitable contributions that would ordinarily not be made. After all, absent the provisions that increased the charitable deductions that the Cheneys would have been allowed to take in 2005, the charities would have had to wait for their money. There is no reason to expect that a similar dynamic is not at work in the estate tax area.

BTW, the WaPo story completely misses the post-Katrina change in the tax law as the reason that the Cheneys' contributions in 2005 were so high. Instead, it buys into the Cheney cock and bull story that the contributions were made in late 2005 because the "options were at a good value for the benefit of charity." Right. And the estate tax overly burdens family farms and small businesses and there are alligators living in the sewers in New York.

What Did the Trustee Know and When Did He Know It?

2006-04-10T07:26:00.000-04:00

A memorandum recently issued by IRS Area Counsel, PLR 200614006, promises to be a major headache for trustees of various types of trusts. Specifically, the memorandum asserts the following:

The IRS can levy upon payments from any trust to a beneficiary in order to enforce its rights under a tax lien even if the trust contains spendthrift provisions.

Perhaps more significantly, in the event that the delinquent taxpayer/beneficiary has a fixed right to trust income, the levy attaches not only to each payment, but also to the taxpayer/beneficiary's "fixed right to obtain a future distribution from the trust." This means that the Service can seize and sell the actuarial right to the payment stream. It does not mean that it can demand immediate payment from the trustee. However, this is potentially devastating to the taxpayer/beneficiary since the payment stream, sold at auction, is likely to be sold at a deep discount. Thus, the seizure and sale will likely make only a small dent in the taxpayer's liability to the IRS, while possibly stripping the taxpayer of his or her patrimony.

Most troubling from the standpoint of a trustee, the memorandum concludes that when a trustee distributes funds that he knows are encumbered by a federal tax lien and the funds "enter the stream of commerce and cannot be traced" (which presumably occurs virtually any time cash is paid to the beneficiary and it can't be recovered), the trustee is liable for tortious conversion for intentionally impairing the lienor's security. This would seem to pose significant problems for institutional trustees such as banks. In many cases, one department of a bank (e.g., the mortgage service department) may have knowledge of a tax lien against a beneficiary. That knowledge is likely not regularly transmitted to the trust department and, in many cases, the mortgage service department may not even be aware that its customer is a beneficiary of a trust with respect to which the bank is the trustee.

PLR 200614006 is part of an emerging trend where the Service aggressively pursues various sorts of rights to satisfy tax liens, even in cases where the rights had traditionally been considered protected from creditor attack. These methods of asset protection, most of which are effective against non-governmental creditors, such as disclaimers, tenancies by the entireties, and spendthrift provisions in trusts, simply will no longer ward off attacks from the Service.