ataxingmatter

Executive Pay vs. Worker Pay

Did you see the story in the LA Times that the CEO of Occidental Petroleum made about $460 million in 2006, including base salary, options and bonuses of about $55 million?   

Okay.  This is not a tax entry.  If you don't want to hear any more about outsized CEO compensation issues, you can tune out.  But I just read that $460 million figure a few days ago and it struck me that is more than one million dollars a day.  I doubt that there is any way that any one person is so  indispensable to a company that they merit such compensation.  I find that especially doubtful in an industry that made windfall profits at a time when it enjoys substantial tax incentives.  And especially worrisome in a nation that claims to care about democracy and the contributions of many different individuals to our society.   What is the impact on workers who earn in a year only a pittance of what the head of their companies earn in half a day?

This trend towards outsized pay at the very top does not appear to be changing.  The April 9, 2007 Mercer Study (commmissioned by the Wall Street Journal), shows CEO pay continuing to rise at about double the rate that ordinary workers' pay rises.   In 2006, the median CEO direct compensation (as defined by the study, and looking at just the 350 companies included in the study) rose 8.9%, with oil and gas executives getting the highest media direct compensation of $11.2 million.  Meanwhile, the 2007 AFL-CIO's Executive Paywatch report shows the average Standard & Poor 500 company executive compensation at $14.78 million, for a 9.2% increase over 2005.  As the AFL-CIO materials note, adding to the problem are the stock option backdating scandal at a large number of US companies (William McGuire, formerly of UnitedHealth, may have gotten about $333 million of his 2006 pay from illegally backdated options) and the golden parachutes for CEOs (even ones whose companies perform poorly) compared to very short transitional payments for ordinary workers.  Interested in checking the pay of a CEO at a company you know?  Use the Executive Pay database on the AFL-CIO website.

Why is CEO pay increasing so fast?  A few analysts have noted that CEO pay tracks the S&P 500 market capitalization, rather than a particular CEO's company's performance.  See, e.g., Gabaix et al, Why Has CEO Pay Increased So Much? (July 2006) (noting the parallel six-fold increase for CEO pay and S&P 500 market capitalization);  The Consumerist (Apr. 9, 2007) (showing that. betweem 1995 amd 2005, "CEO pay rose 298.2% by 2005, and corporate profits by 106.7%, the average worker pay has only risen by 4.3%...[but] CEO pay does track nearly parallel with the S&P 500"). 

Not surprisingly, when firms expand in size, they pay their CEOs more and when firms decrease in size, CEO pay does not go down.  See Bebchuk, Firm Expansion and CEO Pay (Harvard Law & Economics Discussion Paper, Nov. 2005).  Does the huge size of today's firms have something to do with their willingness to treat workers as fungible (disposable) commodities and to care little whether their firm is centered here or abroad?  Somehow. then, our corporate incentives are working against quality of life for ordinary Americans.   That's what Congress should think about as it re-assesses everything from deductibility of golden parachutes and regular corporate pay to rights of shareholders to have a say in managerial compensation to, yes, whether an increase in the minimum wage has to be "bought" with even more tax goodies for businesses.

Corrected 4/20/07 3:47 pm

Inequality, Racism, and Political Correctness

E.J. Dionne's op-ed in today's Washington Post touches on a subject that more of us need to think about--the relationship between inequality and the ability of civil society to confront and repair its ills.  The gist is that we have to begin to address the "structural problems of poverty, racism, and class inequality."  Here's an excerpt.

According to the U.S. Census, black households in 2005 had a median income of $30,858, compared with $50,784 for non-Hispanic white households. The black poverty rate was 24.9 percent. The white poverty rate was 8.3 percent.

In 2005, according to the Justice Department, 4.7 percent of black males were in prison or jail, compared with 0.7 percent of white males. For men in their late 20s, just under 12 percent of blacks were incarcerated, compared with 1.7 percent of whites. Life expectancy for black men is more than six years shorter than for white men. ...

Dionne challenges us to recognize that condemning Don Imus for his unwarranted, racist and sexist slur against the Rutgers women's basketball team is all fine and good.  The response, however, will be just a point in a long line of gestures that do not get to the heart of the matter if we do not carry it further.  We must connect our condemnation of the trash-talking about African Americans to a condemnation of the unequal economic status of many African Americans in our country today.  And that condemnation must go beyond mere words:  we have to find solutions that address the economic and social contexts that perpetuate that status.

For me, that means that the media, among others, has to do a better job of de-bunking the claims of narrow special interest groups to be speaking for the good of ordinary Americans--especially when it comes to interpreting the role of the "market" and the impact of tax law changes on everyday lives. It  means understanding that a capitalist market system is only good if the market works for ordinary people, with broad-based economic growth shared across the spectrum rather than narrow economic growth for those at the very top (the hedge fund managers who are able to postpone tax on their wages and magically transform compensation income into preferentially taxed capital gains income and the corporate managers who are able to use all the many incentives in the code for timing their income and taxes to their benefit while treating corporate employees as disposable commodities).  It means developing a tax system focused on fair treatment of ordinary Americans. 

Candidates' Returns: Obama first to release

Tax Prof linked this morning to a Chicago Tribune story announcing the release of Obama's federal income tax return.  At the Chicago Tribune story, there is a link to the return itself. 

The story notes a few key facts based on the return and a campaign release about the return:

• 2006 taxable income of  $983, 826 includes: book deal $506,618, Senate salary  $157,082, Chicago hospital administrator salary $273,618 and board fees $51,200.
• 2006 charitable contribution deductions of $60,307 includes: church contribution $22,500, Congressional Black Caucus $13,107, CARE $15,000, and Muntu Dance Theater $5,000.

Kudos to Obama's campaign staff.  It is encouraging to see Obama's willingness to release his return immediately after filing.  Let's hope that this release sets the standard for similar releases from every other national candidate.

It is discouraging, however, to see once again more concrete evidence that candidates for our highest public office are almost inevitably millionaires in the very top percentage of  the income distribution curve.  (Obama's income in 2006, by the way, is about half a million less than it was in 2005, when he had more income from his book deals.) 

That simple fact brings home, again, the class/status problems in this country.  The disparity between the economic backgrounds of most of our elected (and nonelected) officials and the rest of America makes it very difficult for public officials to identify with the problems of the majority of ordinary Americans who make much, much less a year.   It also makes it much easier for corporate executives, who have come to view their workers as disposable commodities even while they receive higher and higher multimillion-dollar pay packages, to have a significant influence over public officials, on our laws and on official attitudes towards issues like global warming or health care, sometimes (often?) to the detriment of ordinary Americans.

One of those problems, of course, is the alternative minimum tax (AMT).   In the Wall Street Journal and the New York Times, the discussion about the downward bracket creep of the AMT suggests bewilderment that it could mainly target "middle class" taxpayers who make from $200,000 to $500,000 a year.  But remember that the wealthiest American taxpayers don't pay AMT because their incomes are so high that they are paying the higher rate tax under the regular tax system (the regular tax maxium rate is 35%, compared to the 28% maximum rate, on a broader base, of the AMT).  And the $200-500 thousand income range is still way up in the top quintile of incomes in the US--not really the middle class.  It is the AMT reach down to some households in the $100,000, $75,000 or even $50,000 income range that is disturbing, since those households are ones that are more likely to need the tax relief intended by the tax cuts passed in the last six years.  The solution that I have argued for--to define a cut-off point below which the AMT will not apply, based on a total income determination--may be hard for politicians from the upper crust to enact, since it would require those with considerably higher incomes to continue paying a higher share of taxes.

Tax Filing Time: Extended to April 19 for Storm Areas

The IRS announced today that taxpayers in northeastern areas hit by the incapacitating storm that has resulted in power outages and traffic delays will have until April 19th to file their returns instead of April 17th.  Under IR-2007-89, taxpayers need only write "April 16 storm" on their return to claim the extension.

ABA Tax Section and Economic Codification

The ABA Tax Section issued a report this month supplementing its 2003 comments on the proposal to codify the economic substance doctrine.  See this link.  The comments were approved by the Tax Section's Council and "represent the views of the Section" but certainly not of all attorneys (such as me) who may be a member of the Section and have had no opportunity to comment on the report before its filing.  It is one of those things that I sometimes resent about the way the ABA (and NYSBA, for that matter) function:  executive committees of people who have been invested in the organization for a long time decide the position that the Tax Section will adopt, without plenary sessions or other means of gathering a sense of the members on the issue.

The ABA Tax Section report essentially argues for a limited approach to any codification--one that would merely "clarify" how a court should apply the doctrine in two rather narrow ways.  The claim is that anything more would disrupt "legitimate business transactions" and harm "tax planning."

“[W]e continue to believe that any codification of this judicial doctrine should be limited to clarifying that when a court determines that the economic substance doctrine does apply, (i) the taxpayer must establish that the non-tax considerations in the transaction were substantial in relation to the potential tax benefits; and (ii) in evaluating the potential economic profit from the transaction, all costs associated with the transaction (including fees paid to promoters and advisers) should be taken into account.”  Id.

The second item is clearly necessary to the adequate functioning of economic substance as an anti-abuse doctrine.  If the promoter fees and other amounts necessary to smooth the transaction (getting a bank to go to the trouble of treating a regular financing as though it were a partnership equity interest, for example) were not taken into account, a transaction might appear to have had a potential for a pre-tax profit even when it was actually a losing business.

The first item is more troubling.  Saying that non-tax "considerations" must be "substantial" in relation to tax considerations is at most providing a vague notion that some economic substance might be lurking somewhere in the transaction.  "Substantial" is far less than a "principal purpose" test.  It doesn't even measure up to "must predominate" as a test.  In fact, it may be nothing more than a statement that non-tax "considerations" were not "de minimis" in the deal.  Should that be enough to legitimize twisting of statutory provisions to provide a tax benefit that was never contemplated by the drafters and that clearly pushes the boundary of permissible use of the Code to generate lower tax liabilities?  I'm not so sure.  That test seems rather self-serving for tax professionals, to me.

The ABA Tax Section expresses its particular concern with the requirement that the transaction be a "reasonable means" of accomplishing the taxpayer's stated business purpose.  Does the ABA Tax Section Council really think that taxpayers should be able to use unreasonable means of accomplishing their business purpose in order to get tax benefits that it would otherwise not be entitled to?  The section's objections are couched in terms of the importance of avoiding uncertainty.  Again, I am not so sure that certainty merits elevation to the pedestal on which the ABA Tax Section Council places it.  If there is some area of uncertainty regarding the degree of aggressiveness permitted, taxpayers are likely to be somewhat more cautious than they would otherwise be.  That's not a bad outcome. I've used the analogy before of the yellow strip next to the subway in New York City.  Stepping there is not a per se death decision, but it surely places one in considerably more jeopardy than the safe position back of the strip.  Why not encourage taxpayers to stay in the safe zone when they are determining how to shape and report their business transactions?  Is it really necessary for "legitimate business" that we encourage "tax planning" that steps right up to (and therefore inevitably sometimes over) the line? 

Similarly, the ABA Tax Section Council argues that a 40% strict liability for transactions lacking economic substance is "overly harsh".   What that means is that tax practitioners know such a penalty would do even more to discourage those borderline transactions.  Again, why not?  There is little, if any, social merit in encouraging aggressive tax planning transactions.  If a high penalty would actually encourage taxpayers to try to get it right, that is an argument for the penalty, not an argument against it.  The report argues that increased penalties under recent legislation (in particular, the (misnamed) 2004 "American Jobs Creation Act") are all that's needed.  But clearly those penalties remain much too low to be effective in most cases.  Given the extremely low audit rates and the extremely low chances of detection of errors on audits, you might need penalties in the1500% range before one could truly hope a rational tax avoider would pay attention to the penalty possibilities.  Heftier strict liability penalties are a reasonable tool against the aggressive tax avoidance planning that still goes on, from the "family limited partnerships" used to retain control of assets while ostensibly creating "valuation discounts" that let those assets escape the estate tax to the disguised financings using the flexbility of partnership allocations to give the lending bank a slightly higher interest rate in return for acting as an accommodation party to the deal.

Now, I am not saying that I support economic substance codification, especially in the weak form that the Senate bill proposes.  I think it is absolutely appropriate for courts to apply judicial doctrines in the federal common law area of tax law--without that, taxpayers would always be able to distort the statute and stay a step ahead of the government.  The courts should continue what they can indeed do very well--looking to statutory purpose, the coherent interpretation of the statute in context, whether a transaction is germane to the taxpayer's business, and other issues tied in to the "substance over form", step transaction, business purpose, sham and economic substance judicial doctrines in their various manifestations in the courts. Courts should apply these doctrines judiciously, but they should not excuse aggressive transactions merely because there is a business purpose if there is no reasonable expectation of a pre-tax profit (and they should treat foreign taxes as expenses in making those determinations). 

Tax Filing Time

Tax filing day for most Americans is almost upon us.  Next Tuesday, April 17th, is the day.   If you can't file in time, get an extension.

The IRS announced in an April 13th News Release that there is a new tax scam where a non-government entity pretends to be the IRS and offer "free filing".   The sting--since it isn't a genuine filing with the government, the government won't receive the tax filing.  The double-sting--since it isn't a genuine filing with the government, somebody else will have acquired confidential information about the taxpayer.  Taxpayers with adjusted gross income of $52,000 or less who want to take advantage of the government's "free file" arrangements (a partnership between the government and 19 tax software firms) should go to the irs.gov website at http://www.irs.gov/efile/article/0,,id=118986,00.html.  They can use the software to prepare their taxes and then electronically file their return.  Some states also permit free filing but there may be a fee for state returns.

Finance tops DOJ and other miscellany

Senate Finance Committee Annual Hearing on the Tax Filing Season--tax preparer scams and other problems

The Senate Finance Committee is holding a hearing tomorrow on the kinds of tax filing scams that taxpayers should avoid.  One of the people they want to have testify is serving jail time for identity theft and tax fraud.  The Department of Justice didn't want the witness testifying to Congress and so tried to quash the subpoena for the witness.  But Finance won, and the witness will appear tomorrow.  See this release at the Finance Committee website (with links to the habeas corpus petition and other information).

Makes me very curious about this particular witness--just what kind of id-theft information is so secret that Congress shouldn't know about it?  Tune in after the hearings, and we should all know.

Health Care, Tax Deductions, and Presidential Proposals.

As most everyone is aware by now, the President's FY 2008 budget proposes significant tax changes related to health insurance and health care by taxing employer contributions to health insurance, eliminating the current deductions and exclusions, and instead creating a new standard deduction for all taxpayers who obtain insurance.  The idea is to push taxpayers to purchase their own insurance and eliminate the employer-provided insurance system.  The plan claims to increase coverage and reduce health care costs by making taxpayers responsible and reducing the incentive to overconsume.

Len Burman and several other people at the Urban Institute/Brookings Institution provide an extensive analysis of the budget proposal in the March 12, 2007 issue of Tax Notes.  To quote the abstract:

The basic thrust of the proposal--leveling the playing field for health insurance--is laudable.... But the plan fails to address some of the most significant problems in today's market for health insurance and actually threatens many of the most vulnerable families....  Id. at 1013

Here are a few of the concerns the authors raise about the proposal:

• the change to a standard deduction will likely increase demand for insurance without providing the risk pooling provided by large employers, with the likely effect of reducing group coverage and fragmenting risk pools since business owners and managers would not have to offer insurance to workers to qualify for a tax break on their own insurance; and the erosion of employer-provided insurace might lead to many workers deciding to forgo insurance altogether (ultimately leading to higher health care costs for everyone)
• The net effect of the loss of employer-provided coverage could be a very slight increase in the number of insured Americans or an increase in the number of uninsured.  In either case, it is likely that "the households that would lose insurance would tend to be sicker, older, or poorer, and thus unable to purchase coverage in the individual market as now structured, while the households that would gain insurance would tend to be healthier, younger, and financially better off."  Id. at 1017
• even while tending to push people off employer provided health insurance, the proposal inappropriately expands the tax breaks for health savings accounts rather than eliminating them
• although the current tax breaks for insurance are regressive (the largest tax benefits go to families in higher tax brackets or with larger employer contributions to insurance), the proposed deduction is also regressive, since it is of more value to higher bracket taxpayers than to lower bracket taxpayers.

"The bottom line is that, although the new proposal would increase the progressivity and targeting of health insurance tax subsidies, it would still be worth relatively little to low-income families who most need help." Id. at 1020.

Of particular merit is Appendix 4: Effects of the Proposal on Low-Income Taxpayers (at page 1024).  The report notes that the proposal might be helpful to certain low-income families that have health insurance through their employers, since the insurance would count as wages, thus increasing their Earned Income Tax Credit and providing a considerable benefit.  But since most low-income workers do not have health insurance through their employers, that benefit is not likely to materialize.   Furthermore, for low-income workers who do have employer-provided insurance and incomes between $16,740 and $30,100, the analysis shows that the change would instead increase their tax liability.    

CRS Report on Capital Gains; Republican Push for a Consumption Tax

The Congressional Research Service has put out a small report on capital gains taxation, Capital Gains Tax Rates and Revenues (Apr. 4, 2007), available in BNA Tax Core.  It provides a useful chart with a comparison of ordinary income tax rates and capital gains rates since 1913 and another that looks at capital gain revenues and taxes from 1955 through 2002 (and projected forward). 

Corporate managers and owners (who are the main holders of capital assets in this country) are stepping up the arguments for corporate capital tax rate cuts (see the earlier A Taxing Matter posting on this issue) and individual capital gains tax rate cuts (or purported "fair taxes" that tax only consumption--see Republican bills introduced in the House H.R. 25 and Senate S. 1025).  Regretably, this country already has incredibly low rates on capital gains that give a decided advantage to those whose wealth rests on their ownership of financial assets--the upper crust.  As the report notes, "the current maximum statutory tax rate on long-term capital gains income is lower than it has ever been in the post World War II time frame."  CRS, Capital Gains report (above).

The report considers one of the frequent arguments made by proponents of having income other than capital gains bear all the tax--that having a tax on gains "locks in" capital inefficiently by causing people to hold onto their assets til death (when they get especially preferential treatment) rather than sell the assets and invest in better assets.  It's of course not so clear that assets are really locked-in because of the tax, and it is even questionable whether lock-in is a bad phenomenon, since it would help counter the senseless "day-trading" mentality that currently predominates for many investors.  As the report notes, "[c]ritics are concerned about the distributional effects, possible tax shelter abuses, and the revenue losses associated with reductions in capital gains taxes."  Id.  I'd add an additional overreaching concern--the fact that capital gains accrue mainly to the upper crust, who get the lion's share of tax cuts when rates are reduced on capital gains income, resulting in real threats for democractic institutions.

The report considers an accompanying argument made by capital gains tax-cut proponents--the discredited Laffer notion that cutting taxes raises revenues.

It appears that over the long-run, the revenue generated from an increase in capital gains realizations accompanying a tax cut would not be large enough to offset the static revenue loss from the tax cut itself. A net revenue gain is also less likely under current law than it was in the past, in part because the increase in realizations would be taxed at lower rates than would have been the case in the past.  Id.

Tax Freedom Day--The TF continues its obfuscation

About this time last year, I noted, in a post titled "Tax Freedom Day: Clarification or Obfuscation," the many problems with the Tax Foundation's much-cited "statistic" that they call "tax freedom day."   The Tax Foundation appears to have a particular axe to grind--it wants Americans to think their tax burdens are unreasonably harsh--and apparently a misleading device for accomplishing that goal will be used over and over again, as long as it gets picked up by the media and used.  And the media do pick it up, as well as others.  See this "Hubbard's Ghosts" posting just a few days later last year, reporting on one economist's misuse of the information.  The artificial and meaningless statistic is touted each year (2007's misleading information is linked, here) as though it actually conveyed some meaning--telling ordinary Americans that they've been working for the government all the way til some time in April. 

It just ain't so, Joe.   There are numerous problems with the tax freedom day statistic.  Perhaps the biggest one is that the calculation is distorted by the definitions of income and taxes used and the fact that the "average" amount for taxes paid exceeds what almost all ordinary taxpayers pay since those in the top 5% with multimillion dollar annual incomes distort the average numbers so as to make them meaningless when applied to those in the lower quintiles of the income distribution.  See the Center for Budget and Policy Priorities' March 29, 2007 posting on the matter, here.  Even Alan Greenspan noted in a 2002 hearings that the Tax Foundation's idea of dividing total tax receipts by GDP to produce a notion of the amount of taxes paid on income produced was flawed.

Even beyond the misleading nature of the "tax freedom day" statistic is the harm done by the presupposition behind the statistic--the notion that taxes are a bad thing from which we need to be free.  Here's one progressive blogger's note on that point.

"Notice the words that the Tax Foundation and Hyman use: Tax Freedom Day, the time when Americans have paid off their tax burden. Taxes take a bigger share of our earnings. The language conjures up images of taxes as imprisonment, as dead weight that must be lugged around, or outright theft."

"Those metaphors distort reality. The truth is that taxes are the biggest and most direct way the majority of Americans serve their country. It’s the way we help provide for the future welfare of the nation."  Ted Reminington, The Counterpoint: you get what you pay for (April 2006).

Tax Exemption for Hospitals

There has been a growing concern about the tax breaks provided to not-for-profit hospitals (a state law designation)  who receive tax-exempt status for federal income tax purposes yet appear to operate business as usual very similar to, if not identical to, hospitals that do not have tax exempt status.   Areas of concern include billing practices, executive compensation, and provision of unreimbursed care to those who are not insured or cannot pay.  See, e.g., Non-Profit Hospitals' Tax Exempt Status Under Fire, Journal of the Business Law Society, University of Illinois, October 2006; National City, The Tax Status of Not-for-Profit Hospitals Under Siege (White Paper); Appleby, Hospital Lawsuits Fall Flat, but Debate Rages, USA Today (April 24, 2005); Hospitals: How Much is Too Much?, Health Care Blog (Feb. 7, 2007) (discussing high executive compensation at hospitals); Lagnado,  Hospital Found 'Not Charitable' Loses Exempt Status, Wall St. Journal (Feb. 2004); Unland, Not-for-profit Community Hospital's exempt status at issue in charity care controversy, Journal of Health Care Finance (Aspen 2004) (discussing the revocation of the state not-for-profit status for Provena-Covenant Hospital in Urbana, Illinois and other states' concerns about failed charity care); Gloria Bazzoli, The Corporatization of American Hospitals, 29 Journal of Health Politics, Policy and Law,  885 (2004), John Colombo, a professor at the University of Illinois School of Law, testified before the House Ways and Means Committee on the questions about the basis for tax-exemption for such hospitals whose businesses are scarcely different from that of for-profit hospitals, indicating that "the [new] community benefit standard for exemption has proven to be an unmitigated disaster both as tax law and as health care policy."  Read full testimony here.   Other authors see real benefits for communities from not-for-profit hospitals, using local accountability standards.  Schlesinger & Gray, How NonProfits Matter and What to Do About it, 25 Health Affairs 287 (2006). See also Hyman & Sage, Subsidizing Health Providers Through the Tax Code: Status or Conduct? Health Affairs website.

Sen. Grassley, ranking member of the Senate Finance Committee, wrote today to ask the Government Accountability office to further study uncompensated care and other community benefits provided by nonprofit hospitals.  His letter to David Walker, the comptroller general, notes the IRS's change from requiring hospitals to provide charity care to the vague "community benefit" standard in 1969 and raises questions about inconsistent reporting of charity care because of varying standards set by hospitals on eligibility and practices for collecting on bad debts. Letter available in BNA at http://op.bna.com/dt.nsf/r?Open=gker-6zys4b.  The letter also notes concern about hospital executive compensation, "lavish lifestyle[s]", and conflicts of interest because of "involvement in for-profit business ventures with the nonprofit hospitals." 

The GAO study should provide useful information.  It should be done quickly and Congress should deal with this issue in a timely manner once it has the detailed study.  Tax exemption that does not result in significant public service is not merited.