ataxingmatter

Capital Gains: Is it laffer curve or boom and bust that determines amounts of capital gains realized?

As readers of my comments on the Laffer Curve silliness well know, it is not at all established that cuts in taxes increase revenues.  In fact, the contrary is empirically the sounder position. 

Many of those who argue for low or even zero capital gains taxation do so ideologically--they appear to firmly believe that people with capital should pay no taxes and that only people who labor should pay taxes.  They argue that zero capital gains taxation encourages growth and that growth is good for everyone. 

Of course, each of those positions is questionable.  In a fair society, most of us believe that everyone should pay their fair share of taxes.  While we are not always sure what constitutes a fair share, most of us have a sense that fairness requires each to pay from the type of income they have.  To exempt capitalists--who most often are the richest in the society and are those with the greatest power to set the tax terms in their own favor--is anti-democratic and elitist.  It's not at all clear that low taxes on capital gains increases growth.  In fact, it may well be that low taxes on such gains just increases passive investment overseas and has little positive impact here.  Even if it somewhat encourages growth, growth is not a per se good--it can be destructive (e.g., the environmental pollution in China), it can appear good in the short term but lead to devastating changes that have not been adequately prepared for in the long term, it can be entirely enjoyed by one segment of the society at the expense of all other segments of society, as the growth in the US economy generally has been over the last few years.  On the other hand, equal taxation of capital gains and labor should put the worker and the boss on a more egalitarian playing field, and limit the power of capital to control the terms of work and social life.

Citizens for Tax Justice had a worthwhile discussion of the April Democratic debate between candidates Clinton and Obama. Charlie Gibson Repeats Misinformation at Democratic Presidential Debate, April 18, 2008, CTJ Digest. Most viewers think the debates were handled terribly by the media, in that they spent a considerable amount of time on trivial questions rather than providing an avenue for genuine discussion of issues of interest.  But CTJ points out another area of disservice--the commentators got used misleading ideas about taxation to question candidates!  Charlie Gibson asked Obama a question about capital gains that mistakenly treated the Laffer Curve idea (cut taxes and you get more money) as credible.   Read the story.  Then maybe we should all write the mainstream media to insist that they quit parroting misinformation when they address tax issues.

Harry Willner, former IRS agent and now convicted tax crook

In mid-April, the US Attorneys Office for Southern New York issued a press release about the indictment, conviction and sentencing of Harry Willmer for tax fraud.  Willmer had been involved in a purported company (with the same address as Willmer's home address) for which he claimed almost $900,000 in operating losses from a bad debt.  He then promoted a scheme to others whereby they would assign their income to his company, he would report the income but offset it with the NOL, and then he would pay the income to them (as a loan payment) minus a "small" fee for his services in saving them taxes.  He even used the scheme himself, having a school district for which he sometimes taught pay his salary to the company and purportedly saving himself about $20,000 in taxes through the fraudulent use of the purported NOL.

Willmer was sentenced to a year in jail, a year of supervised release, a $10,000 fine, and payment of taxes, penalties and interest.  See this short item on US News & World Report.

About the same time  that Willner was sentenced, Actor Wesley Snipes got his sentence of three years for failing to file tax returns (and of course there's taxes, interest and penalties to pay as well).  Will these cases provide guidance to the tax protestor movement, or will they continue to claim they owe nothing?  Hopefully, these glimpses of prison time for tax cheats will at least cause the protestor movement to have second thoughts about brazen violation of the law.             

Second Stimulus Package?

The House and Senate are working towards completion of a housing tax bill that may include other tax items.  H.R. 5720 (the housing tax bill with $11.6 billion in benefits) and H.R. 5830 (the FHA housing Stabilization and Home Ownership Act of 2008 that proposes to provide federal guarantees for home mortgages) are to be combined into one bill and then sent back to the Senate, which passed its version of housing relief in H.R. 3221 some time ago.  The Bush Administration has threatened to veto the bill.

Meanwhile, the request for corporate welfare continues.  A coalition of S corporations is asking Congress to provide more tax cuts for their businesses.  The specific tax cut requested--the built-in gains tax that is required when domestic C corporations become S corporations.  Of course, that built-in gains tax is a tax that the C corporations essentially are permitted to defer when becoming S corporations.  To permit S corporations to forego paying it would be inappropriate--it would improperly reward conversion to S corporation status with relief from taxes due. 

What's the rationale given by the S corporation coalition for this new corporate welfare request?  They argue that the tax prevents sales of assets when they should be sold, and thus distorts decision making.  One doubts that is true, since a business has to make decisions that make sense for the business, and the S corporation status already eliminates the corporate tax generally.  What seems to be more accurate is that these businesses will lobby for the reduction or elimination of any tax. 

Congress's role is to recognize that these requests for tax reductions will never cease and that they do not necessarily merit much attention.  Providing further tax reductions for S corporations that already enjoy pass-through taxation simply should not be a priority, especially when the reductions requested are an unreasonable default on the basic agreement allowing C corporations to convert to S corporation status.

Tax Rebate Checks: stimulus or waste?

Tax rebate checks begin arriving this month.  Will the result be the stimulus to the economy desired by Congress, bridging the problems caused by banks issuance of too many subprime loans and failure to work with their borrowers to work  out the debts to avoid foreclosure?   Yves Smith at the Naked Capitalist has a few choice words on this issue.   

More on Private Equity and Hedge Funds

I've written often about the "two and twenty" arrangement for hedge fund managers who are able to treat most of their compensation as though it were a capital gain, paying much lower taxes than ordinary people pay on their salaries or wages. 

Adding fuel to the fire, much of the activity carried on by private equity funds is destructive rather than constructive.  A reader criticized my comments about the destructive nature of private equity funds, suggesting that if they were able to sell assets at a gain, then the activity must be positive and constructive rather than destructive.  That kind of comment misses the point--the capital markets often reward short-term activity that is destructive in the long term.

The private equity managers created a new coalition, the Private Equity Council, to present their story in Washington.  These lobbyists liken the private equity managers to entrepreneurs.  But we might do better comparing them to marauders, especially when the funds engage in leveraged buyouts.  Those are deals where they find a business that looks ripe for a takeover, buy it with considerable leveraging that will generate tax deductions (essentially getting the fisc to fund the takeover), lay off workers and outsource activities to cut costs (even when that outsourcing may destroy the community in which the business is located and may cause the business to cease a large part of its activities), sell off the best assets piecemeal and then sell off whatever is left, reaping significant management fees at every step and earning compensation as preferentially taxed capital gains.

Congress considered changing the rules that let these firms make such huge gains with preferential taxation but hasn't done anything yet.  These Wall Street moneymen wield unfortunate power and ordinary taxpayers' interests are easily disregarded when lobbyists like the Private Equity Council come to town.  The Council argues that endangering the moneymen's profits would ultimately hurt Wall Street and freeze up money needed by business.  I've commented that these appear to be rather empty threats--if you earn $400 million and have to pay twice as much in tax as before, you still have hundreds of millions.  These managers aren't going to pull out of the business if their free ride finally comes to an end.  The threat of pulling out if their free ride doesn't continue is the real class warfare that is going on every day in Washington as inequality mounts.  Here's the way Andrew Ross Sorkin described this last year in the New York Times.

Let’s be honest: it is a charade that private equity firms have claimed their 20 percent performance fees at the lower capital gains rate. To qualify, they invest a nominal amount of their own money to demonstrate that they have put something at risk, but it’s a ruse. They are paying capital gains rates for doing their job, which should be taxed at the regular income rate. Andrew Ross Sorkin, Of Private Equity, Politics and Income Taxes, Mar. 11, 2007, NY Times.

The lobbyists have done everything possible to paint a sympathetic picture of the managers who pocket millions for managing funds and pay only a pittance in tax because of the preferential capital gains rate they claim under unclear partnership rules.  David Ignatius of the Washington Post ran a good story on the pay issue, and noted the lobbyists' claims that the capital gains rate is a just reward for the "sweat equity" the managers invest. 

The giant private equity funds are nervous enough about the pressure building for tax changes that a few months ago they created their own Washington trade group, the Private Equity Council, which is already producing studies to justify the existing tax breaks. Its Web site explains that although fund managers may be putting up little of their capital, they deserve special tax breaks because they are contributing "sweat equity." Try telling that to the guy on the shop floor who's actually sweating -- and paying taxes at a far higher rate. David Ignatius, A Backlash Against Billionaires, Washington Post, July 19, 2007.

Ignatius' actually had a couple of quotes from private equity managers who admitted that it was absurd that they should be taxed at the preferential capital gains rate on their compensation.  One unidentified financier had the following to say:

"Amusing what is going on in the tax charades of the money managers. How in the world anyone can uphold those [making] egregious amounts of money paying low or no taxes is really becoming laughable. . . . The private equity guys I know admit they do not have an argument that holds water."   Id.

For more, you can read a book by the founder of the Economic Policy Institute (and a Distinguished Fellow there), Jeff Faux, The Global Class War, or an article by Nomi Prins, Barbarians at the Gate: Private Equity, Public Enemy, Nov-Dec 2007, Mother Jones.

Republicans Plan a Giveaway: for the Wealthy

Republican Wally Herger of California appears to think that what is wrong with the economy is that the wealthy aren't keeping enough of their capital gains.   He and seven other Republicans (Dreier of CA, Johnson of Tx, Brady of Tx, Cantor of VA, Linder of GA, Campbell of KY and Conaway of Tx) have put legislation forward in the House to eliminate any federal income tax whatsoever on the main source of income of the very rich--capital gains and dividends.  H.R. 5908, available here Download hr_5908.txt .

Not surprisingly, Herger's press release in support of the bill is an attempt to hoodwink ordinary Americans into thinking that the bill is going to do them good (in spite of the fact that the bill is another piece of welfare for the wealthy).

• Herger talks about the importance of avoiding the purported "double taxation" on investments.  Of course, That is simply bunk.  Most corporate investments are NOT double taxed. Empirical studies show that more than 200 of the largest corporations in the country pay absolutely no U.S. federal income tax.  So as things stand today, corporate shareholders of those corporations are paying only 15% on their dividends and capital gains from selling shares on corporate earnings that haven't paid a penny of tax most of the time.  That's while their workers are being made to work longer hours, for less benefits and lower pay, and paying income tax on their salaries at the ordinary income rate, as well as the "payroll" taxes (social security, medicare) that the wealthy don't every pay on their capital gains and dividend income.
• Herger talks about this being intended as a benefit for everyone since "over half" of Americans own stocks and bonds.  Again, this is simply a deceptive way to try to gain support from ordinary Americans for a program that is intended to provide a windfall to the wealthy.  About half of Americans do own some small amount of stocks and bonds, but for anyone below the top quintile (those making, e.g., less than about 90,000 a year), that's a very small amount of stocks and bonds and they have very little capital gains or dividends during a year.  This windfall is intended to benefit the wealthy upper class that holds 70% of the financial assets and makes much of the income taxfree already (tax exempt municipal bond income, for example).

Herger and his co-sponsors want ordinary  Americans to believe they are thinking about them, but this bill is intended to provide a windfall for the wealthy and nothing more.  It would be extraordinarily costly, and that cost would have to be paid back out of the taxes on the salarires of the working middle class.

Okamoto and Breenan: Measuring the advantage we give hedge fund managers through the Partnership tax break

I've argued here that it is entirely inappropriate to permit hedge and private equity fund managers to be taxed on their compensation for services at the capital gains rate when ordinary wage earners pay the higher ordinary income rate.  It's particularly unfair, since these managers are merely using other people's money to get rich, and then using Uncle Sam's welfare for the elite to get even richer.  They are not really entrepreneurs, as they argue, but more likely either risky speculators or highly paid destruction crews.  It is these private equity funds, for example, that are able to buy businesses, rip them into pieces, and then resell at a gain.  Often workers are lost along the way, or the jobs are exported overseas.  In this "greed is good" climate engendered by the "free marketarian" fallacy coupled with the MBA in charge who knows very little about fostering a healthy work environment, nobody seems to care about that anymore.  All in all, a situation crying out for change, if only the Senate can be strong enough to take action that will impact a very few people who are very, very wealthy.

Karl Okamoto and Thomas Brennan have put together some empirical research on these hedge fund managers:  Measuring the Tax Subsidy in Private Equity and Hedge Fund Compensation.  Here's an excerpt from their abstract.

[O]ur model suggests that differences in tax account for a substantial portion of the disjuncture that exists at the moment. It also quantifies the significant excess returns to private fund managers that must be taken into account by arguments in support of their current tax treatment by analogy to entrepreneurs and corporate executives. This analysis is important for two reasons. It provides a perspective on the current issue that has so far been ignored by answering the question of how taxation may affect behavior in the market for allocating human capital. It also provides quantitative precision to the current debate which relies significantly on loosely drawn analogies between fund managers on the one hand and entrepreneurs and corporate executives on the other. This paper provides the mathematics that these comparisons imply.

Krugman on McCain and taxes: talking us into a continuation of the Bush irresponsibility

Candidate McCain is eagerly pushing his image as a straight talker.  But those of us who watch what candidates say have a different opinion on McCain's tax talk.  He has adopted the path of least resistance--claim that continuing the Bush cuts is reasonable, complain about the way tax cuts are scored, and then let the nation continue into a deficit-ridden, fund-short future where education, basic research and infrastructure take a back seat to making sure that the wealthiest in the country are sitting pretty while the ordinary workers suffer.

Here's an excerpt of what Paul Krugman had to say today, in Bush Made Permanent, NY Times, Apr. 28, 2008.

"... what Mr. McCain says about taxes shows the same combination of irresponsibility and double-talk that, back in 2000, foreshadowed the character of the Bush administration.  The McCain tax plan contains three main elements.

First, Mr. McCain proposes making almost all of the Bush tax cuts, which are currently scheduled to expire at the end of 2010, permanent. (He proposes reinstating the inheritance tax, albeit at a very low rate.)

Second, he wants to eliminate the alternative minimum tax, which was originally created to prevent the wealthy from exploiting tax loopholes, but has begun to hit the upper middle class.

Third, he wants to sharply reduce tax rates on corporate profits.

According to the nonpartisan Tax Policy Center, the overall effect of the McCain tax plan would be to reduce federal revenue by more than $5 trillion over 10 years. That’s a lot of revenue loss — enough to pose big problems for the government’s solvency.

The American people need to stand up and demand accountability of our political candidates.  They have been giving away the store to the wealthy.  The farm bill, for example, is primarily corporate welfare for agribusiness and has very little to do with helping small family farmers who are in danger of losing their farm.  In fact, big agrifarms are making hay--literally and figuratively--even without taking the federal funds into consideration.  Yet the federal government pays each of these agrifarms hundreds of thousands annually not to grow specific items.  And the Senate has added billions to that bill.  Will we never see politicians again who can do the right thing, instead of the right thing to get funding for their elections from the wealthy?  Not unless ordinary Americans let their Senators and Representatives hear what they really think--that corporate welfare for the wealthy has to stop, and that the farm bill and the Bush tax cuts are a good place to start putting a stop to it.

Wesley Snipes: convicted tax criminal in the news: jail time ahead

When Weslep Snipes was convicted on three counts of criminal failure to file tax returns but not convicted on tax fraud charges, many of the mainstream media put out headlines that were likely misleading to the tax protestor crowd, suggesting that he'd gotten off.  When I ran a blog entry about his conviction on the three counts, tax protestors emailed me saying Snipes was their hero, and that he hadn't been convicted of fraud so it proved their position (that the income tax is illegal or that it is to be paid only by non US people) was correct. 

So I'm pleased that the judge sentenced Snipes to the maximum--three years in jail and one year of probation,  See Rich Phillips, CNN, Snipes Gets the Maximum (updated 4/24/08).  Snipes made a payment of $5 million on his back taxes owed (plus penalties and interest)--nearly $17 million, which will be the subject of a civil case.

Snipes said he was sorry for his mistakes, but interestingly never specifically admitted having violated the tax laws.  See Wesley Snipes Gets 3-Years for Not Filing Tax Returns, NYTimes, Apr. 24, 2008. 

Snipes claimed at his trial that he was an innocent who had been duped by his co-defendants.  But he had joined his co-defendant's American Rights Litigators group back in 2000, a group which has a goal thwarting federal income tax collection.  See this FOX News.com story from the time of the trial: Carmen Gentile, Bad Financial Advice Behind Snipes Tax Woes, Lawyer Argues, FoxNews.com, Jan. 16, 2008.  The tax deniers' arguments are groundless, but they advertise and acquire followers who apparently can successfully convince themselves of any fantasy position in order to keep more money for themselves rather than pay their fair share of taxes to support important government activities.  As David Cay Johnston, Wesley Snipes to Go on Trial in Tax Case, Jan. 14, 2008, reported:

Tax deniers maintain that the law only appears to require payment of taxes. All their theories have been rejected by the courts, including the one invoked by Mr. Snipes, which is known as the 861 position, after a section of the federal tax code.

Adherents say a regulation applying the 861 provision does not list wages as taxable, though it does say that “compensation for services” is taxable. The courts have uniformly rejected all such theories, and eight people have been sentenced to prison after not paying taxes based on the 861 argument.

Snipes' failure to file returns covered 1999-2004, during which time he earned $38 million and paid no taxes.  Id.

I still find it hard to believe that the jury bought such a defense for someone who has made millions and obviously is no idiot.  I suppose the celebrity cult is hard to avoid even in a jury deliberation room.  Although the jury in February only convicted Snipes on the three failure to file misdemeanor charges, they thankfully convicted his co-defendants Kahn and Rosile on the felony tax fraud counts.  Kahn will serve a 10-year sentence, and Rosile four years.  Wesley Snipes Gets 3-Years for Not Filing Tax Returns, NYTimes, Apr. 24, 2008.  There's a great bit of dialogue from Kahn's sentencing. 

Kahn's Statement to the judge upon sentencing:  "For the record, your honor, I don’t accept that.”

Judge's response: “You may not accept it, Mr. Kahn, but you will serve it.”   Id.

Any other resolution of this case would have made a mockery of justice.  A poor guy who swipes a piece of pizza from a kid in California can go to jail for life under California's ridiculously harsh criminal "three strikes and you're out" law, but wealthy elites who mock the nation's tax laws often get off with nothing but a slap on the wrist, if that.  If all they do is pay their back due taxes and interest, even with a penalty, they may come out ahead, under time value of money principles.   Snipes deserves jail.  It's good that he got what he deserves.

Treasury's Proposed Rules for Foreign Investment in the United States

On Monday, the Treasury Department issued proposed regulations amending the rules for review of foreign investment in the United States under the Foreign Investment and National Security Act of 2007 (FINSA).  The review of foreign purchases of US business to be conducted by the Committee on Foreign Investment in the United States (CFIUS) has been expanded, but not as much as some have called for.  A publc meeting on the rule will be held May 2.

The proposed rule includes the following provisions (generally stated).

• An acquisition that does not constitute control is still not subject to the Exon Florio notification provision of the Defense Production Act under FINSA.
• The definition of control is expanded to include the power to block key corporate decisions, which have also been expanded to include decisions that affect minority rights.  As a result, fairly common supermajority voting provisions on basic business decisions are included.
• The acquisition of convertible interests that will convert with the passage of time is also an event that calls into play the Exon Florio provision, if the conversion will result in control under the expanded definition.
• The safe harbor for passive investments of less than 10% is retained; but the proposed rules make clear that the safe harbor does not apply to investments where the investor intends to acquire control at a later time or where the investor also acquires governance rights, such as a seat on the board of directors.
• The definition of foreign persons covered has been expanded, so that offshore vehicles that are more than 50% owned by non US persons will be treated as foreign persons, even if they are controlled by US persons.
• There is no mandatory investigation of purchases by entities controlled by foreign governments, though the Treasury Department and responsible agency must approve the decision not to investigate.
• When notification is required, considerably more information must be provided and more time may be taken by the CFIUS.