ataxingmatter

Florida's "Biblical Use" Exemption

A new Florida statute (L. 2006, H 7183 (c. 164)) takes effect on the first of July.  It provides an exemption from ad valorem tax for the use of property owned by a 501(c)(3) tax exempt organization to "exhibit, illustrate, and interpret Biblical manuscripts, codices, stone tablets, and other Biblical archives, provide live and recorded demonstrations, explanations, reenactments, and illustrations of Biblical history and worship; and exhibit times, places, and events of Biblical history and significance."  Id.

Now, this is clearly not a federal tax issue (the State is merely using the federal tax-exempt organization category as a part of its definition for the tax expenditure).  But is it a constitutional one?  Is it really cricket for a state to single out events and exhibits related to the Bible for a tax exemption?  Yes, parts of the Bible are sacred to both Jews and Christians, but isn't this providing the imprimatur of the state selectively to the Judeo-Christian heritage over all other religious heritages (Muslim, Hindu, Buddhist, etc.)? Maybe the legislators who passed this law, and Jeb Bush who signed it into law on June 9, would argue that it is merely a form of support for a particular type of historical scholarship/experience that just happens to be closely connected to fundamentalist Christian views. 

But the facts, as always, are telling.  This legislation was passed to aid a specific entity--a Christian theme park in Orlando, Florida called the Holy Land Experience.  See this discussion in the St. Petersburg Times.  The park is quite profitable, and the local county in which it is located tried to tax it (about $300,000 a year).  The park argued that the profits financed its Christian ministry and so it was entitled to a property exemption.  The park won the first round in court, but the county appealed.  Then the legislature decided to step in and make sure that the institution couldn't be taxed.  The county has now conceded defeat on the issue and dropped its suit for back taxes.  See Holy Land Experience Wins Final Round.  The Republican state senator who sponsored the bill said it was intended to cover only the Christian theme park and that it had been "stiffly worded" to ensure that object.  Id.  But, of course, there are always loopholes that can be exploited.  Apparently a creationist group that runs a dinosaur park is trying to become eligible for the exemption now.  Id.

Even conceding arguendo the constitutional concern (i.e., a violation of the First Amendment Establishment Clause because the state is selectively endorsing a particular religion), I wonder about the wisdom of this kind of preferential treatment for activities so closely associated with evangelical Christians today.  We are a pluralistic society with people whose roots lie in many different cultural and religious heritages.  Where is the state regard for the Koran, the Vedas and the history of religious societies and worship that those documents represent?   Our basic notion of respect for individuals depends on respectful treatment of each person's core beliefs and values, even though they may differ from our own.  Florida seems to have missed the boat here.

The Tax Foundation doesn't much like the exemption, either (one of the few times our positions are not diametrically opposed).  Predictably, it doesn't express much concern for the impact on democracy, but it does note the market distortions when one theme park gets an exemption because of its religious affiliation and all the others have to compete against that favored position.  See this item on the Tax Foundation site.

By the way, this is not the only time that Florida has been in hot water over tax exemptions applying preferentially to religions.  There is also a lawsuit underway by a Wiccan group that is contesting the Florida sales and use tax exemption for religious books. See here.  The Wiccan group apparently was charged sales tax on a Satanic Bible but not on a Christian Bible.  Even though it is considered a church in Florida, the incident led it to contest the constitutionality of the statute that exempts religious publications from tax.  The Florida Supreme Court has agreed to hear the case. See this Florida Baptist Witness story (the paper filed an amicus brief in favor of the religioius tax exemption). 

One has to wonder just which publications qualify as religious publications?  The Bible, Koran, Torah. Is any publication by a seminarian or theologian or even a scholar in a religious studies department a religious publication?  If so, why? If not, why not?  What about a publication of the writings of Martin Buber?  Is every publication by the Catholic Church a per se religious publication?  What about publications by the State of Israel? 

Apparently, one supporter of the religious materials tax exemption thinks that changes to court personnel (presumably, the Florida Supreme Court, but this could also reach the U.S. Supreme Court) guarantee a religion-friendly outcome to the case. 

According to Mathew Staver, president of the right-wing Liberty Council, which has ... filed a brief in favor of the law, "In case the Wiccans haven't been paying attention lately, they should realize the times have changed. We have a new court." Carl Jones, Daily Business Review, Wiccan Lawsuit May Spell Toil, Taxes and Trouble for Fla. Justices (Nov. 21, 2005).

As someone who believes strongly in the importance of maintaining the separation of church and state, I find that statement worrisome.  The Establishment Clause protects religious groups as well as those who are not religious.  The trend towards bringing religion into the political discourse, funding religious groups with tax revenues (in ways that are not always careful to ensure that the tax funds are not being used to proselytyze), and providing special tax subsidies or exemptions for religious groups (especially for activities that are identified with Christian groups) suggests that we are forgetting the Salem witch trials and all the other problems that develop when there is no wall between church and state.

Estate Tax: More, from Bruce Bartlett (updated)

The Senate apparently won't take up the House's "reform" of the Estate Tax this week, but Frist still intends to bring it to the floor before the November elections, if he thinks he can add enough "sweeteners" to bring in wavering Democrats, like the House's addition of a provision cutting taxes for the timber industry.  I'm still hopeful that the Democrats (and maybe a few Republicans) will stand strong on this one. 

In the meantime, the barrage of op-eds, editorials, and articles continues.  Bruce Bartlett (whose earlier Wall Street Journal op-ed on the taxation of illegal immigrants I found short on understanding of the way these hard workers contribute to our system by paying taxes, under borrowed social security numbers or legitimate numbers provided by the IRS, see this post), also wrote an op-ed for the Wall Street Journal on June 20, 2006 on "Estate Tax Questions."  He raises three questions that he claims "need answers" before final resolution of the estate tax issue.

The first question is whether the current support for raising the estate tax exemption and reducing the tax rate by those who have been opponents of repeal is due to the "strong case" made by proponents of repeal and the ability of proponents to garner majority support in the House and Senate. Bartlett claims that it is "absurd" to consider people with estates at the 2001 exemption level "rich in any meaningful sense of the term" and therefore these smaller estates are inappropriate targets for the estate tax.  He credits the repeal effort for convincing many opponents of repeal that an increased exemption level makes sense, claiming that "the middle class would still be subject to the estate tax without the efforts of those seeking repeal."

To respond requires some unpacking. First, I'm quite willing to credit the estate tax repeal effort with bringing the various attributes of the estate tax to the attention of the nation.  Regrettably, it has been in the context of considerable misinformation and repeated sloganeering around ideas. There has been a well-coordinated and well-funded effort by wealthy families and certain think tanks, such as Grover Norquist's Americans for Tax Reform (see this prior post  about ATR, on a different topic regarding Norquist's apparent use of ATR in connection with Abramoff's lobbying scams), the Cato Institute, and the Tax Foundation, to present a litany of sound bites to convince Americans (and Congressional Democrats) that estate tax repeal is necessary.  The continued drumbeat for repeal tended to cause people to (i) think they might lose their family farm (because of the misleading discussion of loss of family farms and family businesses to the estate tax, without mentioning the generous installment payment provisions already in the Code to deal with liquidity issues or the lack of empirical evidence of any farms being lost because of the tax), (ii) to consider the estate tax inherently unfair (because of the misleading claims of "double" and "triple" taxation, when in fact much of a taxable estate is unrealized appreciation that has never been taxed during the decedent's lifetime or perhaps even during prior decedents' lifetimes),and (iii) to put pressure on opponents of repeal to consider what changes might be acceptable short of repeal, a process that has not yet ended.   Thus the "credit" might rather be "blame" for causing the estate tax to be discussed in an atmosphere of misinformation instead in one of careful deliberation around the reasons for the estate tax, the importance to a democracy of limiting the gap between haves and have nots, the empirical evidence about who pays the estate tax and how much is paid, and the relationship between the estate tax and the income and gift tax regimes. 

Further, it should be made clear that all opponents of repeal do not support raising the exemption and reducing the rate---certainly not to the levels contemplated by the purported "compromise" bill passed by the House.  I would prefer to see the estate tax converted to a more steeply graduated tax, with a top rate above the 2001 rate of 55% (perhaps even 65% for mega-estates) and the bottom rate, for the smallest estates that barely exceed the exemption level, no lower than 40%.  I'd like to see the exemption remain somewhere in the $1- $2 million range, with inflation adjustments to prevent downward bracket creep--it should be high enough to exempt the estates of well-provisioned middle class families, but leave most of the top quintile subject to the estate tax. When the exemption is taken into account, the effective tax rate will be well below the statutory rate.  In fact, the effective tax rate on the largest taxable estates under current law with a $2 million exemption is only about 14%--less than the capital gains rate. 

Further, for most ordinary Americans who have assets well below the $600,000 exemption level that applied in 2001, estates of that magnitude are indeed "rich."  Wealth is relative in a society where the median annual income is considerably less than $50,000 a year and the assets held by a family, even in the middle class, may consist primarily of the equity in a home and a small amount in a savings account.  The fact that $600,000 homes are not "uncommon" does not mean that they are not in fact the exclusive province of a very select group of Americans. The ordinary middle class family of four living on $40,000 a year does not live in a $600,000 home.

It  is true that the staggering wealth of the ultra-rich in this country today is vastly different from the modest wealth that a home and bank account with a few stocks and bonds or retirement annuity represent.  That staggering wealth is indeed the prime target for the estate tax.  That is why a progressive rate structure for the estate tax would be imminently reasonable, with estates worth $30 billion taxed considerably higher than estates worth only $1 million.  The estate tax, after all, is the final chance to collect at least one level of tax on unrealized appreciation that makes up a large portion of such estates, and is a device that protects democracy by making it harder for families to accumulate wealth that can be passed down to succeeding generations, creating an unlevel playing field.

Bartlett's second question relates to the driving force behind repeal of the estate tax.  He says that supporters "constantly say that the repeal effort is driven solely by a few rich familes that are selfishly pushing for repeal."  But he says, "if that is true" why do majorities of Americans support repeal, as shown by various polls and surveys?  He suggests there are two reasons--people believe the tax is unfair--savings and income are taxed during life and shouldn't be taxed again at death, or people believe they will become rich and their heirs will lose more than half their assets to the government when they die.

First, it is clear that the effort for repeal is being pushed by a few wealthy families and affiliated entities.  See this post about the Public Citizen/United for a Fair Economy report on the way wealthy families have bankrolled the repeal effort.

Second, the  majority's apparently negative views towards the estate tax as revealed by polls may well be a combination of Bartlett's suggestions--many Americans may believe it is unfair or believe they will be subject to losing "more than half of their assets" when they die.  But then we have to question the source of those beliefs.  The repeal effort has apparently done everything in its power to make Americans think that way. Certainly, given the exemption level and the fact that the effective rate on even the largest estates is around 14%, it is erroneous for any American to believe that they might lose "more than half their assets" just because the rate (in 2001) was 55%, or to believe that ordinary Americans lose their family farms year after year to the estate tax, or to believe that many families are hard pressed to pay their heavy estate tax burden.  That suggests that the main problem with the majority's view against the estate tax is that they aren't basing their views on a full explanation of the facts. Similar misconceptions about the actual workings of the income tax system--that lead people to support regressive tax reform (i.e., a flat tax or consumption tax) when they actually believe that progressive tax systems are better--have been documented by Joel Slemrod.  See Slemrod, The Role of Misconceptions in Support for Regressive Tax Reform, 59 Nat'l Tax J. 57 (2006). See also Maria Petrova's article on "Inequality and Media Capture," which argues that "[p]eople's support of redistributive policies depends on information they have about the tax system and efficiency of public projects." Id. at Abstract (noting that the rich can capture the media to "manipulat[e] public opinion," at a cost of course, so that "higher inequality is associated with lower media freedom").  The American public's lack of understanding is due in part to failure of those who believe the estate tax is important to adequately inform the public about its benefits and the way it works, and in part to the success of those who are pushing repeal to portray the estate tax as something that hits ordinary families, when in fact it does not.

(Another factor might be Americans' dismal ignorance about the actual income and wealth distribution in this country.  I recall reading--sorry, I no longer have the cite--a statistic along the lines of the following:  more than 40% of Americans think that they are in the top 5% of the income distribution.   That misinformation could easily make Americans worry that their little bit of savings will be subject to tax.)

Bartlett's third question is based on a letter to the editor in the New York Times in which a reader wrote that the estate tax is basically optional because of all the planning around it that can be done, so repeal is really unnecessary.  Bartlett suggests that is "the worst defense of any tax I have ever heard" since it indicates that the tax is arbitrary and falls only on the ignorant.  He concludes with the statement that "estate tax supporters have a lot of nerve turning a fatal flaw in that tax into a prime virtue."

Come now, Bartlett.  It really isn't cricket to take a single (tongue-in-cheek?) letter and imply that "estate tax supporters" generally are taking that position.  (To be fair, Bartlett says that he "often hear[s]" such an argument.)  I saw the letter to the editor when it appeared.  I thought at the time that elimination of loopholes is the answer, not elimination of the estate tax.  So  there is a point to be considered here.  As Bartlett notes, proponents of revenue reductions have frequently made the "argument from noncompliance" in favor of one more revenue reduction.  It goes something like this.  "There is a tax on X.  Taxpayers have been evading the tax on X.  Therefore we can cut evasion of taxes by eliminating the tax on X."  My response to those arguments, made elsewhere in this blog, has consistently been that the effort should be directed to the problem.  If avoidance or evasion is the problem, develop ways to eliminate the avoidance, not the tax.  So, in the case of the estate tax, Congress should simply legislate away the various known devices for avoiding the estate tax rather than eliminating the tax.  Neither Bartlett's response (noncompliance by sophisticated taxpayers is a "fatal flaw" that should lead Congress to repeal the tax) nor the letter writer's assertion (it's "optional" so no need to repeal it) is an appropriate legislative response to noncompliance and loophole usage.  Noncompliance, and the various devices currently permitted for avoiding estate tax, should be dealt with so that sophisticated taxpayers cannot simply "plan around" it.   

All in all, Bartlett's arguments seem rather like straw men on the field that really counts--should we eliminate the estate tax, which serves as the one way to capture tax on much of the value of wealthy estates, or should we retain it?  If we retain it, in what form does it make sense to have a wealth transfer tax apply?  Should we, in fact, enhance the millionaire's estate tax, so that it plays a more significant role in leveling the playing field for new generations?  In answering that question, do we need to consider the way wealth translates to power and influence in a democracy?  Are there points at which accumulations of wealth can actually threaten democracy's sustainability?

These are the questions that should be openly discussed on the floor of the Senate the next time Frist brings estate tax "reform" to the floor.

KPMG Tax Shelters (4): Thompson Memorandum

In an earlier post, here, I discussed Judge Lewis Kaplan's hearing regarding the prosecution's apparent application of the Justice Department's Thompson Memorandum to pressure KPMG to withdraw payment of attorney fees for the KPMG employees indicted in the tax shelter scandal.  KPMG first capped the fees it would pay at $400,000 and then terminated legal fees for some of the indicted employees.

Judge Kaplan held a hearing on May 8 in which he appeared to side with the individuals and against the government.  See, e.g.,  Judge Kaplan Has KPMG, Prosecutors and Thompson Memo Under a Microscope, 20 Corporate Crime Reporter 21 (May 19, 2006).  As Mark Hamblett  noted in the May 26 New York Law Journal, the "Briefs [for the hearing] Reflect High Stakes in Fight Over KPMG's Attorney Fee Policy."   

Big guns fired for the defendants--the Securities Industry Association, The Association of Corporate Counsel, the Bond Market Association, the Chamber of Commerce, the New York Council of Defense Laywers and the National Association of Criminal Defense Lawyers all filed amicus curiae briefs.  Id. They argued that government pressure on firms to withhold funds for representation is unconstitutional interference with the Sixth Amendment right to counsel and the Fifth Amendment right to due process, as well as deprivation of a property interest.   One amicus brief argued that the potential for a firm to refuse to pay legal fees would make it harder for employees to get loans from financial institutions to cover their defense and would make the "busiest and most effective" criminal attorneys reluctant to represent them.  Briefs [for the hearing] Reflect High Stakes in Fight Over KPMG's Attorney Fee Policy. 

The government, for its part, argued that it had not pressured the firm but merely inquired about its practices.  The government suggested that its interest had not been determinative:  it sent four letters to KPMG about employees who were not cooperating, and in only one of those cases did KPMG terminate fees.  Id.

Tuesday morning Judge Kaplan released his decision on  KPMG executives' attorney-fee claim.  He ruled that the government had "held the proverbial gun to [KPMG's] head" and "violated the Constitution it is sworn to defend."  He found violations of both the Fifth and Sixth Amendment rights, and concluded that the "volume of evidence and the limited budget of many of the defendants had hindered their ability to construct defenses."  See this Jonathan Stempel story on Reuters and this New York Times story. 

I am not a constitutional lawyer and so will not comment on the intricacies of the Fifth and Sixth Amendment claims.  As someone who cares enormously about the way our justice system works in practical matters in a society that is increasingly divided between the haves and the have nots, however,  I find myself wondering why these defendants should be entitled to hundreds of thousands of dollars of legal fee assistance from their firm, when poor defendants may be stuck with a barely competent attorney from a public defenders office who has neither the time, money, nor inclination to acquaint himself with his client or mount a sophisticated defense.  It seems to be yet another example of the way our system is tilted in favor of those who have access to power.  This decision will ensure that powerful executives continue to have the best team of defendants that their employer corporation can provide to sift through reams of evidence, but it won't do a thing to protect the many poor criminal defendants who may even face the death penalty with counsel who literally sleep on the job. 

I  wonder, too, about the role that corporate indemnification arrangements play in managers' decisions to engage in aggressive strategies that push the legal envelope, whether in terms of financial accounting ,as in the Enron case, or tax shelters, as in the KPMG case.  By removing the risk of having to use personal resources to pay for their own defense or possibly having to use less skilled lawyers, indemnification arrangements may free managers to take "too much" legal risk.  One way to lessen the impact that such arrangements may have would be to require employees to repay the funds if they are found guilty, as is sometimes done.  Reasonable caps on the indemnification amount might also provide a cautionary signal to managers.

Income Inequality: The Dwindling Middle Class

The decline in the middle class, and the explosive surge in the income of those at the top, is beginning to impact neighborhoods in cities across the countrry.  See Study Shows a Dwindling Middle Class, in the June 22 New York Times.    

                                        

Source: The New York Times

(click to enlarge).

The Times story reports on a recent Brookings Institution analysis of census data from 1970 to 2000, announced with this release: Where did they go: the decline of middle-income neighborhoods in Metropolitan America (the study itself is availabe in pdf format at the link).  In particular, the study found that middle-class neighborhoods are disappearing, from 58% down to 41% today, and that neighborhoods are more and more likely to tip towards one or the other end of the income spectrum--either all high-income or all low-income.   Central city, middle-class neighborhoods are becoming especially scarce--dropping from 1970's 45% of all central neighborhoods to 2000's 23%.

One has to wonder about the impact of the growing homogeneity of neighborhoods in big cities.   Will  the wealthy reside more and more behind their gates protected from any interaction with ordinary Americans, like the Green Zone in Baghdad?  As rich people have less and less occasion to encounter ordinary Americans in the middle class, will they become even more blase about economic deprivation?  Will they tend to be even less supportive of fiscal and tax policies that require them to give up some small portion of their wealth so that government functions can continue? 

The loss of middle-income neighborhoods may change the character of cities in far-reaching ways that we can only begin to imagine.  It is but one further worrisome aspect of the increasing gap between rich and poor.

Buying the Taxpayer Movement: Abramoff and Norquist

This is a different kind of tax scam.  Not the case where a wealthy taxpayer sells a business and wants to avoid tax on a $70 million capital gain so hires a well-known accounting firm to devise a complex transaction using various financial derivatives to generate an artificial loss to offset the real gain.  Not the outright fraud of the shim-sham man who counseled hundreds that the federal income tax applied only to foreigners. 

Instead, this involves buying influence and power over Congress.  It turns out that Jack Abramoof didn't always want it to be clear whose money was going to whom for what.  So the corrupt lobbyist did what most crooks do--he "laundered" the money.  What is interesting here is just who did the laundering.   In effect, some tax exempt organizations served as a hidden part of Abramoff's lobbying empire.  See this AP story on Prob Links Norquist, Abramoff.

Remember Grover Norquist, who consulted with Mr. Bush back in 2003 about the best way to cut taxes for the rich?  Norquist runs Americans for Tax Reform, a group that has aggressively lobbied for estate tax repeal, privatization of Social Security, and consumption-type taxes that exempt capital income from taxation.  Norquist hosts get-togethers in Washington where people of privilege can rub shoulders with high officials in the Bush Administration.  See this item on DailyKos from the National Journal.

Norquist is also an old buddy of Abramoff, from college days, so Norquist's group also served as a conduit for money flowing from Abramoff clients to finance fake grassroots campaigns--Abramoff just needed to remind himself to "Call Ralph re Grover doing pass through."  (That'd be Ralph Reed, the purportedly upstanding leader of the Christian Coalition and now a politico in his own behalf.)  See Susan Schmidt and James Grimaldi, NonProfit Groups Funneled Money for Abramoff, Washington Post, June 25, 2006, at A1 (reporting on the Senate Indian Affairs Committee report on tribal lobbying). 

Abramoff also cautioned Norquist to be discreet, since they wouldn't want to appear to be "buy[ing] the taxpayer movement."  Id.    The article notes that Norquist claimed that his group and Abramoff's gambling clients just happened to share the same anti-tax views and that ATR wasn't concealing the source of funds.

The Senate hearings on the lobbying activity are available at this Indian Affairs Committee site.  The 373-page report, "Gimme Five--Investigation of Tribal Lobbying Affairs" (June 22, 2006), is available in pdf form here.  The report concludes that various tax-exempt organizations were engaging in activities outside their purpose, helping to channel funds to hide their source and/or to evade taxes, and serving as "extensions" of lobbying organizations.  Yet the committee concludes that no further legislation is needed and settles for recommending some "best practice" measures.

I suspect lobbying needs to be more strongly regulated.  How about publicising the time, place and names of lobbyinsts who meet with any government official?  And organizations like ATR that have funneled money from one pocket to another should be denied tax exemption.  These activities of serving as a conduit go  to the core of the purpose of tax exemption--it was not intended to facilitate the Abramoff-Norquist type of influence-peddling.

Trading the Golden Age for the Gilded Era (2)

In the prior post with this title, I outlined various statistics indicating growing inequality in America today.  The growing income inequality has caught the attention of various writers.  Here are two quite different articles worth noting. 

First, Mother Jones ran a catchy two page item by Clara Jeffery, on Poor Losers: How the poor get dinged at every turn, 31 Mother Jones 20 (July-Aug. 2006) (not yet available online).  A graphic, titled "The Rich Rise, the Poor Stagnate" shows average household income by quintile, with the top quintile taking off steeply and all the rest staying about the same or rising only minimally.  The two page "loser" item is one statistic after another showing the way that ordinary Americans are losing out. Here are a few.

During the 1980s, 13% of Americans age 40-50 spent at least one year  below the poverty line; by the 1990s, 36% did.

51% of the uninsured are $2000 or more in medical debt.  16% owe at least $10,000.

Since 1983, college tuition has risen 115%.  The maximum Pell Grant for low-and moderate-income college students has risen only 19%.

2 in 5 elderly live on less than $18,000 a year, including Social Security benefits.

52% of poor college-qualified students go to a 4-year college within 2 years of graduating.  83% of richer qualified students do.

The average credit card balance for households earning less than $35,000 is $4000. At 11.5% APR, making the standard minimum payment of 2% per month, it takes 13 years to pay off a $4000 balance.

1 in 4 subprime lenders are predatory, charging recipients 7% in up-front fees.  Conventional or 'prime' mortgage users are charged only 1%.

Nationwide, the number of payday lending outlets has risen 11,000% since 1990.

Think about what these statistics mean, next time you pay a credit card bill or take a child to a hospital emergency room.  For many ordinary Americans, once an emergency overtakes them, they are in hock for the rest of their lives to predatory lenders and pawnshop owners who make their living off the poor's desperate need of funds.  These stark realities are getting worse, as more families slip below the poverty line.

Second, the New York Times, June 25, 2006, at BU 4, ran a special "Economic View" by Anna Bernasek on Income Inequality, and Its Cost.   The following graphic illustrates the growing disparity.

 

Source:  New York Times, Jun. 25, 2006, BU-4 (starting at about 1986, and showing the share of total income going to the top 1% and the top 0.1%.  The top 10% garner a full 42.9% of the income).

Bernasek begins with an interesting question.

Inequality has always been part of the American economy, buyt the gap between the rich and the poor has recently been widening at an alarming rate.  Today, more than 40 percent of total income is going to the wealthiest 10 percent, their biggest share of the nation's pie in at least 65 years.  The social and political repercussions of this disparity have been widely debated, but what about the effects on the economy?

Looking to the few studies done, she notes "disturbing" results.  There is more bad health in unequal societies.  People who live in unequal societies are stressed out and unhealthy, costing society dearly.  For example, the US is a less egalitarian society than the UK, and people in the US are sicker than people in the UK.  There is also more corruption, especially in democracies with lots of wealthy people to buy and influence government officials.  Corruption impacts the economy by interfering in the efficient operation of government, leading to special allocations of resources, distortions of investments and maybe even creating asset price bubbles.  Inequality may also bring about psychological effects that lower productivity.  Workers who see CEOs getting obscene pay can't quit, since they need a job, but they may work less hard and pay less attention to quality.

Inequality is hard to cure, since the more of it there is, the more there will be.  It's a little like rabbits breeding in Australia.  The rich use their influence to get policies made to suit themselves, so they can get richer.  Just which policies?  Here's what Bernasek has to say.

In the United States, there is plenty of evidence that this [wealthy influence of political outcomes, leading to less redistribution] has been occurring.  Bush adminstration policies that have already reduced the estate tax and cut  the top income and capital gains tax rates benefit the well-to-do.  It seems hardly an accident that the gap between rich and poor has widened.

That, of course, is the topic of the next item in the series summarizing my YearlyKos economics panel presentation on inequality, revenue reductions, deficits, debt, and gimmicks.

Trading the Golden Age for the Gilded Era

The following is drawn from Linda Beale's presentation at the Panel on the U.S. Economy at the YearlyKos Netroots Conference in Las Vegas, June 9, 2006.

From 1948 to 1973, the US experienced a period of broad-based well-being based in high GDP growth coupled with high real per capita income growth of about 2.7% annually.  That Golden Age coincided with significantly lower income disparity than in current times, triggered in part by the Great Depression (which brought considerable real economic loss to many oligarchic families), WWII price controls (which limited excess profiteering from wartime necessities), and the post-war GI Bill of Rights and Civil Rights legislation (which provided enormous opportunity for human capital enhancement for a burgeoning middle class). See Bejamin Friedman, The Moral Consequences of Economic Growth, Ch. 8 (2005).  Although the income base subject to tax, tax rates, income brackets and number of taxpayers covered varied considerably during the period, the Golden Age also coincided with a significantly more progressive federal tax system than today's, with the highest marginal rate between 70 and 94% and considerably more bracket and rate differentiation among groups of taxpayers.   See this Tax Policy Center chart of marginal rates, this chart of top rates and income level at which those rates applied at TruthandPolitics.org, this Tax Policy Center chart of brackets by year for 1954-1964 and this schedule for checking brackets for other years, as well as this Treasury Department Fact Sheet on U.S. Tax History .  (Caveat: the Treasury fact sheet must be read with some skepticism, in recognition of the extent to which this agency's documents have become politicized and partisan in descriptions and filtering of facts, including statements about cause and consequence that may not be substantiated--such as the statement that tax increases in the thirties "weakened the economy" and the description of the Reagan revenue reduction of 1981 that fails to explore the 1982 and following revenue increases.  Similar concerns surround the revamping of the IRS website, which apparently now archives the Statistics of Income reports only back to 1999.). Today, of course, those with hundreds of millions of annual income are taxed at rates no higher than those with a few hundred thousands.  See Section 1 of the Internal Revenue Code. 

It would seem reasonable to conclude from that Golden Age that our economy and our democratic society prospers most when opportunities and the benefits of growth are spread broadly.  Why, then, have we traded the kinds of policies that facilitated the Golden Age for red-ink, "borrow and squander" fiscal policies that appear to reflect willful indifference to the well-being of ordinary Americans? 

This Congress and Administration have enacted revenue reductions year after year that most benefit wealthy corporate managers and investors who can already afford whatever savings they wish and who already disproportionately enjoy reduced tax burdens due to the many tax expenditures for generous retirement savings, home and vacation home ownership, and unrationed health costs including spas and pools that ordinary Americans cannot afford even when desperately needed. Worse still, these revenue reductions that benefit the wealthy have been financed with enormous long-term debt and executed or threatened program drawbacks in areas that are most important to ordinary Americans--especially students and the elderly-- such as Medicare, Social Security, and student loans.  If such drawbacks continue, ordinary Americans whose savings and earnings are too fragile to cope with sudden, unexpected expenditures will likely face growing malaise regarding fears of disease, disability and disaster.  That lack of confidence in the future would magnify qualms about the government's fiscal irresponsibility, negatively impacting ordinary Americans' consumer spending, which is the main engine of the US economy.

This reverse-Cinderella story, from the Golden Age back to the Gilded Era, rests on five factors: growing income and wealth disparities, revenue reductions, deficit budgets, debt financing, and legislative gimmicks.  This post will focuse on the first factor.  Following posts will look again at the way revenue reductions, deficit budgets, debt financing, and legislative gimmicks have worked together to undo the Cinderella magic of the New Deal effort to bring prosperity to all.

The gap between the rich and poor has been growing steadily over the last quarter century:  the wealthiest 1 percent have gained in wealth share and the rest, most of us ordinary Americans, have lost.  See, e.g., this Wealth Report, The Nation, Mar. 8, 2001.  In 2001, the top 10% in the wealth distribution owned 69% of America's net worth (63% of asseets, 82% of stock, 91% of businesses and only 30% of liabilities).  Id. The trend noted in the 2001 Nation report has continued.  Looking at the period from 1989 to 2004, the Federal Reserve's Arthur Kennickell reports that the share of US wealth of the top 1% grew from 30.1% to 33.4%, while the share of the bottom 50% shrank from 3% to 2.5%.  Arthur Kennickell, Currents and Undercurrents: Changes in Distribution of Wealth 1989-2004, Federal Reserve.   A recent paper The Evolution of Top Incomes: A Historical and International Perspective, by Thomas Piketty and Emmanuel Saez, NBER WP 11955, January 2006 looks at the top deciles' share of income, and sees similar increases, especially for those with enormous corporate salaries.  See this summary and selected charts on Economists' View.  Corporate wealth shares have risen for top income Americans, while declining for everyone else, "a trend that began in 1991 [and] accelerated in the first year that President Bush and Congress cut taxes on capital."  Corporate Wealth Share Rises for Top-Income Americans, by David Cay Johnston, NY Times (also reported on Economists' View). 

While the wealthy have been garnering more (both in terms of assets and corporate salaries), the most recent Census Bureau data show falling median household income under the Bush Administration.  U.S. Census Bureau, 2004 American Community Survey, Selected Economic Characteristics, Multi-Year Data (showing falling media income from 2000 to 2004).One big cause is the 571% increase in CEO pay between 1990 and 2000, with the top CEO annual pay in 2005 at more than $230 million, while worker pay increased only 37%.  Institute for Policy Studies, New CEO/Worker Pay Gap Study (2001 and updates).  Retirement then creates a "galactic gulf" because lower-income earners simply cannot accumulate enough, compared to the generous pension plans of wealthy corporate managers and the abundant reserves provided by inherited wealth.  PBS Frontline: Can You Afford To Retire (May 16, 2006).  Cf. Jeffrey Ball, Exxon Pensions May Draw Pressure Against Board, Wall St. J. (May 20, 2006), at A2 (noting the $98.4 million pension payment to retired Exxon CEO Lee Raymond). Not surprisingly, poverty in American is on the rise: only 9.3% of families lived below the official poverty line in 2000, but today 10.1% do.  U.S. Census Bureau, 2004 American Community Survey, Selected Economic Characteristics, Multi-Year Data.

These statistics paint a strangely bleak picture for a country whose leaders boast of economic expansion and whose wealth is the greatest of any nation in history.  It behooves the country to consider what policies it should be changing to give ordinary Americans from the middle class down a fairer shake.

Estate Tax: Yet Again

The drumroll claiming a need to reduce taxes on investment income because of inefficient distortions continues.  Martin Feldstein, Reagan's chief economic adviser, writes in the June 2006 Economist's Voice that "Taxes on Investment Income Remain Too High and Lead to Multiple Distortions."  He reiterates the same  arguments made by others who argue for minimal or no taxation of investment income.  The high rate of taxes on the corporate sector drives capital to foreign investments, he says.  This is interesting, when our effective taxes (rather than statutory rates) are actually much lower than most developed countries. One suspects that the drive to foreign investments has much more to do with the higher growth in GDP in China, India and other countries than it has to do with the tax burden in the U.S.  Feldstein also argues that if we assume that only consumption counts (and not the other uses of wealth, such as status and influence) and if we assume that a person who saves today will use those savings in the future, then a tax on savings is effectively a tax on future consumption and therefore distortive.  Those assumptions don't hold, of course, since the the wealthy do not consume all of their wealth during their lifetimes and the wealthy are able to use their wealth for many purposes without consuming it.    In addition, the efficiency arguments gloss over concerns that nontaxation of capital income will further exacerbate inequalities and erode democracy.

The House, however, is actively heeding Feldstein's advice.  On Thursday, it passed yet another profligate tax cut primarily for those with considerable investment income when it passed a modification of the estate tax that eliminates its application to all but the largest estates.  See Jonathan Weisman, House Sacrifices Revenues and Earmarks, Washington Post, June 23, 2006 at A6.  The text passed was H.R. 5638,  introduced on June 19th by Ways and Means Chair Bill Thomas, with a Manager's Amendment providing for inflation adjustments to the $5 million exemption amount and certain relief for surviving spouses. 

The JCT's revenue estimate suggests that the cost of the bill will be only $280 billion between 2006 and 2016.  That is deceptive, because it assumes that the current lower rates will end in 2010, and the rates for capital gains (and hence the estate tax) will revert to pre-2002 levels.  The Republican majority in Congress and the White House, of course, is on record that it does not intend for that to happen.  Without the higher rates, the revenue hit would be considerably more.

Under the 2001 tax legislation, the revenue collected through the estate tax was reduced by gradually increasing the exemption amount and reducing the rate so that in 2009, the exemption amount will be $3.5 million and the rate will be 45%.  Under a budgeting gimmick used to permit politicians to claim the tax cuts were not creating a larger budget deficit than the targeted amount, the estate tax was scheduled to sunset for one year in 2010 and then return to its original 2001 levels in 2011.  Those supporting the measure at the time intended to repeal the estate tax permanently, and there have been various efforts to do so since, including a failed vote in the Senate this month. 

The 2001 legislation also included a number of other provisions that essentially reduced the estate tax burden on millionaire's estates.  The installment provisions that were designed to help closely held family businesses pay the tax due over time were extended to larger partnerships (increasing the maximum number of partners from 15 to 45).  Financing businesses and holding companies that held readily tradable stock of operating companies  were permitted to use the installment method.  Conservation easements were broadened to include easements on any land.  The generation skipping transfer tax rules were also modified to facilitate application of the exemption.  See the discussion of pre-2001 estate, gift and generation skipping transfer tax rules in the Joint Committee on Taxation's Technical Explanation of H.R. 5638.

The bill that passed in the House on Thursday reunifies the estate and gift taxes, by providing a common exemption and rate schedule.  It increases the exemption to $5 million and sets the rate at the capital gains rate (currently slated to be 15% through 2010 and 20 percent after 2010).  The largest estates will be taxed at twice the capital gains rate.   Any exemption amount not used by a deceased spouse may be rolled over to the surviving spouse (subject to a ceiling of $5 million in the case of multiple spouses).  It reinstates the basis step-up (or down, in the case of losses) rule.  It repeals the sunset for the other taxpayer-favorable provisions relating to installment sales, conservation easements, and generation-skipping transfer tax. 

Thus, the bill again cuts taxes signficantly on the very wealthiest Americans at a time of large budget deficits, uncontrolled spending on wars and national security priorities, an increasing accumulation of wealth for those at the top who are receiving most of the benefits of tax cuts, related to a decreasing purchasing power for those at the bottom.  See Professor Maule's discussion of increasing disparity, here on his Mauled Again blog.  In addition, because the estate tax rate will be tied to the capital gains rate, the provision lays the groundwork for more easily abolishing the estate tax in its entirety in the future, without a direct political battle over the estate tax.  The same legislators who support estate tax repeal also support zero taxation of capital gains. 

In order to try to get this tax cut for multimillionaires through the Senate, the House leadership added a "sweetener" (which, as Professor Maule notes , leaves a sour taste in one's mouth).  It is a tax break for the timber industry (an election to deduct 60% of the taxpayer's qualified timber gain for computing both regular tax and the alternative minimum tax.  The assumption is that Democratic Senators in timber states who may be up for election, such as Maria Cantwell in Washington, will be induced to support the bill with this subsidy for their timber industry constituents.  There have always been tradeoffs in bills in order to get passage, but this is an example of the crass kind of tradeoffs that corrupt the Code and the public trust.  It is an attempt to force legislators to vote against their reasoned view of the appropriate treatment of millionaire estates in order to "bring home some bacon" for a particular group of constituents.  Let's hope that timber state Senators develop the spine that is needed to resist being bought in this way.

In-Lieu Payments for Past Tax Shelters?

Some wealthy U.S. taxpayers seem to have begun to view the old saw about the inevitability of death and taxes as 50% wrong.  Taxes are supremely manipulable, they find.  If you can hire the right lawyers, accountants and (especially if your deal involves shifting taxable income away from yourself) amenable foreign investment banks, you can structure a transaction for tax purposes that may look like it has enough of a business reason to exist, and then you may have a nice little tax shelter.

GE worked that magic in its Castle Harbour deal--a purported partnership that shipped most of the taxable income for the limited duration of the venture to some foreign banks, while keeping most of the tax benefits for GE, permitting it to "refresh" its depreciation deductions on a bunch of old airplane engines.  The purported partnership provided a guaranteed rate of return higher than an equivalent investment in GE's commercial paper would have provided the foreign banks, thus rewarding them with a basis point spread for facilitating GE's tax strategy.  The banks took no real risks, since they required that the funds they had loaned be held throughout the limited term of the "partnership" in GE's commercial paper and they arranged other assurances of payment of their return. The banks, in other words, performed as accommodation parties to GE's tax strategy.  In their documents, they treated the transaction as a loan.  GE received tax benefits that it would not have received if the loan had been made by a direct purchase of GE's commercial paper  (and paid a higher rate of return than it would have paid on an investment in its commercial paper).  That higher rate of return can be viewed as the fee paid to the banks to accommodate GE's tax strategy by documenting the purchase of commercial paper as a partnership investment.   Like the stepped-down preferred structure, the GE partnership essentially provided a tax benefit for a loan repayment. 

One  could consider such transactions to violate the integrity of the Internal Revenue Code.     Financings formulated as partnerships in order to deflect taxable income from the domestic debtor "partner" to the foreign lender "partner" who will not be subject to tax could be overturned under the substance- over- form judicial doctrine.  The district court that heard the case against GE, however, upheld the taxpayer's characterization of the transaction as a partnership and did not permit the government to collect the $62 million in taxes that it claimed GE evaded through the structure.

Interestingly, Professor Harold Bierman, Jr., at Cornell's Johnson Graduate School of Management released a working paper last October, On Jack Welch's Watch: General Electric's Tax Strategy in which he concluded that the transaction structure  was "probably not what Congress had in mind in writing the tax laws."  He suggested that the use of clever accounting mechanisms to provide such a tax benefit, even if legal, may be unethical.  He even went so far as to suggest that the new CEO of GE should make an "in-lieu" payment of $62 million to the government.

I doubt that anyone should hold their breath waiting for that to happen.  But the ethical issue of corporations pushing the envelope to develop and engage in aggressive tax strategies is a real one that needs to be addressed.  What ethical obligation does a corporation have to behave as a good citizen that pays a fair share of the taxes due on its income and how can that obligation be made real in today's global business environment where corporations, through their managers, have attenuated bonds to the country in which they incorporate? 

I argued in my first academic paper that the SEC should formulate a tax risk profile disclosure for public firms, that would let investors (and consumers) know whether a company engages in aggressive tax shelter transactions.  Some argued that the disclosure would simply encourage a race to the bottom, as competitors would view it necessary to maintain an equally aggressive tax risk profile in order to stay even.  That is certainly a possibility, and the success of GE's tax strategy in court may tend to encourage others to operate in a similar vein.  In my conversations with tax professionals, both in and out of the academy, I find that many say that corporations should push the envelope as far as possible, as long as their transactions fall within the literal language of the Code.  The social norm on this issue, in other words, may tend to view aggressive tax transactions as a reasonable way for competitive corporations to gain an advantage in a cutthroat market.

On the other hand, the public reaction to the information about Wal-Mart's reliance on publicly funded medical care for a vast number of its employees suggests that the public does care about the social responsibility of firms who become a part of the community.   Disclosure may play a similar   role in encouraging companies to take more conservative approaches to "managing" their tax burden.  Tax sheltering is socially wasteful and a huge cost to U.S. revenues.   It may help if companies become more cognizant of  ordinary Americans' disapproval of aggressive tax avoidance planning.

Tax Poetry

Awright, I know this is supposed to be a serious blog.  But the TaxProf listserve got bit by the poetry bug, and I can't seem to shake it off.  So here's my once-in-a-blue-moon offering for the readership of A Taxing Matter.

Teaching tax can be quite a chore, if students think, as some will do, that rules and regs are just a bore.  Even those who've not yet made their pick of where to practice, at their firm, will give the Code a mighty kick.

We profs continue nonetheless to talk of principles that glue the rules and substance-over-form judicial finesse.  We hope to inspire one or two to see the fun of using statutory tools and merit of shaping good tax policy.

And at the end, we want them to know how central tax is in dealing fair with those who have lots, and those who have not.