ataxingmatter

Doggett is dogged in pursuing his "stop tax haven abuse act"

Congressman Lloyd Doggett of Texas has been introducing bills to eliminate tax loopholes and ensure better tax enforcement for decades.  When I first became an associate at Cleary, Gottlieb in New York, I remember reading about his effort to clamp down on tax shelters.

Finally, he is likely to find a more responsive Congress.  While his full "Stop Tax Haven Abuse" Act may not be passed, it is quite likely that some of the provisions will make it into law.  I've dealt with this in two earlier postings this year:  Tax Havens: legislation in sight?, Mar. 12, 2009 (extensive discussion of proposed legislation by Carl Levin in the Senate and Lloyd Doggett in the House), and Congresspeople Seek Budget Consideration of Large Corporations' Use of Offshore Tax Havens to Avoid US Taxes, Feb. 20, 2009.

Today, a Ways and Means Select Revenue Measures Subcommittee hearing questions Treasury officials and tax experts on banking secrecy practices.  Doggett's questioning of Reuven Avi-Yonah, Michigan tax prof, is available on video at this link.  In other parts of the hearing, IRS Commmissioner douglas Shulman asked Congress to extend the statute of limitations for offshore tax liabilities from the current three years to six years, to enable the Service to better enforce the law.

Right-wing Think Tanks: favoring tax havens and tax competition, arguing against reregulation of the financial industry

The right-wing "think" tanks--e.g., the so-called "center for freedom and prosperity" (CFP) (which operates often in conjunction with the corporate-funded Cato Institute and American Enterprise Institute)--continue the push to protect tax evasion and tax competition.  See e.g., CFP website with various articles and video links in favor of tax competition and tax havens. 

CFP has in its sights the efforts by the OECD and influential governments to create international cooperation on tax policy so that tax cheats can't use the policies of tax haven countries to undermine the tax policies of their home countries.  CFP wants multinational corporations and wealthy individuals to be able to hide their assets and avoid tax or to be able to pit one country against another in order to get the most advantageous (lowest) rate of taxation.  It builds up phony straw men arguments (worries about an "international tax cartel" ) and false dichotomies (no individual freedom if governments are able to work together to prevent cross-border tax evasion) to persuad Americans to support views about taxation that are both naive and damaging for complex societies, such as its misleading arguments in favor of the "Laffer curve" (see this earlier ataxingmatter posting) and in favor of flat taxes.  In both of the latter cases, the CFP makes statements that are factually wrong--such as the claim that the Laffer curve is a "theory" that "proves" that cutting taxes results in broad-based growth, or the claim that a flat tax at a rate of about 20% would be sufficient to raise the same revenues as the current income tax.  Those approaches are certainly not good for any country's tax system, including the US.  Tax competition is not a good that we should encourage, and the existence of tax havens is something that we shoudlw work against.  So read their views and watch their videos with a very skeptical mind.  This is a bill of goods for a sale that will jeopardize American society if the American people buy it.

The CFP also has its sights on the reinvigorated government effort to rein in Big Banks and prevent the kinds of problems we saw emerge from the Reagan deregulatory era from happening again.  The Center is busy preaching that the problems with the current financial crisis don't stem from the hands-off view that the government adopted since Reagan, but in fact from too much government oversight. See Government Intervention, Regulatory Policy, and the Financial Crisis, a video produced by CFP with the American Enterprise Institute.  It preaches a misleading concoction of anti-government rhetoric and selected history to blame the government for the current crisis.

Here's my quick analysis.  The video starts with a statement that current politicians are blaming "unchecked capitalism and deregulatory efforts" for the crisis, but that "can't be right, since banks have been the most heavily regulated entities and are at the heart of the trouble" (paraphrase of statements on tape). The real culprit, it claims is the government chartering of Fannie and Freddie, where the market treated the corporations as having an implicit government guarantee.

Let's decipher these statements.

First, banks are regulated under Basel, but those regulations primarily deal with capital reserves.  The deregulatory actions that took place starting with Reagan and culminating with Phil Gramm's midnight putsch in the Commodities Futures Modernization Act left 1) the Depression-era walls between commercial banks, insurance companies, and investment banks destroyed, so that all those financial operations could now be down under one enornous roof and the entities were able to shift resources around and have one area do work to support another area while at the same time 2) all the financially engineered "derivatives" inventable by these financial whizzes were placed outside the scope of regulation, permitting banks to gamble without requiring appropriate reserves to back those gambles.  That was the real cause of the crisis--the speculative risktaking that put the entire financial system at risk.

Second, Fannie and Freddie did not originate the problematic loans, and did not even get into securitization of those loans in nearly the same quantity that private investment banks did.  it was the banks' desire to make big killings off the mortgage loan securitization possibilities that changed the business from a fairly mundane one to a risky business creating a ever-growing appetite for loans of any kind.  The banks first encouraged creation of ever larger numbers of loans--the bigger the securitization market, the more loans are needed to feed it, and that push led to riskier loans, since that was the only way to satisfy the volume.  Fannie and Freddie's securitizations were not guaranteed by the government--it was the unregulated market that distorted those assets and treated them as though surely the government would back them up rather than let them fail, therefore making the assets, in the market participants' views, less risky than the enterprises actually said they were.  Read any offering from Fannie and Freddie, and you will see quite clearly the reminder that there was no government guarantee.  But the market participants (particularly banks and insurance companies) speculated in the market on their bet that if they did so, the government would feel obligated to back the companies if the companies' products should default.  So again, the cause lies with the risky speculation in the market, not with the two companies' mortgage securitization products.

The CFP/American Enterprise video would have you believe that the existing regulation of the banks caused the problem, so that the cure is to deregulate.  This is a twisted version of reality that ignores the facts outlined above.  The financial meltdown is due to the speculative risk-taking of banks that had been allowed to consolidate through the removal of the Depression era barriers and whose engineered products were allowed to be developed and sold without regulation. 

The CFP/American Enterprise video prescribes 4 "cures" for the "problem" of "government intervention" and "over regulation" that the video claims to have established.  What are they? 

1. don't allow the government to make category distinctions within the financial system
2. remove government "overregulation" and special requirements (such as trying to make housing more affordable for the poor)
3. eliminate any special regulations for some companies that creates the perception that the government won't allow those companies to fail
4. eliminate any possibility of global regulation of the financial system, since this crisis has "proven" that governmental regulation is a failure

These prescriptions for success are a genuine prescription for failure. This crisis has hammered in the truth that we should not allow the financial system to regulate itself, because it will fail.  It will engage in highly speculative, risky endeavors out of greed rather than deal in the mundane area of investing and lending that will grease the wheels of productive enterprise.  We got off base, thinking that all this "financial engineering" could substitute for the real engineering in manufactured goods that this country was losing.  It can't.  Financial engineering wreaks havoc on the system, especially when it takes place in a Wild West atmosphere in which banks set their own rules and financial engineers are just hired guns striving for the top gun of the west position--"what fancy new derivative can they invent that makes them a lot of money, and damn the system."

It will be particularly lamentable if the American people are swayed by these erroneous and propagandistic videos put out by CFP and American Enterprise Institute, whose main purpose is to protect their corporate funders from taxes and to prevent any regulation of the enterprises.  Deregulation and the speculation that went with it caused this financial crisis.  It's time to go back to much more stringent controls on consolidation within the financial industry and to put in place stringent regulation of financial derivatives.

Cap and Trade

Angry Bear's Tom Bozzo has an interesting discussion of cap and tradeproposals (Mar. 18, 2009) and notes a Tax Foundation article, Chamberlain, Who pays for climate policy? New estimates of the household burden and economic impact of a U.S. cap-and-trade system, Mar. 16, 2009 (discussing the implicit tax burden of cap and trade).

As Tom Bozzo notes in the comment section, cap-and-trade may impose tax burdens on households similar to a carbon tax, but if the system is coordinated with payroll tax relief for those at the lower end of the income distribution, as proposed in the Obama budget through the extension of the "making work pay" credit, it would be neutral as to tax while lowering our carbon footprint.

The Republican Alternative for FY 2010: Is it a budget? a plan? Nope, it's Same-Again-No-Man.

The Republicans, with great fanfare, recently released their "budget" to compete with President Obama's budget for FY 2010. 

As an appetizer,you might want to read this The NEXTRight blog posting on "The Republican Strategy on the Budget" where blogger Bryan Pick talks about the Republican strategy heralded by Mike pence and Cathy Rodgers, is to note that Democrats spend, borrow and tax too much, while Republicans believe in "free markets, fiscal restraint and tax relief as the keys to growth."  

Folks, "free market/tax relief" ideology is what has been operating under the Republicans since Reagan, and it got us into this Deep Recession that we are in right now, because the banks used the "free markets" to speculate away a relatively decent financial system created by appropriate public oversight and the Congress used the "tax relief" to give away the store.  Meanwhile, "fiscal restraint" hasn't been around for four decades--military budgets became bloated with the excessive deficit spending.  Even a NextRight commenter knows the GOP won't substitute anything worthwhile, so long as the military is a sacred cow. 

Another appetizer is Mike Pence's tease about the way Republicans will cure the problems that President Obama's "most fiscally irresponsible budget in the history of our nation" doesn't cure.  Mike Spence's statement on the floor in response to Obama's press conference Mar. 25, 2009, states that "in the coming hours, Republicans will unveil a better solution, to pass a budget built on fiscal responsibility and the principles of growth."

Then you might want to actually sample the main course-- the Republican "alternative" to the Obama FY 2010 Budget, The Republican Road to Recovery, March 2009.  Here's my buffet of ideas connected with the Republican pseudo-budget pamphlet.

The pamphlet begins with about the only numbers it includes--the Obama budget calculations about the amount of deficit spending and borrowing caused by the economic mess that the Bush Administration dumped in Obama's lap.  From there, it is mostly hot air--a promise of an "economic plan" that will deliver less spending, more jobs, lower taxes, less debt and grow the economy.  In other words, the same old line that the GOP used to pass every tax cut bill that was paid for by borrowing, while passing military spending bills that were paid for by more borrowing, and that resulted in a rapidly shrinking economy after eight years of growing the debt, shrinking the upper crust's tax bills, and doubling the federal debt that Bush started with.

Here are the GOP's claims as to what they can do with the same old policies that they had absolute hegemonic freedom to impose for the last 8 years (items from their summary are filled in with the "specifics" in the body of the "budget" pamphlet:

1. "curb spending"

"secure entitlements by enacting common sense reforms" (read that--cut Medicare and Social Security benefits?);

"undo" the "reckless and wasteful" stimulus spending

how would they do that? The language attacking Obama's planning names a bunch of the GOP red herrings like Acorn, Corporation for Public Broadcasting, Labor union green jobs programs, National Endowment for the Arts, Americorps, Family Planning and other "spending programs that will do nothing to help our economy recover" that are likely to be targets of the GOP drive to close down any government spending that doesn't support Big Business, wealthy capitalists, and the military-industrial-financial complex.

and just what would they do to lift the country out of the Deep Recession?  They don't offer any ideas, even, much less numbers.  Reagan's favorite of adding to the bloat of military spending comes to mind as a possibility for their "cure" (with, of course, the perennial tax cuts that they propose for every situation, whether its jobs or growth or surplus sharing or borrowing reduction or deficit limiting, since the GOP leadership is stuck with its love of the laughable Laffer Curve--see this posting on the Laffer Curve on ataxingmatter)

cut "nondefense spending" by "reforming or eliminating a host of wasteful programs

That's probably things like those mentioned above, or maybe  the EPA, the consumer protection agencies, the FDIC, the Education department, the energy agency--all those that the GOP has threatened to dismantle

But, like Reagan, the GOP intends to keep a bloated military--"fully fund our ongoing commitments overseas" and use savings to "rebuild[] our military" and a few other things

2. "provide universal access to affordable health care": 

The statement presents as fact what is merely a projection about "entitlements" --it states that "Social Security, Medicare, and Medicaid are going bankrupt and will consume the entirety of today's budget by 2040".  That's a misrepresentation and gross oversimplification of the entitlement story, particularly in respect of social security.   I'll refer readers here to Bruce Webb's 44-part series on Social Security on Angry Bear.  Generally, there are myriad possibilities for Social Security's future, and whether we continue paying out Social Security benefits several decades hence at the same rate as we do today depends as much on political will and democratic decency (we can make people a priority and tax ourselves sufficiently to cover entitlements even when current income isn't sufficient) as it does on very hard to forecast economic trends decades in the future (especially hard to forecast in the midst of a recession caused by an insistence on the same GOP policies being touted here).  A different window on the situation might say the following:  Social Seucrity is sound through 2040 without any changes; if we want to continue it beyond then with the same expanding benefit programs, we can do so by an extraordinarily modest increase in taxes, such as by taxing capital as well as labor to fund the social safety net programs, or by increasing the cap on which the payroll tax is charged.

Medicare, of course, is expensive, and we will need to figure out what to do to provide universal health care at a reasonable cost.  But the GOP alternative includes a set of old criticisms intended to raise the shibboleth of "government run health system" and scare people away with anecdotes of loss of choice and "horror stories" from other countries.  The facts don't fit the GOP story--US health care, as is, is much more costly than in all those western countries that have figured out how to have universal health care, and millions of Americans don't even get any care for all that excess cost. 

What's the GOP alternative that is going to "provide universal access" with "common sense reforms"? 

• more tax cuts like the medical savings accounts:  Doesn't work to provide care or cut costs;
• more deregulation for the health insurance industry so folks can cross state lines:  Not new, since McCain proposed this in April 2008, and the GOP has argued for it for a long time, but not a good solution, since it will mean everybody who has money and already has insurance will shop, but adverse selection and deregulation of insurers will result in higher health care costs for most ordinary Americans, as insurers refuse the high risk insureds and take only the low-cost, low-risk healthy and wealthy folks and then also refuse (in the glory of deregulation) to routinely cover important tests and procedures, so that nobody but the wealthy can afford to pay for needed care (mammograms; biopsies, colonscopies, coronary bypass, etc.).  Net result would primarily be that insurers would pile into the states with the least regulation, leaving them free to choose which state's non-rules they like the best.
• limits on noneconomic damages:  The GOP ideal of tort reform rears its head again, based on (i) providing succor to Big Medicine when it harms patients to save medical costs rather than reforming Big Medicine to prevent harm to patients to save medical costs; plus (ii) an empirically erroneous conclusion that tort cases have been increasing medical care--read David Hyman et al Medical Malpractice Litigation and Tort Reform: It's the Incentives, Stupid, 2006, to see sound empirical evidence that "caps on non-economic damages and attorneys fees will not [address the liability system shortcomings]".   Yes, you can cut the cost of medical care if you let medical providers make huge mistakes without compensating patients for it and therefore reduce the incentives that the current system provides for medical providers to provide the right kind of care.  But that's not the kind of cutting costs that anyone should support
• combating Medicare fraud:  Fine--but with deregulation and reduced funding for federal agencies, Medicare fraud will be hard to fight, and it won't save that much anyway
• flexibility to the states in Medicare programs:  This is proffered as a way to serve people better, but it amounts to a way to let states cut benefits, which just redefines the problem as solved by removing the problem from sight, like the Colombian towns that solved the problem of poverty by building barricades that hid poor children ("gamines") from the Pope's route when he visited Bogota in the late 1960s.  Furthermore, it is interesting to look at this call for "flexibility for states" when on other issues the GOP proposes to do away with a state's ability to regulate health insurance (one of the results of the proposal above for cross-border insurance shopping, which would be a boon to Big Insurance and a nightmare for states, as noted above).

3. "reduce the tax burden on working families and small business, in order to create jobs and unlock private capital": 

The GOP reduced the tax burden most on wealthy families, and didn't create jobs (jobs under Bush didn't ever catch up to jobs under Clinton, and started disappearing at the end of his reign) and didn't unlock capital--the credit freeze is a Bush result.

The "Republican solution" says that Obama's allowing the Republican-enacted laws' sunset provisions to take affect for some few Amerians at the top is a case of Obama "raising taxes."  Nope. It's really the GOP's dead hand raising taxes, because they knew the cost of their program of tax cuts was enormous and would not have passed if they hadn't had the sunset gimmick.  Obama's proposal just lets the GOP temporary provision die for the wealthiest Americans, and actively cuts taxes for the 95% remaining by eliminating the sunsetting provision for them.

The GOP says it is offering an alternative--10% rate on income up to $100,000 and 25% thereafter, with "a generous standard deduction and personal exemption".  Also fixing the AMT.  Also providing new business deductions.  But this section is conspicuously numberless.  No numbers for the cost.  No numbers for the huge deficits this would create.  No numbers for who would pay for this new tax cut for the wealthiest Americans.  In fact, no distributional charts with numbers letting the reader see that this is an enormous tax cut for the wealthiest Americans, from a 39.6% top marginal rate (the rate that would apply after 2010 under the Republican-passed legislation) to a 25%  top marginal rate. It is of primary benefit to the very wealthiest Americans and will have a heavy cost in terms of federal revenue reductions.

4. "want energy independence with increased development of all our natural resources": 

"wanting" is fine, but "doing" is better, and all the GOP has showed itself interested in here is the McCain/Palin mantra of "drill, baby, drill."  Need I say more? 

The GOP "better solutions" include the following Big Energy-friendly, environmentally devastating, alternative-energy delaying "budget" proposals, all without any attempt to specify their view of any actual budgetary impact (there are no numbers here either) and all without any attempt to hide their deregulatory stance and their desire to permit the government to act as servants to Big Energy:

• increase exploration for American oil and gas
• immediately lease oil and gas in the Outer Continental Shelf (with revenues going to the states and to a trust fund to eventually pay for renewable energy programs)
• opening the Artic Coastal plan to energy development, including the National Wildlife Refuge
• streamline leasing (making it easier and cheaper for Big Oil, and less environmentally friendly)
• expedite judicial review in a single (Big Oil friendly?) appellate court, with limited periods for complaints (making it easier for Big Oil to avoid class action suits for the extraordinary environmental and people-damages it causes when it uses these expedited leases in these environmentally sensitive areas)
• deregulate nuclear power ("streamlining judicial review process"; placing "reasonable limits on arduous anti-energy litigation")
• develop oil shale public lands and have the federal government create the market for oil shale/tar sand fuels 

5. control the debt by ending bailouts, reforming the financial system, keepying the cost of living low: 

sounds great--I'd like no debt, no bailouts, reformed financial system, and low costs of living.  But how are you going to do it?  What contributes to the solution?  Why? 

This is ideology, not policy.  Remember that (i) these same "policie" created the conditions that necessitated the bailouts in the first place, (ii) the GOP under Bush actually initiated the bailouts in fall of 2008, not Obama, (iii) Phil Gramm and other GOPers  intentionally rammed through deregulation and "unreform" of the financial system, and (iv) the GOP years are directly responsible for ordinary Americans facing stagnating incomes while the upper crust enjoys staggeringly high increases in their income from deregulation (that led to the financial crisis we are enduring now). 

The GOP pamphlet drags out its same old nemeses--the Community Reinvestment Act of 1977 (blamed by Peter Wallison, a fellow at the American Enterprise Institute, as a primary cause of the mortgage crisis, in "What Got Us Here"), as well as the federally created Fannie and Freddie, as the cause of the foreclosure crisis and financial meltdown.  It doesn't bother to note that CRA banks aren't the ones that generated the demand for, and the way to use, the toxic waste.  See, e.g., The Community Reinvestment Act: A Welcome Anomaly in the Foreclosure Crisis: Indications that the CRA deterred Irresponsible lending in the 15 most populous U.S. metropolitan areas, Jan. 7, 2008 (concluding that "CRA Banks were substantially less likely than other lenders to make the kinds of risky home purchase loans that helped fuel the foreclosure crisis"), and The Community Reinvestment Act of 1977: Not Guilty: mortgage data refute charge that the CRA is at the root of the financial crisis, Jan. 26, 2009.  It's the Big Banks like Goldman and Morgan Stanley and the bankrupt bailed out AIG and the defunct Bear Stearns and Citibank that created or guaranteed synthetic CDOs and REMICs and reREMICs -- and had an insatiable appetite for buying up nonagency generated mortgage backed securities -- that created the Countrywides and other mortgage giants that issued the worthless paper that broke the back of the American homeowner.  See, e.g., Ex-Leaders of Countrywide Profit from Bad Loans, NY Times, Mar. 3, 2009 (noting that Countrywide (now owned by Citibank) is a "banking behemoth [that] made risky loans to tens of thousands of Americans, helping set off a chain of events that has the economy staggering").

The GOP then tries to have it both ways on the bailout--it was necessary, but it can't go on.  But it doesn't show how it could change the strategy.  The GOP pamphlet says it would let the markets work without government intervention--but they weren't and aren't working on their own!  Saying it won't make it so.  The GOP pamphlet says it would "end the bailout strategy"--but it doesn't say what it will do to make it work, other than by "refusing to assume additional spending for bailouts" and having the financial industry that is being bailed out provide self-insurance to ensure some portion of each firm's toxic assets.  What portion, how discovered, at what cost, and how the firms that may actually be insolvent and in any case have already received hundreds of billions of taxpayer monies are supposed to "self-insure"--those questions are all treated as irrelevant details that the GOP "plan" need not answer.

Of course, the GOP still plans to privatize Fannie and Freddie, modify the Community Reinvestment Act (undoing the incentive for loans in underprivileged areas)  and amend the Humphrey Hawkins Full Employment Act (wikipedia link).  The pamphlet claims the latter encourages the Fed to keep rates artificially low.  This is very vague, but since the HHFEA was intended to apply Keynesian budgetary policies to create both incentives for business and work for the poor, the statement in the pamphlet sounds like a desire to have Fed policy leave the piddling matter of helping keep Americans employed out of the budgetary picture.

By and large, the pamphlet appears to support the very policies that created the financial crisis and the economic Deep Recession, yet it claims that these approaches will lead to a "swift" financial recovery! 

The GOP "road to recovery" sounds more like a yellow brick road to the Emerald City.

To accompany this three-course meal, you can snack from among the following responses to the GOP rollout of its budgetary wishlist: GOP offers alternative to Obama plan, AP, ajc.com, Mar. 27, 2009 (calling the response a "pamphlet with few details" that calls for a nirvana of tax, spending cuts and borrowing cuts);  this MSNBC interview (video link) on the matter (suggesting that the meager delivery of the same old--cut taxes, cut spending, and cut borrowing, without any numbers for how to do it, disappointed the PR buildup) and  George Stephanopoulis (video link from ABC) (showing the Democratic ad response to the Republican non-budget). 

But the dessert--that'd be the Wall Street Journal "Capital Journal" blog by Sara Murray, Political Wisdom: GOP's Botched Budget, Afghanistan progress & Mexico, Mar. 27, 2009.  Murray quotes NBC's First Read that "[t]he rollout was a disaster."

irrelevant economics?

Mark Thoma, over at The Economist's View, as always has a number of interesting posts, often picking up on posts by others.  For example, there's his posting (and related comments) of Anatole kaletsky's Goodbye, homo economicus, in which Kaletsky asserts that "the economics profession must bear a lot of the blame for the current crisis.  If it is to become useful again, it must undergo an intellectual revolution--become both broader and more modest."  The Kaletsky posting is followed by  What Academic Economists Do and the Need for Better Data (Mar. 26, 2009). 

The thing I like about Thoma's blog is that the comments are as good as the postings.

First, I found particularly interesting the commenter (on the first Kaletsky post who added his view of what economics, as a profession, needs to do to address its failings.  One thing mentioned--to "embrace the truth that the economic power [that] players have at the beginning of any scenario is a powerful determinant of the 'equilibrium' they end up with at any point." 

Dare I borrow that for a riff on one of the ongoing discussions within tax?  The owners of capital are paid attention to in our economy in ways that ordinary wageearners are not.  And they use the power that wealth provides to help tilt the rules in their favor--from preferential capital gains rates to the lower and lower estate tax rates even now being considered.  That initial position of wealth translates into power and is a significant factor in the "equilibrium" between taxation of capital and taxation of labor that is reached.  So I would say that not only does economics need to embrace a different paradigm, but also many other disciplines, such as tax theory, need to embrace a different paradigm that recognizes the truth of the role that positions of power play in determining the outcome of changes.

Second, there are a number of comments about the failure of ecoomics to grapple in a helpful way with the real problems that face us.  One commenter on the second post articulated my own frustration with much of the academic econometric literature of the last few years, noting that "with [modern math model mania], economists reify the model.  They make assumptions, write a model, then actually believe the model IS the reality... [B]ecause RC assumes that markets clear, it concludes that fiscal stimulus cannot work. ... It has assumed away the real economic issue and then announced reality can't be the way it is. " The result is that "most of the core fundamentals are based not on tried, tested, and falsifiable models, but on pure assumption, belief, and ideology."  Or as another commenter notes--economics "has become a slave to math models that are built on empirically incorrect assumptions."  Another noted that the public's impatience with the "spectacular failure of economics in this episode is that too many economists speak as though they actually do know, when they clearly do not." 

And third, a comment that goes to the heart of the problem: "This recession is the result of inequality.  That's the driving factor. As income accrued at the top, the median household income stagnated.  And used easy credit to continue to maintain its lifestyle. ...and what you saw in the Bush boom was the attempt to define it away.  This reached the height of ridiculousness when some [Chicago school types] came out with a paper claiming that the poor were accruing all the gains from free trade by being able to buy cheaper at Walmart."

And finally, how we got here.  "We have just come off a 40 year period where dogma was the primary tool of choice.  This led to Laffer curves, trickle down and free market policies.  Even when face with actual failures the remedy recommendations remained the same.  In fact those in this camp are still suggesting minimal regulation, balanced budgets and/or tax cuts." Robert Feinman, comment.

My conclusion.  Feinman is absolutely right.  And as a consequence, our precarious economic situation and resulting fiscal challenges will not be resolved without a change of heart within Congress and a willingness to understand that last point.  Forty years of dogma have left us with a tax code riddled with provisions to provide effective subsidies for favored taxpayers, including the Very Big Banks that have gotten us into this crisis (the active financing exception, among others).  Four decades of a "greed is good" mentality, illustrated by the  "I deserve it" attitude of the AIG bonus recipients (not to mention the rest of Wall Street's bonus mania in a time when these same banks were accepting tens of billions of dollars of taxpayer money either directly or through insistence on full payment under AIG's swaps) have left us with a financial system run by banks that are too big, by managers that are too greedy, and a shadow banking system--in the hedge funds and private equity funds--that is too risky.  We need to change the dogma and we need to change the greed-based "culture" in the financial and shadow financial system, or we'll never get to real tax reform rather than ideologically based cuts for the cronies of power. 

Amnesty offered for taxpayers who hid assets offshore

The IRS has announced that it plans to let Americans who hid their assets from the government to avoid paying taxes they owed off the hook for a large portion of the penalties they would otherwise expect to pay if they come forward within the next six months under the announced leniency program.  See IRS Memo on Penalty Framework for Voluntary Disclosure Regarding Unreported Offshore Accounts and Entities, Mar. 23, 2009 (BNA link since not yet available on the IRS website); Donmoyer, UBS Offshore Customers Offered Eased Tax Penalties, Bloomberg.com, Mar. 26, 2009.  Normally, penalties for secreting your assets from the government are stiff--the penalty under the Bank Secrecy Act for failure to file the required report about assets in foreign accounts is 50% of the amount in the account (or $100,000, if more) for each time the required report is not filed (and criminal penalties may also apply).  In just a few years of failed reporting, those penalties alone can confiscate the assets in the account.   But now the IRS says it will only try to collect such penalties at a rate of 5-20% of the maximum amount of assets held during the last six years (and that would be on top of taxes, interest, and the ordinary accuracy penalties, which will be assessed without application of any good faith/reasonable cause affirmative defense). 

BNA quotes Commissioner Shulman in a phone call as saying that this approach is "a firm but fair resolution."  Id. (Bloomberg report).  Certainly, the approach will lead to more voluntary disclosures of foreign-held accounts, following on the IRS summonses to UBS for 52,000 account holders' names.  Voluntarily revealing failure to file reports is typically treated with some leniency, in order to encourage compliance and to make the administrative and enforcement job easier.  Compliance initiatives are fairly common for shelter cases.  See, e.g., Kent Lawson, Offshore Misdoings, Repentance, and the US internal Revenue Service, 2006 Private Wealth Management 46 (discussing the increased focus on use of offshore tax havens and the tendency to view taxpayers who turn themselves in as "less culpable" , as well as several prior voluntary compliance initiatives from 2003 and 2005).

But the announcement of a penalty abatement initiative like this nonetheless reinforces fairness concerns about the administration of the tax laws.  In many cases, though by no means all, those taxpayers who have not reported their assets held in foreign accounts are intentional tax avoiders with lots of money.  Is our government through these compliance initiatives actually establishing two types of penalty systems where the rich who steal the most government revenues (by failing to pay their fair share of taxes) get off the hook too lightly?  This leniency, while it may make sense administratively, appears as one more component of the class warfare that has been waged since the Reagan presidency started.  The wealthy get tax laws that suit them most of the time, and they get treated fairly leniently even when they engage in obviously inappropriate tax-avoidance behavior.  Evidence for the first is available by simply looking at Sen. Baucus' plan for tax reform--it retains the ghost of an estate tax enacted by the Republicans who were intent on eliminating the tax (3.5 million exemption per taxpayer, so 7 million for a couple, and 45% rate); it retains the ridiculously low capital gains rates that give preference to the wealthy who own most of the financial income; and it maintains the AMT exemption in ways that lowers the tax considerably for those rich people who make between $200,000 and $500,000.  Evidence for the latter is the many times that the IRS has created settlement programs or announced other lenient enforcement strategies for the wealthy who have engaged in one or another of the various tax shelter schemes, including offshoring of their assets.

It would be appropriate if IRS were able to discover the identities of a sufficient number of them to put a spotlight on this criminal behavior through a criminal tax enforcement action.  So it is fitting that along with the penalty abatement policy, the IRS released a memorandum on "Emphasis on and Proper Development of Offshore Examination Cases, managerial Review and Revocation of last chance Compliance Initiative," Mar. 23, 2009 (again, BNA link), which places "the highest priority" on offshore cases and instructs examiners to use "the full range of information gathering tools" to develop those cases.  There is a useful addendum in that memorandum that lists the various penalties that may apply to unreported foreign accounts, including the Bank Secrecy Act penalty (greater of 50% of the account or $100,000 for each failure to report), tax fraud penalties (75% of unpaid tax), failure to file returns penalties (25% - 75% of unpaid tax), failure to pay tax due penalties (maximum 25%), accuracy-related penalties (20% -40%), failure to file information returns with respect to various specified entities (e.g., for failing to file regarding a foreign trust, 5% of the gross asset value owned by the US person).

According to one report, taxpayers with Swiss accounts who come forward are now being faced with a detailed list of questions that appear aimed at discovering how and by whom the tax evasive financial devices were promoted.   See IRS Squeezes Swiss Bank Clients for Evidence, AP, International Herald Tribune, Mar. 26, 2009.  Those questions could reveal not just other taxpayers using the accounts, but also bankers and accountants and tax lawyers who may have assisted taxpayers in figuring out the financial devices to hide their assets.

One tax attorney reported that he has clients who are still planning to "'roll the dice' and see if the IRS catches them."  Id. (International Herald article).  That's an allusion to the "game" these taxpayers have been playing that is made possible by our low standards for taxpayer compliance--the audit lottery.  But the lottery could have an appropriately harsh downside: those who don't come forward voluntarily will likely face tough prosecution when they are discovered, which could include jail time.  Take a  look at the Lawson article cited above--83% of tax crime convictions end up going to jail, with an average jail time of 42 months (2005 data). 

Gaming the Public-Private Investment Fund?

The Big Banks are having a hayday.  First, they speculate us into a deep recession, making lots of bucks along the way as they recklessly lend and securitize with big fees at every step of the way.  Then, they use the bailout money that the Fed has given them (billions) to pay themselves big bonuses and to acquire other banks so that they can be even bigger than too big to fail.  Then while they continue to hold back on lending, they figure a way to game the newly announced asset buyback program intended to buy the toxic assets off balance sheets so everybody can have faith in the banks.  They buy up toxic assets with TARP money, and plan on putting it (at higher prices) to the PPIF to be bought out with more taxpayer monies.  How to leverage bailout monies into more high stakes for the Big Banks, in ten easy lessons.  I guess the financial engineers at the Big Banks just don't know any other way in which to think.  One more reason why we should give Treasury authority to take these banks over.  

Here's more at Naked Capitalism, Has the Gaming of the Public-Private Partnership Begun?, Mar. 25, 2009. One good thing out of this--some trading in those toxic waste assets is taking place.  But if it is with this gaming in mind--to sell them back to the government funded entity at artificially puffed prices--that will leave the taxpayer on the hook and the banks with the puffed up profits. 

Senate Budget Committee FY 2010 Resolution: Why does estate tax/ AMT relief for the wealthy trump Making Work Pay relief for ordinary taxpayers?

On March 26, the Senate Budget Committee voted out the Conrad budget plan for FY 2010. 

Taylor, Key Senate Panel Backs Obama's Budget Blueprint, AP, Mar. 26, 2009. 

Rogers, Conrad carves up Obama's budget, Politico.com, Mar. 25, 2009;

Summary of Chairman's Mark FY 2010 Senate Budget Resolution, Mar. 25, 2009;

The Chairman's Mark: FY 2010 Senate Budget Resolution, Mar. 25, 2009

Transcript of Remarks by Senate Budget Committee Chairman Kent Conrad at Markup of FY 2010 Senate Budget Resolution, Mar. 26, 2009;

Statement by Senate Budget Committee Chairman Kent Conrad on Budget Committee Passage of FY 2010 Senate Budget Resolution, Mar. 26, 2009;

The Conrad bill calls for making the Bush tax cuts permanent except for the highest earners and patching the AMT for 3 years without a requirement for any offset.  It permanently extends the ridiculous section 179 expensing rules.  It  expands net operating loss carrybacks and eliminates capital gains taxes for small businesses. It makes the 2009 estate tax levels permanent (with indexing of the exemption amount) and extends all of the "temporary" tax provisions that would otherwise expire in 2009 and 2010 (the treatment of dividends favorably as net capital gains, the active financing exception that lets Big Banks pay no tax on their overseas income until they repatriate it, thus leading them to defer repatriation, etc.).  It doesn't commit to making the Making Work Pay reduction in payroll taxes permanent or even to shifting the Pell Grants to the mandatory funding status proposed by Obama (merely providing for a "deficit-neutral reserve fund to allow for increases in Pell grants").  The budget bill doesn't endorse the cap-and-trade proposal supported by the President, and doesn't provide specifics on clean energy or paying for universal health coverage.

So the Senate Dems are more concerned about providing tax relief to those making $200,000 to $500,000 a year (the upper class that is hit by the AMT) or multimillionaires (estate tax "reform" for the ultra wealthy) than in providing much needed payroll tax relief to ordinary taxpayers who make the ordinary wages made by the huge majority of taxpayers in this country.  The cost of the revenue reduction measures in the Budget Committee's proposal is $825 billion over 5 years, and suggests a deficit of $1.2 trillion in 2010.   

And this is a budget bill written by Democrats?!?   The summary calls estate tax "reform" and AMT relief "tax relief for the middle class."  Folks, how many times must it be said that those who pay the estate tax are NOT middle class by any estimate, even going back several years to the $2 million exemption amount (amounting to $4 million for a couple).  Nor are those folks who make $250,000 to $500,000 that are aided by most of the AMT patch middle class.  They are, quite clearly, in the upper crust, the top quintile.  The Blue Dogs are misplacing their priorities.  One wonders why they are aiming for deficit reduction at all in their budget, rather than aiming for re-targeting spending away from the grossly bloated military budgets that have been produced by four decades of the "Reagan revolution" and back towards sustainable environment and people-oriented policies.  But if they are going to aim for deficit reduction, why not do it by (i) letting Bush's estate tax cuts to benefit the wealthy die the death they are supposed to at the end of 2010, reverting to the 2001 estate tax rate; (ii) letting the AMT come into play for taxpayers making more than $200,000 a year, patching only for those at lower income levels; and (iii) enacting payroll tax cuts for people at the bottom by extending the "payroll" taxes to earnings from capital?

Senate consideration will take place next week, where the budget resolution, which requires only a simple majority and is not binding legislation, will likely pass.

Meanwhile, the Senate Finance Committee has posted the text of its tax bill, S. 722, the Taxpayer Certainty and Relief Act of 2009.   The bill makes much of the Bush tax policy in favor of the wealthy permanent:

• AMT: the higher exemption amount is made permanent, with indexing for inflation
• Tax rates: replaces the pre-Bush 28% rate permanently with a 25% rate and the pre-Bush 31% rate permanently with a 28% rate, and for two years replaces the pre-Bush 36% and 39.6% rates with 33% and 35%, respectively;
• Capital Gains rates:  makes permanent the Bush reduction in capital gains rates of 0% and 15% for everybody (but the rate for the top two brackets of income will revert to the still very low 20% )
• Credits: Adoption, Earned Income, and other Credits are made permanent, and the so-called "marriage penalty" relief is made permanent and families with 3 or more children get a larger child credit percentage
• Estate tax: the Bush estate tax reduction as of 2009 (3.5 million per taxpayer exemption, 45% rate) will be made permanent, and the exemption amount will be inflation adjusted.

Textron Rehearing

There is a new development in the Textron case worth noting.

For those who need a refresher, way back in August 2007, I reported on the District Court of Rhode Island decision in the Textron tax accrual workplace case, in Textron, Inc.: Tax Accrual Workpapers, Attorney-Cleint Privilege, and Work Product Protection. 

The court concluded that tax accrual workpapers generally come under both attorney client privilege and work product protection, but that the company had waived the privilege when sharing materials with the primary auditor.  The First Circuit has adopted the ridiculously broad "because of" test from the Second Circuit's Adlman opinion for work product protection.  As I noted in that first posting on Textron, that test "turns the prupose of work-product protection on its head, especially in the tax context.  Work product protection is supposed to give an attorney a 'zone of privacy' when he is preparing a case for trial, so that he can work through strategies and approaches without revealing his every hand to his adversary.  Preparation of tax accrual papers to make the determination of how much funds should be considered reserved in the eventuality that the tax positions taken over time by a company on its returns are not held up after an audit is not an advitivity at that stage of an adversarial process--in fact, it should not be viewed as adversarial at all at that stage."  So I argued that tax accrual workpapers should not be entitled to work product protection (and certainly not attorney-client or tax practitioner privilege).

I had hoped that the appellate panel would fix the mess.  Regretably, this January the First Circuit three-judge panel affirmed the decision. See Textron: First Circuit Comes to the Wrong Conclusion, with some weak arguments, Jan. 24, 2009 (opinion linked in the posting). 

The January posting presents a detailed analysis of the First Circuit's opinion, and a harsh judgment about the panel's reasoning and conclusion.  As I said there, "Textron, my friends, is wrongly decided.  It is about as bad as the decision in Murphy, where the court simply didn't know how to read a tax statute."  I delved into my analysis in the "Tax Advice Before the Return" article, and showed that work product doctrine should not be applied to routine tax-accrual workpapers that must by their very nature consider the  possibility that a position could be reversed on audit. 

[T]ax accrual workpapers are in  no way documents prepared in anticipation of litigation.  They are documents prepared on an annual basis by every public company for financial reporting purposes to comply with the securities laws, regardless of whether they expect their aggressive tax positions to be caught by the IRS on audit or not.  They are no more work product than any other document that a company prepares throughout its existence, with an eye towards the "what if" of some potential future litigation always shaping the way things are phrased.  Tax accrual workpapers are business documents that are not protected by attorney client privilege or the tax practitioner privilege and they are not work product.

***

 The First Circuit here has created a version of the work-product doctrine that is so broad that it would, as the IRS argued, "afford a 'blanket' protection" that would "swallow the attorney-client privilege".    It is a version of the work-product doctrine that applies with special force to tax, where every item must be reported on a tax return, and every item reported on a tax return that is not 100% certain is potentially subject to becoming an issue on audit.  It is as though the First Circuit judges were trying to make sure that the IRS could not use its summons power to get any information in the taxpayer's hands that would be relevant, since this blanket work-product protection would leave almost no document having to do with tax positions on a return unprotected!  ... As the dissent in Textron noted, it is not the subject matter discussed in materials that controls applicability of the doctrine, but whether documents are prepared in the ordinary course of business or specifically because of litigation potential. 

The Textron court completely misunderstands the context here.  It said that because the documents had to analyze the possibility of litigation to determine the extent of reserves necessary, it meant that the "driving force" behind the documents was expected disputes with the IRS over tax positions on the return, and therefore the documents were created in anticipation of litigation.  It has it backwards.  Because the company had reported some positions with less than 100% certainty on its tax returns, it was necessary for the company to calculate appropriate reserves on its books.  The driving force behind the documents was the need to calculate reserves for financial accounting purposes, and therefore the documents were not created in anticipation of litigation. Textron: First Circuit Comes to the Wrong Conclusion, with some weak arguments, Jan. 24, 2009

On March 25, 2009 the First Circuit entered an order to rehear this case en banc. The panel opinion and dissent are withdrawn and the panel judgment vacaated.  Any supplemental briefs will be filed by April 22, and the rehearing will take place June 9.

So there is hope.  Maybe the en banc court will clean up this mess and recognize that tax accrual workpapers are not entitled to protection under the attorney client privilege, the tax practitioner privilege or work product doctrine. 

Geithner's Toxic Waste Plan: good? bad?

BloggingStocks thrills that "Before the bell: Stock futures jump on Geithner's plan to buy toxic assets," Mar. 23, 2009, as investors look positively on the plan to "clear as much as $1 trillion of the toxic debt off bank balance sheets."  Wall Street Journal headline blares "Toxic-Asset Plan Sends Stocks Soaring: Dow jumps nearly 500 points on unveiling of public-private program to buy up to $1 trillion in soured loans and securities", Mar. 24, 2009.  The front page article shows Tim Geithner at the Wall Street Journal Future of Finance Initiative, and a chart with the day's stock ticker soaring upwards.  Here's the Dow ticker for Mar 20-Mar 24 closing (showing that Monday's euphoria wore off a little on Tuesday with profit-taking).

What's the plan, and why did Wall Street like it so much?

The plan involves the government setting up an arrangement for purchasing toxic waste off banks' books (Paulson's original idea).  What would unaided investors pay for this toxic waste right now?  A price very much discounted from face value--after all, there's a reason it's called toxic waste, and that reason is the sky-high foreclosure rate on the mortgage loans backing up the "assets" in the securitization pools.  There's good stuff (that's the mortgages on the wealthy who aren't under water) and there's bad stuff (that's mortgages on ordinary guys who are losing their jobs and their homes at the same time).  It's the bad stuff that the banks want to get rid of, of course, not the good stuff.  So why hasn't that waste been sold long ago for a discount price, like desperate department store "the holidays are here" crappy merchandise at after-Christmas sales?  Because the banks are holding on--they want a price closer to face value, and they think if they hold on long enough the federal government will ensure they get it.  After all, the economy depends on it..... 

So, for example, we have assets with face of 100, which the banks don't want to let go for less than 80 and nobody wants to buy for more than 40.  In real markets, the banks would sell for what they can get without a subsidy from the government.  What would happen here, if the banks didn't think they'd eventually get a subsidy from the government?  Many banks might have to sell because of liquidity needs.  The waste would go off their books, but some of the big ones might be very close to insolvent.  The deals would reveal what the market really thinks, and it might force some of the banks to go out of business.  The banks know that the government is afraid to let that happen, after the Lehmann Brothers experience.

Big Banks are powerful.  And one way or another, they seem to be managing to get both the Bush administration and the Obama administration to give them the same obeisance.  They are holding out for federal subsidies. 

And the current Geithner Plan seems to give them exactly what they (and the big private equity firms with lots of cash on their hands) were looking for.  So "The Geithner Private-Public Partnership: The cure may be worse than the disease!, BloggingStocks.com, Mar. 24, 2009, notes that

Here's how the plan gets around the no willing buyer-no willing seller impasse.  Treasury puts some of the TARP funds (say, $100 billion) in a "public-private investment program" that is going to bid on the toxic waste.  Somebody with cash--likely a group made up primarily of private equity firms--matches those funds.  Somebody with cash (also likely private equity firms) lends the public-private investment program the money to buy the toxic waste, backed by a guarantee from the federal government.  The private investors have an incentive to let the price bid go up more than they otherwise would have--because the government is going to pick up any loss beyond their actual equity stake, and they are going to pick up almost all of the upside.  See, e.g., Mike Madden, Pay no attention to the Treasury secretary behind the curtain, Salon.com, Mar. 24, 2009;

The banks love it--they get their higher-than-market-value price up front.  They win no matter what, without having to wait to see how the economy pans out.  The private equity firms and other investors love it--they are not likely to lose much, with the federal guarantee taking the lion's share of any loss, and they could make a killing.  (But they don't have any qualms about using the government's obvious need for their ready cash to protect themselves from any bonus tax bill or other compensation limits, and Geithner has already agreed!  See U.S. Toxic Asset Plan Needs Hedge Fund, P.E. Backing, Mar. 23, 2009.)  If the economic future of this country isn't too blighted and we pull out of this Deep Recession before too long, the taxpayers might just get their money back as well as a little bit of upside.  So the government acts as the money bags for the private equity "masters of the universe" whose big deals are a part of the reason for the mess, as a way to "save" the banks and get the financial juices flowing again, like "normal" (meaning, too much credit?), for businesses and homeowners and the economy in general.  In the process the banks get a good bit higher price than the true current market value, because the fed is ponying up part of the money and the auction bid is backed by the federal guarantee.  What's not to love?  This is a made-for-Wall Street deal. 

Paul Krugman,in his blog Despair over financial policy, Mar. 21, 2009, suggests that  the "zombie idea" that toxic waste is really worth more than zane investors would pay for them are fundamentally a view that we can just kickstart the financial system back to where it was, because "there's nothing fundamentally wrong" with it.  The result, though, is that Treasury itself will have skewed the incentives by offering nonrecourse loans to investors that overbid so that banks' balance sheets can look good.  Then the next day his op-ed column again roundly condemned the "cash for trash" policy: Financial Policy Despair, Mar. 22, 2009.

Doug Roberts notes, in The Geithner Private-Public Partnership, The cure may be worse than the disease!, BloggingStocks.com, Mar. 24, 2009:

[T]he government appears ready to create substantial incentives for these private investors to purchase at higher prices, possibly including non-recourse loans and government guarantees. This assumes that the banks are right, and these assets will eventually return to higher values.  However, suppose that the investors are right, and these assets are worth very little. We are merely paying private investors and banks with taxpayer funds to postpone the inevitable write-down of these assets.

Brad deLong, I think Paul Krugman is Wrong, Mar. 22, 2009, disagrees.  He suggests that the Geithner approach is politically necessary, even if nationalization of banks ultimately is required.  (The comments are a must-read on this post.)

Doug Mataconis collects Krugman's, Galbraith's, and Stiglitz's responses to the Geithner Plan on his Below the Beltway blog, Economists Against the Geithner Plan, Mar. 24, 2009.  Galbraith and Stiglitz use even stronger language than Krugman. Galbraith says the banks will benefit from their own fraud--"fraud in the inducement, fraud in the conveyance, and fraud in the ratings process."  Stiglitz says the plan is outright "robbery of the American people."