ataxingmatter

One in 189 of those with $200,000 or more in AGI paid no federal taxes in 2009

[edited 5/30 to correct "one in four" goof]

 The IRS recently released another "statistics of income" report.  This one has news that should make most ordinary Americans think twice about the GOP agenda of reducing taxes for the rich while cutting back on all kinds of programs that serve ordinary Americans--the fact that a large percentage of the upper crust--one out of every 189 Americans with $200,000 or more in income --pay no federal income taxes whatsoever.  See Rubin, IRS Finds One in 189 High Earners Paid No U.S. Taxes in 2009, Bloomberg.com (May 29, 2012).

  How does someone with $200,000 or more in income pay no taxes, when ordinary folk with jobs who make $50,000 to $75,000 pay 15% to 25% of their income in taxes? 

• As I've often discussed here (see items under charitable contribution deduction), rich folk can easily afford to give away more to charity and they get a tax bonus that is much more than that available to poorer folk when they do so.  They get an especially big break if what they give away is appreciated stock that they bought a while ago--and rich folks own most of these financial assets, so they are the ones that get almost exclusive enjoyment of this lucrative loophole:  they get to deduct the full value of the stock they donate, without having ever paid taxes on the appreciation.  That's one of the boondoggles in the Code that Congress can and should get rid of, no matter what else it does about taxes. 
• Another way rich folk pay less in taxes is by ensuring that the income they earn is of a type that isn't subject to tax.  Big CEOs generally have rich pension plans and other forms of deferred tax compensation that facilitate lowering their tax bills.  Rich folk are the buyers of municipal bonds, which again enjoy a specific tax break in section 103 of the Code that excludes the interest income from the owners' tax returns.  This is supposed to help municipalities, since the tax break gives the wealthy an incentive to buy the bonds even though they pay lower rates, since all the interest is tax free.  But it is a costly break that provides an advantage only for the rich.  Wouldn't it be better to eliminate it and tax wealthy people on all of their interest income at ordinary income rates?  Maybe the tax money could also fund programs for important municipal projects--like intracity rail transportation in Detroit, a much needed idea whose time has come.....
• A third way that rich people avoid taxes is by having so many deductions--high-end medical "equipment" (like swimming pools for arthritic patients), lots of interest on mortgages on high-end homes, and other deductions of special value to those who would otherwise pay tax at a higher rate.

 As the Rubin article notes, the IRS announced that for 2009 there were 10,080 households with "adjusted gross income" of $200,000 or more who paid no US or foreign income taxes. Adjusted gross income is not economic income--AGI does not reflect items that are excluded from the calculation of income for tax purposes and is reduced by certain "above the line" deductions that are especially beneficial to the wealthy. "Using an expanded concept of income that includes some nontaxable items and looking only at U.S. income taxes, there were 35,061 households, or 0.88 percent, that paid nothing."  Id.

The Alternative Minimum Tax was initially enacted to deal with the general unfairness of having extraordinarily well-to-do people be able to avoid tax entirely.  As it was modified over time, it came to function as a way to ensure that those who accumulate lots of different deductions nonetheless pay tax, by treating some of those deductions as unqualified preferences for AMT purposes.  But the AMT has lost a lot of its punch as Congress has eviscerated its provisions, such as the limitation on foreign tax credits.   This is one of the reasons that many progressives have supported two things--elimination of the preferential rate for capital gains (a type of income especially enjoyed by the ultra rich) and adoption of a new type of minimum tax on some high level of gross income (the Buffett Rule).  This new information about the number of rich people who end up paying nothing in federal income taxes should result in more people telling Congress that it's time to pass these two proposals.

More on Greg Mankiw's weak arguments for the Bain capital gains preference

A few days ago, I commented on the weak arguments Greg Mankiw had put forth in his op-ed to support the preferential treatment of compensation for private equity and real estate partnership "profits" partners.   He points out the categorization problem--that it is not always easy to be sure what is a "capital gain" and what is "ordinary income".   I concluded along the lines of arguments I have repeatedly made on this blog:  the main thing the categorization problem teaches us is that we should eliminate categorization problems that create inevitable inequitable differentiations by eliminating the category difference. 

Get rid of the preferential rate for capital gains (and with it the need to distinguish capital gains from ordinary income), and you will in one stroke simplify corporate and partnership and individual taxation tremendously.  Much of the Code is invested in trying to prevent smart tax lawyers from using tax alchemy to convert one type of income into another.  See, e.g., section 1059 (extraordinary dividends to corporate shareholders), section 304 (sales between affliated corporations treated as redemptions), section 302 (providing tests that, if not satisfied, treat redemptions as dividends if there is e&p), etc.

Uwe Reinhardt makes a similar argument in the Economix blog carried by the New York Times.  See Capital Gains vs. Ordinary Income, New York Times Economix Blog (Mar. 16, 2012).   Reinhardt uses Mankiw's own introductory textbook in microeconomics to make the tax equity argument that many have been making about carried interest--it is unfair to tax a money manager at a preferential rate compared to firemen, postal inspectors, college professors, school teachers and neurosurgeons.

In his popular textbook “Principles of Microeconomics,” Professor Mankiw teaches students that “horizontal equity states that taxpayers with similar ability to pay should contribute the same amount.” Well put.

Consider now a person who bought a vacation home for $500,000 and two years later, during one of our recurrent real-estate bubbles, sells it for $1.5 million. That $1 million profit is now taxed at a rate of only 15 percent. If the home had been the principal residence of this person and his or her spouse, half of the $1 million profit would not be taxed at all.

Suppose next that this tax-favored person’s neighbor were a busy neurosurgeon whose many hours of hard, physical and intellectual work earned him or her a net practice income of $1 million during those same two years. That neurosurgeon would pay the ordinary income-tax rate on that income (on average a bit less than 35 percent, because only income over $388,350 a year is taxed at 35 percent).

By what definition of the term would can one call the glaringly differential tax treatment of the real estate investor and of the neurosurgeon horizontally equitable?

Reinhardt goes on to make another of the arguments that I have been pressing for months in this blog--that the assertion that preferential rates are necessary for stock market transactions because they are rewarding investment in the corporations is baloney--most reported gains on securities are from secondary market trades, not from direct investments in corporations. 

[T]he proponents of lower capital-gains taxation conjure up an image of, say, Jones purchasing shares of stock directly from the issuing corporation, which then invests the proceeds in new structures and equipment.

More typically, however, sales and purchases of corporate common stock take place among parties quite outside of the issuing corporation. For example, Jones may buy the stock from Chen, who may have reaped a capital gain from once buying and now selling the stock. Chen may have bought the stock from another person not related to the issuing company.

When Jones pays Chen, it is anybody’s guess what Chen does with the money. For all we know, Chen will spend it on a luxury car. Why, then, should any gain Chen enjoys on his or her investment in that stock be granted a tax preference? No new capital formation was supported by this trade in a stock sold by the company years ago.

The ugly truth about the  insistence on the capital gains preference is that it rewards people at the top of the income and wealth distribution and serves to maintain the status quo of the allocation of resources.  This is what is really meant by "fiscal conservatism" these days--ensuring that resources remain inequitably distributed to the very wealthy who are the "shakers and movers" of society through the influence their money can buy.  The right-leaning Supreme Court has made that even more inevitable than it was before, through the Citizens United decision upholding the right of corporations to contribute any amount to influence political campaigns, based on the laughable assertion that such "super-PAC" rights undergird free speech.

Greg Mankiw attempting to justify carried interest

Greg Mankiw wrote an op-ed in the Sunday Times Money section: Capital Gains, Ordinary Income and Shades of Gray, New York Times (Mar. 4, 2012). 

Mankiw notes the historical trend in the US to differentiate between capital gains and ordinary income regarding tax rates (though we have had notable experiements, both in the regular tax and in the AMT, to the contrary).  He asserts that there are "good reasons" for the preference for capital gains income--offering only the standard idea of lack of indexation for inflation/deflation as an example. 

The purpose of the piece is to justify the carried interest treatment of money managers' gains from dealing with other people's money as equivalent to a carpenter who fixes up a dilapidated house and gets capital gains on the sale of the home, though the gains are really paying off the carpenter's sweat equity.  Since the carpenter gets capital gains under our system, he says, why shouldn't the money manager who does an analogous activity (assuming--which may be a rather big jump-- that hedge fund, private equity and other money managers are doing "sweat equity" that adds to the value of the assets under management, and should be viewed analogously to the carpenter).

The problem with making these analogies, especially in the area of capital gains, is that the idea of capital gains is problematic to start with.  We'd be much better off with a code that made no such distinction, since there are certainly instances where the distinction is an arbitrary one.  Since the line drawing isn't easy (and it isn't), then the distinction shouldn't exist at all in the tax code.  That would be the right solution overall.

Nonetheless, the fact that a category is hard to apply generally doesn't mean that there isn't a right answer--or at least a better one-- in particular circumstances.  It is particularly inapt to compare money management with rehabilitation of dilapidated property.  Rehabilitation of real property adds "real" value, in that the property is upgraded and will physically last longer than it would have without rehabilitation.  Money managers don't necessarily add any value--they may make money for themselves and others, but there is no real productivity gain in the economy in many (if not most) instances and certainly in any case where the gain is primarily speculative (often the case with hedge funds) or destructive of domestic businesses (often the case with private equity funds). 

Private equity fund managers, you will recall, invented the leveraged buyout (or maybe it would be more accurate to say that the idea of the leveraged buyout led to private equity funds).  The idea behind leveraged buyouts was to take a stable, money-making company that wasn't heavily debt-ridden, load it up with debt to cover the acquisition cost of the company, and use the cash flows from the company to pay off the acquisition debt.  Private equity funds like Bain Capital could then leverage a minimal investment of their own with the purchased company's debt to get huge profits, once the debt was paid off with good cash flows (already existing out of the company, with nothing due to the "management" of the money manager).  The better the company taken over was, the more its cash flow could be counted on to pay off the debt, the more leverage would be added, the quicker the debt was paid off, and the better the ultimate profit.  Sometimes this takeover was relatively harmless for the "good" company, but many times it was harmful--the takeover changes and debt resulted in focus solely on profits and not on long-term investment, and the company's long-term stability was destroyed.  The process was seldom positively beneficial for the company  over the long term or for its community (though it may have been for particular shareholders and the managers themselves).  The point here, of course, is that the LBO was targeted to  (already)"good" companies with low leverage and high cash flow that could easily borrow in the market to cover the cost of the acquisition.

Later, of course, as the age of financial speculation got fully underway, private equity firms started taking over companies that could never expect to pay back the additional debt the LBO loaded them with.  The private equity firms made their money in these cases by driving them into bankruptcy and laying off or firing the workers.  Equity firms still got their profits out of the deal by selling off the components.  But the companies (and especially their workers) were done for--if the companies survived at all, they were just parts of some conglomerate with very different functions.

Making money from managing other people's money, in other words, is not per se productive for the economy as a whole and is not something we should reward with low taxation that acts as an incentive to the activity.   We should recognize the money manager's take as what it is--compensation for work done--and tax accordingly.

As an aside, I'll note that it wouldn't be unreasonable to have a handyman take ordinary income on his share of the profit that serves as reasonable compensation for his labor, but in most cases that's a difficult facts and circumstances issue for the Service to sort out after the fact.  One reason carried interest is such an obvious place to repair the problematic categorization of labor income as preferential capital gains is that there will be a partnership and there will be records of "management fees" and "carried interest allocations".  Given our sophistication about partnership allocations, identifying and classifying the carry as ordinary income is a relatively simple endeavor.

 

Buffett Rule Legislation

In early February, Sheldon Whitehouse introduced the "Pay a Fair Share Act"--legislation embodying the so-called "Buffett Rule" to ensure that the highest income Americans who make more than a million  a year would pay at least a 30% rate on all of their income (including capital gains), rather than being able to pay less than 15% as in the case of Mitt Romney.  The bill is estimated to bring in about $50 billion a year.  (If the Bush tax cuts are allowed to expire, the additional amount would of course be less, around $25 billion a year.)

Whitehouse appeared on the Keith Olbermann show (Feb. 3, 2012) to help spread the word about the bill.  You can watch the episode/read the transcript here.   The Congressional Research Service has estimated that a quarter of all millionaires--more than 94,000 people--pay tax at a "rate lower than most middle class taxpayers."  Whitehouse explains that "[w]ith all the advantages that do come with enormous income, paying a lower tax rate than regular, working families should not be one of those advantages."

You can voice your support--and help give Congress the courage it needs to buck the Big Money that wants to rape the government by forcing the little people to pay taxes while the wealthy get off scott free--by going to www.Buffettrulebill.com.  Tax policy shouldn't be set as a quid pro quo to suit the reigning plutocracy.

 As usual, the anti-tax argument from the right is that if you raise taxes on the extraordinarily wealthy, you will drag down the economy and hurt small businesses.  That's bunk, of course, and the right knows it.  Whitehouse points out that studies have shown little relevance between rates for the wealthy and any negative impact on small business. Fact is, if someone makes more than a million a year out of their business, they can afford to pay 30% in taxes and still will be doing quite well, thank you.  The taxes aren't coming out of their businesses--they're coming out of their profits.

(There's a snippet of discussion about Romney's tax plan, which would save the average Middle Class American a whopping total of $167 a year in taxes, while cutting the bills of millionaires and billionaires by tens or hundreds of thousands of dollars.  Romney's response to a question about the fact that a typical middle class American would get only $167?  "It's not nothing.")

 

Politicians' wealth and the tax policies they support

[edited to correct typos]

A story in the Boston Globe by Britt Peterson on Feb. 19, 2012 explored "Why it matters that our politicians are rich" (available here on Boston.com).  A key point--the four remaining GOP presidential candidates all are millionaires, with most making more than a million a year and worth multiple millions, while the median net worth of members of Congress is "$913,000, compared with $100,000 for the rest of us."  Id.  That should worry us because, as the article reports, studies have shown that rich people become more focused on their own well-being, less empathetic with the suffering of others, more likely to view their own wealth as due to merit (and others' lack thereof to reflect lack of merit), and ultimately "more callous, self-absorbed, and self-justifying than the people they represent."  Id.

In 2009, Michael Kraus, Paul Piff, and Dacher Keltner, all then of Berkeley (Kraus is now at University of California, San Francisco), published research that divided up sample groups by family income as well as self-reported socioeconomic status. People of higher socioeconomic status were more likely to explain success or failure as a result of individual merit or fault; lower-class people, on the other hand, felt less control in their own lives and were more likely to blame events on circumstance. In other words, higher-status people were more likely to feel that they’d earned their high place in society, and that poorer people hadn’t. 

***

More recently, similar research—involving not just surveys, but heart-rate measurements —has found that higher-status people tend to be less compassionate toward others in a bad situation than people of lower-class backgrounds.

***

The result of these differences, say researchers who work on money and social class, is that people who are confident in their status have a completely different worldview from those who lack that confidence: more self-involved, self-justifying, and even, as the dehumanization study suggests, crueler. And the higher up the spectrum you get, the stronger the effect . . ..

***

Power itself can trigger similar changes. . . . Gaining a sense of power, then, even if it happens through random selection in a lab, alters you on a very basic level, making you “less attentive to others, more free to act, and more free to act in a way that doesn’t take account of other people,” said Adam Galinsky, a psychologist at Northwestern’s Kellogg School of Management who has been studying the effects of power for a decade.  Id.

That sense of personal merit (and lack of responsibility in others) can lead to disastrous policy choices.  The "ownership society/personal responsibility" mantra of the Bush presidency justified heaping tax breaks on large corporations and their owners/investors at the top of the income distribution while preaching deunionization, privatization, and safety net withdrawal.  It permitted a method of bailing out "too big to fail" banks from the financial crisis they caused by profiting immensely from risky speculation (made possible by deregulation) in ways that didn't require a  clawback of the rentier profits received by the "ownership class," resulting in privatization of gains/socialization of losses.  In essence, the "ownership society/personal responsibility" mantra provides justification for class warfare on the middle class and poor who happen not to be as well-off as  the rich.

Similarly, Congress' inability to empathize with ordinary Americans has led to significant numbers of Congresspeople (particularly members of the GOP) who support privatization of Social Security, reduction of benefits under Medicaid and Medicare and unemployment insurance at the same time that they continue to argue for zero taxation on the unearned income of the rich. And each of the GOP presidential candidates reflects that overarching goal of reducing taxes on the ownership class.  See, e.g., Gingrich's "optional 15% flat tax" (zero tax on unearned income); Cain's 999 transitioning to a national retail sales tax proposal (a flat consumption tax that would be heavily regressive and leave rentier profits of the wealthiest essentially untaxed); Santorum's tax proposals (even less protective of the poor than Gingrich's), Romney's tax proposals (including zero taxation of estates, extraordinarily low taxation of corporations, etc.).   Rather than supporting a repeal of the "carried interest" loophole that allows private equity fund managers like Romney pay ridiculously low tax rates on their very high compensation income, these candidates and politicians support continuing the tax policies of redistribution upwards that have led to the decline of the middle class as the "ownership class" gathers for itself all the productivity gains of the economic system.

"

Misleading Tax Rhetoric Abounds

I got the same piece of mail that my colleague and fellow blogger Jim Maule got--a disturbingly misleading rant trying to make a case for zero taxation of unearned income.  I started to write a post about it, since this is the kind of material that gets my ire up.  It is written with what appears to be an intent to confuse or mislead.  It applies vague language when that suits the writer, and fails to explain even the simplest transactions acceptably.

Maule beat me to it.  He has an excellent post on Issue 9.04 of Tax Bytes, put out by the Institute for Policy Innovation (a think tank on the right):  When Double Taxation Doesn't Exist, MauledAgain (Feb. 8, 2012).

The problem with the IPI starts with the title of the piece--"when investment earns you additional--not lower--taxes".  Right there they are conflating two things--the original amount earned that was put into the investment, creating a "tax basis" that will not be subject to tax on any disposition of the investment; and the return on the investment when it is sold (or when dividends are paid on it), creating additional "gross income" that will be subject to tax, though at the preferentially low, low rate currently applicable for capital gains.

As Maule points out, the piece seems to be written to try to make the unknowing reader think that all the proceeds of a disposition of an investment will be taxable, not just the NEW income represented by the gain --the increase in value of the investment over the original basis.

The fact that a think tank could publish this kind of tax rhetoric, with so many misleading or erroneous statements, is just one more reason that I have urged my colleagues here at Wayne Law to require all our students to take at least the basic federal income tax course.  No student will come out of that course making the mistakes the IPI made in its piece on the taxation of gains from investments.  And every lawyer ought to have that foundation, so that they don't make such foolish statements as those in the IPI piece.

Obama FY 2013 Budget Proposal Released Today--President's Message

The Obama administration released its FY 2013 budget proposal today.  Obama projects that the deficit will be cut by over $4 trillion over the next decade, coming within the goalpost of 3% of GDP by the end of the decade.  That includes a reduction in defense spending of almost $500 billion over the decade.  At the same time, Obama makes the case for continuing the nation's investment in non-defense research & development--including clean energy. 

The President's message (part of the budget document, see link at bottom) sets the theme of attention to the way the gains of the top 1% have coincided with aggravated problems for the majority of hard working Americans.  It notices, that is that budgetary and tax policies, combined with  deregulation and financial crisis, are moving ordinary Americans towards despair and out of the middle class.

By giving every American a fair shot, asking everyone to do their fair share, and ensuring that everyone played by the same rules, we built the great American middle class and made our country a model for the world. Today, ... for many Americans, the basic bargain at the heart of the American Dream has eroded.

Long before this recession hit, there was a widespread feeling that hard work had stopped paying off; that fewer and fewer of those who contributed to the success of our economy actually benefited from that success. Those at the very top grew wealthier while everyone else struggled with paychecks that did not keep up with the rising cost of everything from college tuition to groceries. And as a result, too many families found themselves taking on more and more debt just to keep up—often papered over by mounting credit card bills and home equity loans.

Then, in the middle of 2008, the house of cards collapsed. ... Banks had packaged too many risky loans into securities and then sold them to investors who were misled or misinformed about the risks involved. Huge bets had been made and huge bonuses had been paid out with other people’s money. ... [M]illions of hardworking Americans lost their jobs, their homes, and their basic economic security. ...

We built this Budget around the idea that our country has always done best when everyone gets a fair shot, everyone does their fair share, and everyone plays by the same rules. It rejects the “you’re on your own” economics that have led to a widening gap between the richest and poorest Americans that undermines both our belief in equal opportunity and the engine of our economic growth.

The President's message also points out something important for citizens to bear in mind as the elections hurtle towards us at the end of this year--the reason for the financial crisis and the huge deficits we face now relate to the irresponsible tax cuts of the Bush administration--all passed when everyone knew that they would result in significant deficits that would be hard to ever make up--and the military buildup underway since Reagan, in particular the huge costs of two preemptive wars undertaken by that administration.

When I took office 3 years ago, my Administration was left an annual deficit of $1.3 trillion, or 9.2 percent of GDP, and a projected 10-year deficit of more than $8 trillion. These deficits were the result of a previous 8 years of undertaking initiatives, but not paying for them—especially two large tax cuts and a new Medicare prescription drug benefit—as well as the financial crisis and recession that made the fiscal situation worse as revenue decreased and automatic Government outlays increased to counter the downturn.

The budget proposes a number of good changes. 

• Obama proposes ending "special tax breaks" for Big Oil;
• Obama wants to finally end the "carried interest" fiasco, whereby equity fund partners that make much of their money by purchasing companies, overleveraging them to pay out debt proceeds to partners, and then breaking them up and firing workers are allowed under current interpretation of the partnership rules to treat their compensation income as capital gains if that is what the partnership they are servicing has. 
• Obama proposes enacting a Buffet Rule (a type of alternative minimum tax requirement that millionaires pay at a rate at least equal to the middle class--the sentence presenting this in the President's message is badly botched); 
• Obama wants to limit certain deductions for high income taxpayers to 28%: various deductions were subject to phaseouts at higher incomes before the Bush tax cuts but were  phased out under those cuts. 
• Another good change relates to the various temporary tax provisions enacted in the Bush administration that are a significant cause of the country's current deficits.  Obama recommends allowing the temporary Bush capital gains rate decrease (from 20% to 15%) to expire as scheduled for high income taxpayers, and allowing the dividend treatment as a net capital gain, instituted first as a temporary measure in 2003 and extended several times so that it currently is set to expire at the end of this year, to expire as scheduled for high income taxpayers.  The result would be that the unearned income from dividends would once more be taxed  at the same rate as earned income from wages, a circumstance which many provisions of the corporate tax in Subchapter C--those  designed to prevent schemes that "bailout" of corporate earnings at capital gains rates rather than the expected ordinary income rates--presuppose as basic to the corporate income tax (see, e.g., the section 302 redemption analysis that considers whether the redemption is a sufficient reduction to count as an exchange or rather should be taxed as a distribution under section 301).

We can expect that the proponents of corporatism--especially the corporate coalitions fighting for preserving the benefits for the mostly higher-income shareholders such as ALEC and the U.S. Chamber of Commerce--are prepared to raise a stink about this provision and will expect the GOP members in the House and Senate to vote with them.  The obstructionist GOP is already holding a press conference and conference calls on the matter.  See this C-SPAN item.  This will be a test of whether Congress has been listening to the issues raised by the Occupy WallStreet movement across the country. 

The arguments made by the corporate coalitions don't hold water.  See various earlier posts on this matter at A Taxing Matter.  Clearly, the dividend rates until 2003 didn't prevent people from investing or prevent people from making lots of money investing.   Nor did the change in the dividend rate lead to corporations retaining more income in the US--instead, after getting one "tax holiday" in 2004, more corporations moved more money offshore in expectation of continuing the gravy train with future tax holidays.  Anything the ALEC group says has to be taken with a very large grain of salt.  Especially about how increasing the sum total of corporate and dividend taxation will drive people awy from investing and reduce corporate capital formation.  The fact is that corporate taxation is at an extraordinary low and that most sales and purchases of corporate shares take place in the secondary market, putting no cash into corporations whatsoever!

But there's a good bit not to like as well.  The President calls for "corporate tax reform"--a favorite agenda item of the radical right that will decimate any plans for reducing the deficit without overburdening the middle class if the GOP is able to move it forward.  Obama suggests that corporate tax reform should close loopholes and lower rates so that it doesn't result in increased deficits.  But any loophole closure will be undone shortly thereafter, and any lowering of rates will never be undone.  It is folly to think that the kind of base broadening/rate lowering model applicable in 1986 could work in the "greed is good/taxes are bad" poisoned climate of 2012.

Office of Management and Budget FY2013 Budget Overview

 President's Message

White House Budget Proposal Text

President Discusses Budget Proposal (at Northern Virginia Community College) (with C-SPAN video)

Romney reveals a little about his taxes

Source for this article:  Emily Friedman, Romney Reveals His Tax Rate Is 'Probably Closer to 15 Percent'", ABC News, Jan. 17, 2012.

At a press conference following the GOP debate last night, GOP presumed favored candidate Mitt Romney acknowledged for the first time that his effective tax rate is around 15%.  That's a lot lower rate than middle class taxpayers typically pay. 

Romney isn't releasing his full return--at least not yet.  He says maybe he'll release just the 2011 return in April.  But not any back returns. (That'd tell us more about his gains at Bain Capital than he probably wants us to know.)

What are his sources of income?  Romney acknowledges that during the last 10 years, his income comes "overwhelmingly" from some investments made in the past.  Other sources include a "little bit" from his book and "not very much" from speaker fees.  ("Not very much" is obviously a relative term.  Romney's financial disclosure report released in August indicated that he was paid more than $370,000 in speaker fees for that filing period.  That's considerably more than any middle class taxpayer makes---but doesn't amount to "very much" for Romney, who is worth somewhere around $250 million or so.)

So for 10 years, Romney admits, he hasn't labored much, but has nonetheless made considerable investment income that gets preferentially taxed.  That of course is a core problem with the preferential rate for capital income--it merely makes the festering wound of hugely unequal distribution of income (and wealth) worse.  The preferential rate is, essentially, a tax policy favoring redistribution upwards.  The rich get to pay a lower tax rate on their income than their secretaries, and their income is especially protected by other policies as well (like the weakening of unions from Reagan on, privatization of public activities from Reagan on, lax enforcement of anti-trust rules, lax enforcement of banking regulations, etc.).

At least Romney recognizes that the rich don't need (and the economy wouldn't benefit from) even more favorable tax breaks for rich people's favored kind of income.  He noted that "the speaker's plan to eliminate the capital gains tax for high income individuals--capital gains, interest and dividdnds--would not only be a very expensive provision in terms of having to fill an even larger budget hold but that would provide for people of very high income a possibility of no tax at all. ... I just don't think that's the right course."  (But he does want to lower corporate tax rates, which--under the theory that corporate taxes are borne by corporate owners--would be just another form of preferential taxation for rich people who own most of the corporate stock.)

 

Qualified Dividends or Mere Inclusions

Jim Maule has a good post on a recent case exploring the question of what constitutes a qualified dividend for the preferential rate provided (temporarily) in section 1(h)(11) treating dividends as net capital gains.  See Tax Complexity of the Dividend Kind, MauledAgain (Jan. 6, 2012) (discussing the decision in Rodriguez v. Comr.,, 137 T.C. No. 14 (2011)). 

The case touches on a recurring issue in tax law--the fact that there are straightforward provisions such as those governing the characterization of a payment to a shareholder as a dividend in section 301 and then much more complex provisions that may treat a tax item as "equivalent" to a dividend or may "deem" it to be a dividend.  The necessity of characterizing income is due to the preferential treatment accorded capital gains--a treatment that is both at the center of considerable complexity and hard to square with basic concepts of equity.

Maule's comment is on target:

The time, resources, effort, and energy invested by the IRS, by the taxpayers, and by the IRS in resolving this issue is but one of many examples of how the existence of special low rates for capital gains and dividends is wasteful. Taxpayers generally, and their advisors, not only try to find ways to bring income within the special low rates but also to structure their business activities in ways that they otherwise would avoid, simply to take advantage of special low rates. Repeal of these rates would not only allow removal of at least one-third of the Internal Revenue Code and a similar substantial part of the regulations, it would free taxpayers, the IRS, and the courts from a huge chunk of planning and litigation that consume far more of the economy than the special low rates contribute to it. Id.

Inequality, Taxes, and Corporatism viewed thru the lens of Nick Reding's "Methland"

[editorial note: back from a great break in Colorado with children and grandchildren, so postings will resume normal routine. edited in afternoon to add cite to Angry Bear post by Mike Kimel.]

The Congressional Research Service recently released a new report on U.S. income inequality.  See Hungerford, Changes in the Income Distribution Among Tax Filers 1996 to 2006: The Role of Labor Income, Capital Income, and Tax Policy, CRS (Dec. 29, 2011) (Download Hungerford. Changes in the Distribution of Income Among Tax Filers Between 1996 and 2006. Role of Labor Capital and Tax. 122911).   The CRS report is a sobering document, especially in light of the growing unrest as ordinary people realize how their opportunities are limited by the increased control of resources at the top (e.g., Occupy Wall Street, the "99% vs. 1%, etc.).   For example, see the New York Times article today on inequality and the fact that U.S. mobility trails that of Europe and Canada.  The article is based on a number of different studies such as that of Marcus Jantti and colleagues, American Exceptionalism in a New Light, and suggests that inequality has lingering impacts, especially on the poor and the ability of the poor to move out of the bottom.   See Jason DeParle, Harder for Americans to Rise from Lower Rungs, New York Times, Jan. 4, 2012 (in print edition, Jan. 5, at A1).  The article discusses the considerable evidence that there is limited access today to what we have called the "American Dream":  stickiness exists especially for the poor and the affluent, as the poor generally lack opportunities to get out, and the affluent generally have all the advantages they need to stay affluent.  See especially the graphic accompanying the article, Comparing Economic Mobility.  Id. at A12.  The causes of America's mobility problem are multiple--poverty; a thin safety net (threatened even more now by the right-wing's determined attack on earned benefits like Social Security and Medicare under cover of their purported concern about deficit reduction); the disadvantages of single motherhood; high incarceration rates, especially for black males; a long history of racial stratification that still impacts daily life; the pay tilt towards educated workers (usually made up of children of the affluent); the decline in unionization compared to other affluent countries; and the magnitude of the gap between the rich and the vast majority of Americans.  Even conservatives, who tend to think that mobility is overrated as a policy goal, may conclude that "stagnation at the bottom [is] alarming and warn[] that it will worsen."  Id. at A12 (citing conservative journalist Reihan Salam of the National Review and Daily Post).

Meanwhile, not surprisingly, the right-wing in this country continues to pursue exactly those policies that have so contributed to the decline of mobility, the stagnation of incomes for the lower income population, and the loss of employee power in the workplace.  See, e.g., the plan of the Republican majority in Indiana  to enact so-called "right to work" legislation that allows non-union members to freeload off unions by getting the bargained for rights and wages without paying dues to make that bargaining possible.

What those interested in tax policy should pay especial attention to is the role of tax changes over the last 40 years in augmenting the inequality gap.  Tax is not the sole culprit, but it is a contributor and something that Congress can easily do something about, if it can summon the political will to act.  From the report summary:

Inflation-adjusted average after-tax income grew by 25% between 1996 and 2006 (the last year for which individual income tax data is publicly available). This average increase, however, obscures a great deal of variation. The poorest 20% of tax filers experienced a 6% reduction in income while the top 0.1% of tax filers saw their income almost double. Tax filers in the middle of the income distribution experienced about a 10% increase in income. Also during this period, the proportion of income from capital increased for the top 0.1% from 64% to 70%.

Income inequality, as measured by the Gini coefficient, increased between 1996 and 2006; this is true for both before-tax and after-tax income. Before-tax income inequality increased from 0.532 to 0.582 between 1996 and 2006—a 9% increase. After-tax income inequality increased by 11% between 1996 and 2006. Total taxes (the individual income tax, the payroll tax, and the corporate income tax) reduced income inequality in both 1996 and 2006. In 1996, taxes reduced income inequality by 5%. In 2006, however, taxes reduced income inequality by less than 4%. Taxes were more progressive and had a greater equalizing effect in 1996 than in 2006.

Three potential causes of the increase in after-tax income inequality between 1996 and 2006 are changes in labor income (wages and salaries), changes in capital income (capital gains, dividends, and business income), and changes in taxes. To evaluate these potential reasons for increasing income inequality, a technique to decompose income inequality by income source is used. While earnings inequality increased between 1996 and 2006, this was not the major source of increasing income inequality over this period. Capital gains and dividends were a larger share of total income in 2006 than in 1996 (especially for high-income taxpayers) and were more unequally distributed in 2006 than in 1996. Changes in capital gains and dividends were the largest contributor to the increase in the overall income inequality. Taxes were less progressive in 2006 than in 1996, and consequently, tax policy also contributed to the increase in income inequality between 1996 and 2006.

 

The members of Congress who pass such preferences (the GOP in particular, but certainly various members of the Democratic party such as Max Baucus fall into the same group) spin such preference for the rich (a group which includes most members of Congress) as supporting job creation.  Their spin suggests that anytime anyone invests in corporate stock, they are acting as entrepreneurs and increasing the possibility of jobs for the rest of us. 

The spin is mostly just that.  Most of the capital gains from sales of corporate stock have nothing to do with having invested in a company directly in ways that provide more capital to the company and lead to creationof jobs.  Most of such gains are from secondary market sales--sales of stock from one rich person to another.  Secondary market sales have absolutely nothing to do with job creation or entrepreneurship: they have everything to do with acquiring more money with taxes that are at extremely low preferential rates. 

Similarly, getting dividends from a corporate enterprise has nothing to do with job creation--they just make the corporate stock holder richer at a preferential tax rate (under the 'temporary'[ provision enacted in 2003 and extended several times since).   Many 'freshwater' economists and many tax professionals argue for "integrating" the corporate tax and the tax on dividends or outright elimination of the corporate tax, claiming that  the dividend tax represents a 'double' (and therefore wrong) taxation of corporate profits.  That logic has led to an increasingly rich variety of corporate loopholes built by Congress into the Code--from the various expensing and bonus depreciation provisions (letting corporations reduce their taxable income compared to their actual business profits by claiming a deduction for capital expenditures) to various preference gimmicks, such as the "domestic manufacturing deduction" that provided a significant reduction in the corporate tax rate to all kinds of industries, including many processes that few would consider to qualify for "manufacturing." 

 But the double taxation claim is merely that--a claim based on the way the theor treats corporate entities.  Economists been unable to prove empirically that shareholders actually bear the burden of the corporate tax.  But even if they do, there are other reasons having to do with institutional power and the sustainability of democracy for supporting a corporate tax.  If you start out thinking that "only people pay taxes", you would likely conclude that "corporations can't pay taxes; therefore, the corporate tax is 'really' being paid by the owners of the corporation."  Of course, we used to say that only people can vote, so only people should be allowed to spend money on campaign speech.  Now the Supreme Court--which has treated corporations as "persons" under the Constitution since the nineteenth century--has decided that corporations have free speech rights that are broad enough to allow them to use their vast resources to influence who gets elected.  Thus, corporatism has paved the way for corporations to buy elections and then lobby for the laws and regulations that suit them, while arguing that corporations shouldn't pay any taxes to support the government that grants them various subsidies through the election/lobbying/regulation (deregulation) process.  It has supported the US movement towards "free trade" agreements, such as NAFTA, that have been difficult for the poor in countries with whom we trade, for environmental protections in the U.S., and  for locally owned businesses and local workers in the U.S.

If you avoid the corporatist agenda and start out with the assumption that corporations pay tax (because we have treated such entities as taxpayers under the Code), then you can recognize that corporate tax policy can be set to permit reasonable profits and to disincentivize unreasonable--i.e., societally undesirable--behavior.  An example would be the problem of corporate consolidation in a globalized economy, which provides inordinate power to multinational entities (I have called them quasi-sovereigns) and significantly reduces the power of ordinary employees. 

To understand something about the problem of corporate consolidation (as if the 2007-08 financial crisis caused by "too big to fail" financial institutions shouldn't have been enought), read the book Methland: The Death and Life of an American Small Town, by Nick Reding (Bloomsbury 2009).  In trying to understand the causes of the meth explosion in U.S. rural towns, it details the devastating effect of corporate consolidation on rural workers and economies--Big Agriculture and Big Pharma essentially bought out the vertical processes (for Ag, from seed to table, with a few firms like Cargill, Tyson, and ADM controlling huge swaths of the American food system).  In the process of gaining control, they consolidated many small, local producers, shut out unions, sought-out illegal immigrant labor to avoid wage and benefits laws, and dropped wages--in one case, wages for workers in an Iowa meat processing plant dropped overnight from around $18 an hour to less than $6 an hour, with a simultaneous cut off of benefits. See Methland, at 69 (noting the decline in wages when Cargill took over the formerly locally owned Iowa Ham plant in 1987). 

"[T]he evolution of the meth epidemic had occurred in lockstep with three separate economic trends that had contributed to the dissolution of small-town United States.  ...  And the things that spurred this simultaneous rise and fall: the development of Big Pharmaceuticals, Big Agriculture, and the modern Meican drug-trafficking business."  Id. at 109.

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"By 1999 ... Cargill-Ecxel [an agribusiness plant in Ottumwa Iowa] placed newspaper advertisements in the poork, industrial border towns of Jarez and Tijuana offering two free months' rent to workers who could make it to Ottumwa from Mexico.  For Cargill and the rest of the packing conglomerates, employing illegals would appear to have been the best of all possible situations, for the simple reason that these employees, lacking legal identification, didn't technically exist, and therefore had no rights.  Nor were they apt to argue with the harsh conditions of an industry that continues today to have the highest rate of employee injury in the United States.  A failed 2001 federal criminal case brought against a Tyson plant in Shelbyville, Tennessee made clear that corporations would essentially not be held liable for employing or recruiting illegal immigrants to work in the plants.  Despite the fact that two Shelbyville managers were caught on tape by federal investigators asking human traffickers for five hundred undocumented workers over four months, Tyson's defense team successfullyh maintained that it's too difficult for Tyson employees to determine who's who among legal and illegal employees.  The ruling institutionalized the notion that employers of immigrants are not beholden to offering the same rights to workers that other companies must, for the simple reason that they don't know--and don't need to know--who works for them."  Id. at 153.

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"Consider what used to happen in Oelwein, Iowa before the large scale consolidation in the 1980s and 1990s of almost every niche of the food-production chain.  Corn farmers...would have bought seed from the local seed company.  Once harvested, that corn would go to a grain elevator, also locally owned.  It would be shipped to a small feedlot in order to fatten cattle raised in Nebraska, Wyoming, Florida or Arizona; or perhaps it would go to a dairy in northern Missouri, a chicken farm in Indiana, or a pork outfit in Kansas.  The variables were infinite and the market was dynamic.  The barge, truck or railroad car that carried the grain was likely independently owned, too, as would have been the pigs, cows, and chickens it fed.  At each stae, the price would have to be 'discovered' as multiple potential customers vied to handle the product, with competition keeping the price 'true'... in the context of the marketplace.  Eventually, the Oelwsin corn used to feed sows in Topeka might return to Oelwein in the form of hocks to be disassembled, packaged, and shipped at the Iowa Ham plant... From there, a whole new market ... would take over in order to distribute the food and sell it at the retail level, perhaps at the grocery once owned by the Leo family (which today is an IGA).  James and Donna Lein would have been the essential building blocks in a vibrant system in which the variables contributed at all stages to what's called the 'social capital' of rural communities.

Beginning with the precedent set in 1987 with the IBP takeover of Hormel in Ottumwa--and the subsequent takeover of Iowa Ham by Gillette--a few companies would come to control most of the U.S. food business. ... Price discovery no longer happens; the value chain is controlled by a limited number of entities.  Seed is not sold; it's biogenetically engineered by companies like Monsanto, which entered into a joint venture with Cargill in 1998.  Cargill--not the farmer--owns the corn this is grown [under contract]....  In the Illinois and Ohio river valleys, Cargill owns 50 % of the grain elevators and other storage facilities.  Along with Tyson, Swift and the National Beef Packing Company, Cargill owns 83.5% of the beef packing inustry [and so on for turkey production, flour milling, ethanol production, animal feed plants, and soybean crushing]. Id. at 169-160.

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Once competition has been annihilated ... the surviving companies, like Cargill, begin to effect political decisions through their enormous lobbying capabilities.  The government no longer governs unimpeded: it does so in tandem with the major companies. Id. at 161 (citing Douglas Constance, a rural sociologist at Sam Houston State University, Huntsville Texas).

This loss of local ownership through massive consolidation of business enterprises was a change orchestrated from the top of the U.S. government under Reagan's policies of privatization, deregulation, tax cuts (and loosening of tax and antitrust mechanisms that had worked against consolidation), and militarization.  It is a change continued today through the more and more flexible tax regulations and Code provisions governing tax-free reorganizations.  These policy approaches supporting consolidation of enterprises both vertically and horizontally favor the development of powerful corporations that can influence governmenbt in their favor while demanding subsidies (bonus depreciation, expensing, and other tax loopholes that have steadily reduced corporate taxes well below 25% for most of those that pay them at all, even while the rates remained statutorily at 35%.  Looking at the way corporate consolidation has harmed rural America should lead us to ask whether reversing the policies favoring such consolidation--such as making tax-free reorganizations much more difficult, pursuing anti-trust violations under new theories that look to the problems inherent in quasi-sovereign corporate entities, charging corporate and other businesses an expatriation fee equal to the increase in value of business assets while in the United States--may not be worth considering as one step in remedying both the "too big to fail" and "quasi-sovereign" problems while also providing resources to address the thin safety net and falling wages of the bottom of the income distribution.

For more ideas on inequality and its relation to a dynamic, growing economy and more stable society, see Mike Kimel's post on Angry Bear, The Pelzman Effect: Why Economic Growth Has Slowed in the US over Time.