ataxingmatter

Nell Henderson of the Washington Post reported today on the Treasury report released yesterday about financing the Bush Administration's tax cuts. Tax Cuts May Come At a Price, Study Says, Wash. Post, July 26, 2006, at D01.   The report, A Dynamic Analysis of Permanent Extension of the President's Tax Relief, purports to apply a "dynamic" analysis that takes into account the effect of the tax change on the parameters being measured.  Proponents of tax cuts have long pushed for such an approach, with some arguing that tax cuts can pay for themselves  by pushing economic growth so high that tax revenues increase in spite of the cuts.  The report itself begins with a rosy description of the economy, attributing what growth there is to the tax cuts with unequivocal language and describing what many consider relatively weak job growth over the past 5 year-period as "strong". 

As evidenced by key economic indicators such as increased capital investment and Gross Domestic Product (GDP), and strong job growth, the President’s tax relief played an important role in strengthening the U.S. economy as it was coming out of the recent recession, and in the longer-term by increasing the after-tax rewards to work and saving. Lower tax rates enable workers to keep more of their earnings, which increases work effort and labor force participation. The lower tax rates also enable innovative and risk-taking entrepreneurs to keep more of what they earn, which further encourages their entrepreneurial activity. The lower tax rates on dividends and capital gains lower the cost of equity capital and reduce the tax biases against dividend payment, equity finance, and investment in the corporate sector. All of these  policies increase incentives to work, save, and invest by reducing the distorting effects of taxes. Capital investment and labor productivity will thus be higher, which means higher output and living standards in the long run.

It certaintly is true that people who have to pay less in taxes will have more of their income to keep.  But does this really mean brisk economic growth will result?  The facts don't live up to the theory.  Even this report, obviously intended to provide ammunition to support the Bush tax cuts that predominantly provide tax relief to the wealthy, suggests a best-case scenario--in which tax cuts are made permanent and are matched by comparable spending cuts--providing only a 0.7 percent rate of growth in economic activity.  That would be nowhere near what is needed to fund the tax cuts. 

And the assumptions about what produces that economic growth are not very heartening for ordinary Americans.  For example, one possibility is that the reduction in income tax rates might act as an incentive for people to work more, putting in longer hours to add to productivity and thus paying higher taxes in spite of the lower rates.  For ordinary Americans who make up the majority of the workforce and many of whom are already putting in long hours sometimes at two different jobs,  working even longer hours likely has little allure.  Much of American productivity has in fact been gained by longer hours worked, not more productive work per hour.  That results in lesser quality of life for ordinary working Americans and does not bring the kinds of long-term sustainable broad-based economic growth that benefits everyone across the board.

The problem with dynamic analysis is that each component of fiscal policy is like a single item on a mobile--move one, and you likely move the others.  But predicting in which direction the pieces will move is like solving the problem of the impact on an Illinois rose petal of a butterfly's flight in China.  There is at least as much guesswork as there is science. See this 2002 Urban Institute discussion of Dynamic Scoring and Budget Estimation by Deborah Kobes and Jeff Rohaly.  Where educated  but subjective guesswork plays a major role, the result may be influenced by partisan pressure from higher ups.   And, of course, dynamic scoring may well mask the true costs of tax cuts by making it look like they will pay for themselves.  See this discussion of dynamic scoring.

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

A Batty Tax Cut--for corporations

I knew eventually I would have to add a category of state taxes and deal with the many issues at the interface of our federal and state tax systems.  I just didn't expect it to be this kind of an issue that brought me to that point.

There has now been introduced in Congress (again) a proposal to "simplify" the tax system by preventing states from taxing many companies that do business in them.  See H.R. 1956 (as reported in the House on July 17, 2006).  The parallel bill in the Senate is S. 2721.   (I say "again" because a bill like BATSA has been introduced in previous years.  See the 2003 BATSA hearing (noting that a similar bill had been considered in the 107th Congress, and the 2005 BATSA hearing.) 

Like most of the purported "simplification" proposals that have come to the floor of the Congress in recent years, this one is really another tax cut giveaway to big corporations and big money, but here the federal government is giving away state tax revenues!  The "Business Activity Tax Simplification Act" (BATSA) will limit state's ability to impose taxes on businesses that do not have a physical presence in the state.  As the Washington Post noted today, in "Another Corporate Tax Break?, at A14,  the old "physical presence" test is outdated in the electronic age.  "[B]eing there and doing business [there] aren't necessarily one and the same." Id.  The bill creates numerous "safe harbors" from tax, which include various activities that corporations currently conduct in states.  See this analysis at the Center for Budget and Policy Priorities.  Not surprisingly, the Tax Foundation, which never saw a tax it liked, argues for BATSA,  see this link, taking the example of a company with sales into a state but no personnel located there.

The Post reports on a Congressional Research Survey analysis-- State Corporate Income Taxes: A Description and Analysis (Updated June 30, 2006)--that concludes this "simplification" proposal would create more "nowhere income"--income that never gets taxed anywhere.  The Congressional Budget Office estimates the bill will drain $3 billion a year from state coffers by 2011.  The National Governors' Association views the bill as adverse to their states' interests and estimate a $6.6 billion drain from their coffers.  See Impact of H.R. 1956, Business Activity Simplification Act of 2005, on States.   The NGA notes the numerous ways that BATSA would change the current relationship of businesses to states and establish mile-wide loopholes through which savvy businesses would escape taxation.

"H.R. 1956 would upset settled law regarding state business activities of numerous industries including publishing, interstate trucking, general and customized manufacturing, the sale of distributorships, licensing of trademarks, and leasing of computer hardware and software. Sellers of services and intangibles would come under a new physical presence standard that exceeds the provisions in PL 86-272 for sellers of tangible personal property. This extension, along with other provisions in the bill, would create new opportunities for businesses to structure their operations so as to avoid most state business activity taxes entirely. Certain provisions, (e.g., the ability for other parties to perform work on the company’s behalf, the 21 day exemption, and carve outs for specific industries) present likely sources of revenue impact. "

See also this earlier report produced by the Multistate Tax Commission, the National Governors' Association and the Federation of Tax Administrators in response to the 2003 BATSA proposal. 

This batty bill that creates nowhere income needs to disappear into nowhere itself.  Can't this Congress think of any solution to the myriad problems that it and this administration have created for us (and the world) other than cutting taxes?  Congress needs to get a life, and get serious about dealing with the fiscal problems that five years of toadying to the wealthy have created.

If you can't cut the estate tax, cut the enforcement team: making sure the wealthy don't pay their fair share

The New York Times carried an interesting article on a scoop based on internal documents at the IRS.  See David Cay Johnston, IRS Will Cut Tax Lawyers Who Audit the Richest (July 23, 2006, section 1 page 13).  "The IRS plans to cut the jobs of 157 of the agency's 345 estate tax alaywers, plus 17 support personnel, in less than 70 days." Id.  The personal ordering the cuts, Kevin Brown, said it was done because far fewer people need to pay estate tax under the Bush legislation that raised the exemption amount and lowered the rates. But the Times articles notes that "six IRS estate tax lawyers whose jobs are likely to be eliminated saiid in interviews that the cuts were just the latest moves behind the scenes at the IRS to shield poeple with political connections and complex tax-avoidance devices from thorough audits."  Another called them "a back-door way for the Bush Administration to achieve what it cannot get from Congress, which is repeal of the estate tax."

This decision to cut enforcement personnel makes no sense from a policy standpoint or from a collections efficiency standpoint.

As for the policy issue, my views on the estate tax are well known to any reader of this blog.  See any of the items under the estate tax category link at the right of the blog.   I believe it is an important accompaniment to the income tax, since it provides a backstop to our messy realization system that lets the wealthiest taxpayers defer tax (often permanently) on huge amounts of appreciation by simply not selling their stock.  Without the estate tax combined with a progressive income tax, there will be little or no opportunity to tax most of the income of the richest few in this country.  Inequality will increase at an ever more rapid pace, and oligarchic families will have final say on every governmental decision.

As for collection efficiency, one need not look further than the IRS's own statistics.  As noted in the Times article, "10 percent of the estate audits brought in 80 percent of the additional taxes."  In other words, wealthy people are the ones with the most to gain from cheating, and estate tax is one of the ways they can cheat most easily, with fake family partnerships and ridiculously low prefab valuations of their valuable property.  As Colleen Kelly states, "If these lawyers are not there to audit the gift and estate tax returns, than a lot of taxes that should be paid will go uncollected, and that impacts every taxpayer who is paying their fair share." 

The Bush administration seems intent on hobbling the country while treating wealthy taxpayers as a special category deserving of a "go past the tax collector for free" card.  The long-term result will be a dysfunctional government, an overburdened middle class and continuing lack of the broad-based economic growth that creates a sustainable, livable economy for all.

Gender Reassignment Surgery: Religion and Tax Don't Mix

Early in January, the IRS dropped what should have been seen as a bombshell when it released Chief Counsel Memorandum 200603025 (Jan. 20, 2006).  That item, prepared in October 2005 in response to a request for advice on medical expense deductions, held that gender reassignment surgery was not a medical expense deductible under Section 213 of the Code.

Section 213 allows a deduction for "medical care" which is defined to include diagnosis, cure, mitigation, treatment or prevention of illness or disease or promotion of the proper functioning of the body.  Congress restricted the provision in 1990 to ensure that no deduction was allowed for purely personal, cosmetic surgery such as face lifts or hair removal by electrolysis.  As the IRS memorandum notes, the Senate, which added the cosmetic surgery restriction, indicated in the Senate Report that "cosmetic surgery" should not be treated as "medical care" unless it treated a congenital abnormality, an accident or trauma or a disfiguring disease. 

The memorandum concludes, apparently in spite of the evidence in the case that the taxpayer in question had a severe identity disorder that had not responded to psychiatric care, that the taxpayer's gender reassignment surgery was "cosmetic surgery" that was not deductible. The memorandum states  "There is nothing to substantiate that these expenses were incurred to promote the proper function of the taxpayer's body" and they "were not incurred for treatment of a disfiguring condition arising from a congenital abnormality, personal injury, trauma or disease."   

In justifying the treatment of this surgery as "cosmetic surgery" that is generally ineligible for the medical deduction rather than treatment for an illness, the IRS memorandum quotes the work of one person--Paul McHugh, a professor who has served as the sex adviser to the Vatican and fought strenuously against the recognition of gender identity problems.  The McHugh article, it claims, establishes that the treatment is "controversial."  The article quoted, which discusses McHugh's decision, as head of psychiatry at Johns Hopkins, to stop recommending gender reassignment surgery and close down the gender clinic thirty years ago, is available on a website maintained by the Catholic Church and originally published in a Catholic religious periodical, the Journal of Religion, Culture, and Public LIfe.  See Surgical Sex, by Paul McHugh (November, 2004).  It includes a paragraph describing transexual individuals in disparaging terms that belittle them as persons.  I see no resemblance in his description to the transsexual women I have met during my professional life as an educator in New York and Illinois.

The American Psychiatry Association recognized gender identity disorder more than a quarter century ago, and gender reassignment surgery is clearly a medical treatment that is reserved for the most severe cases because of the radical nature of the surgery. See this description at "athealth.com". (For a male transforming to a female, the full surgery amputates the penis, provides hormones to enlarge breasts, and reconstructs the pelvic area to create a vagina-like opening.) The following is At Health's description of the way gender reassignment surgery is handled (mentioned briefly in the memorandum in the "facts" section to note that the taxpayer went through the Benjamin protocol).

Adults who have severe gender identity disorder which has persisted for many years sometimes request reassignment of their sex, or sex-change surgery. Prior to this kind of surgery they usually go through a long period of hormone therapy which attempts to suppress same sex characteristics and accentuate other sex characteristics. For instance, males that have gender identity disorder will be given the female hormone, estrogen. The estrogen causes the male breasts to enlarge, testes to become smaller, and body hair to diminish. Females with gender identity disorder will be given the male hormone, testosterone, to help them develop a lower voice and possibly a full beard. Following the hormone treatment, the adult will be asked to live in a cross-gender role before surgery to alter their genitalia or breasts is performed.

The difference between gender reassignment surgery and a face lift should be obvious to all.  People who have such surgery face a difficult life if they cannot make their bodies mesh with their gender identity.  If cosmetic surgery after an accident scars a face is deductible, then so should this be.   

The IRS's adoption of the position that gender reassignment surgery is mere cosmetic surgery reflects a bias and religious slant that should not play a role in statutory interpretation. Most disturbing is the use of the McHugh piece as the sole authority on the (in)validity of gender reassignment surgery.  McHugh's caricature of those who have undergone gender reassignment and his role as an adviser on sexual matters to the Vatican both suggest a biased approach.  The position, of course, is one that resonates with the right-wing fundamentalist political base of this Administration.  It must ring hollow to those who suffer from severe gender identity problems and must fund their surgery without the aid of the deduction available to others who seek to remedy genuine problems with reconstructive surgery.

Commentary on Paul McHugh's long-time campaign against sex-change surgery

Inequality

Assume you've walked into a classroom and the prof asks you to hypothesize the news source for the following statements:

• "Income inequality has become the next global warming."
• "[T]he mother of all electoral issues [is] the failure of robust top-line growth in the U.S. economy to filter into the wallets of Americans below the top of the pyramid."
• "No amount of chapp can hide the failure of our remarkable productivity surge (and the accompanying robust growth of the overall economy) to meaningfully boost average wages." 
• "We shouldn't try to redistribute our way out of the widening gap, but federal tax policy (referring to "outlandish tax cuts") should not add to the problem."

Odds are you would not guess right.   These statements are in an Op-Ed in the July 19, 2006 Wall Street Journal, whose editorial board always looks kindly on tax cuts for the rich and disfavors any tax increases. 

Recognition of the inappropriate role that federal tax policy emphasizing tax cuts on investment income for the wealthy has played in exacerbating inequality is a first step.  Dare we hope that the Journal will reform its editorial approach?  Probably not.  Like the scientific consensus about global warming and the need to radically change our consumption patterns, income and wealth inequality are a sign of instability that will precipitate greater changes if not addressed.  But like the global warming response of the Street (and the free-market ideologues at Fox News and elsewhere), the response to income inequality is likely to be too little and too late.

Steven Rattner, author of the Journal Op-Ed, is certainly right that we will never have sustainable economic growth without "bringing along Americans who have been left behind."  Congress should reverse the "outlandish tax cuts" and use those revenues to inject much needed vitality into U.S. education, from primary to graduate research.  Tax policy alone cannot accomplish the goal, but fair tax policies coupled with spending that looks to the future and the development of human capital for all Americans could make a big difference.

Focus on the Wealthy

The Bush Administration has claimed that its tax policy--increasingly favoring the weathiest Americans with tax cuts while burdening this and future generations with record debt--has generated economic  growth that proves that "supply-side/trickle down economics" works.  The Wall Street Journal examined this claim in a July 17th piece by Greg Ip and Deborah Soloman titled "As Bigger Piece of Economic Pie Shifts to Wealthiest, U.S. Deficit Heads Downward." 

Yes, the tax revenues have increased this year, resulting in a smaller deficit than predicted (though still significant).  But those increased revenues don't mean that the economy is growing overall.  As the Journal notes,  "[w]hat has changed isn't the size of the economy but how the economic pie is divided.  The share of national income going to corporations and the wealthiest individuals, already large, has expanded, while the share going to typical wage earners has shrunk." 

If this revenue growth is a repeat of the pattern in the 1990s, as  Rudolph Penner at the Urban Institute speculates, we can expect greater volatility in markets. That period's  "irrational exurberance" led to a huge fall in 2001, which could be repeated even sooner in this cycle of focus on the wealthy, with oil and gas prices surging while ordinary Americans' incomes fall.