ataxingmatter

More Class Warfare from the Cato Institute's Dan Mitchell

The "center for freedom and prosperity" (CFP) is one of those so-called "think tanks" that spews out materials on a regular basis to push the ideology of low taxes for the rich, low taxes on business, and low government services for the vulnerable.  It is closely associated with the Cato Institute,  a radical libertarian "think tank", and generally uses Cato Institute's Dan Mitchell as the personalized face of its video productions.  

Generally, these videos are a pastiche of charts and "facts" that have little substance but lots of show.  See, for example, my analyses of the CFP series of videos on the so-called "Laffer Curve"--a non-theory pushed constantly by Cato and CFP to support non-taxation of the rich: CFP's Laffer Curve Video (Feb. 18, 2008) and The Laffer Curve II--proof? (Mar. 10, 2008).  These videos are good examples of CFP's craft--presenting an ideological position (the Laffer Curve) as though it is a substantial theory based on reasonable evidence and supported by clearly established facts, making statements out of whole-cloth inventions that are treated as facts, presenting only selected data that appear to support a position without noting either conflicting data or other (stronger) rationales for the data than that presented.  CFP and the Cato Institute consistently push their goals of shrinking certain aspects of  government (generally, government "entitlements" that help the vulnerable) and letting the wealthy get and stay wealthy (without paying much in taxes).

Now Dan and CFP have put out another video in its class warfare against taxation.  It's called "The Case Against Class-Warfare Tax Policy."  The title is catchy, but of course it is deceptive.  This is not a video about the case against class warfare, it is a video that is offered as a battle in that war to influence tax policy in favor of low taxes on the rich.  Of course, CFP considers progressive taxation class warfare, but it doesn't consider regressive taxation (or changes towards less progressive taxation) class warfare.  The Bush Congress changed the tax code thousands of times, in many ways that reduced taxes on the capital gains and dividends of the rich, thus leaving more of the burden of taxation to the rest of us.  Never once did the CFP or Cato Institute put out a video worried about the class warfare being waged through tax policy on ordinary Americans.  As I've noted many times here and in discussing the concept of democratic egalitarianism, tax changes will inevitably have distributional effects--some will redistribute downwards and many will redistribute upwards.  Most tax expenditures are of the latter variety:  from the mortgage interest deduction to the exclusion of gain on home sales, from the deduction for state sales taxes to the charitable contribution deduction for value rather than basis, they amount to specially beneficial provisions supporting the lifestyle of the rich and reducing their taxes compared to the taxes of those not itemizing (about 70% of the taxpayer population) and those with much lower incomes and lower rates of taxation.   As long as there are activist groups lobbying for positions that favor one group and as long as those with money can organize and lobby more successfully than those without money, class warfare will go on and the war will generally be won by those with money.  So it is important to acknowledge class warfare.  And important to notice how it takes place.  Most of what CFP does is a battle in the class warfare of tax policy against ordinary Americans on behalf of wealthy owners and managers of capital.

So what does Dan Mitchell claim in the video?  He accuses the Obama Administration of trying to "soak the rich" merely because it advocates paying for the bailouts (of the rich) and the stimulus (necessitated by the speculative gamesmanship of the rich) by taxing the extraordinarily wealthy more in line with the pre-2001 levels (though still nowhere near the higher rates under the prosperous Clinton years).   He claims the Obama Administration's policies are "persecuting" the (so-called) rich with higher tax rates--he lists four items:

• increasing income tax rates
• increasing payroll tax rates
• "increasing the double taxation" of dividends and capital gains
• hitting

the rich with a "45 percent death tax if they create a nest egg for their children"

Let's parse this. The rich  pay payroll taxes on only  their wage incomes (and for one of the two, only on the first $100,000 or so).  Many wealthy CEOs receive large amounts of preferentially taxed capital gains and dividend income annually, and earn salaries in the tens of millions annually.  The zero taxes for Social Security and Medicare paid on their capital income, and the peanuts paid on their first $100,000 of wage income means they make only token payments of these two important taxes relative to their overall incomes.  Meanwhile, the vast majority of Americans have very little or no capital gains income and earn less than $100,000 in wages annually, paying both payroll taxes on that full amount.  How can it possibly be "persecuting" the rich to ask them to pay some greater amount of the Social Security and Medicare tax burden that most ordinary Americans share? 

What about "increasing the double taxation of dividends and capital gains"?  First of all, it isn't really a tax increase.  Remember that the tax rate on ordinary capital gains was much higher under Clinton, when it was lowered to 20%.  The Bush regime lowered it still further--to zero percent on capital gains within the lowest two brackets, and only 15% on excess capital gains.  So while many middle class Americans pay taxes at a marginal rate around 25%, the super wealthy with mostly capital gains pay taxes at a marginal rate of only 15% (disregarding the studies that show considerable fraud in reporting basis). The Bush rates were temporary, as they were supposed to act as a stimulus under the discredited "Laffer Curve" idea that cutting taxes increases tax revenues. The rates are supposed to return to Clinton levels, so allowing the statute to play out as it was designed to do would not be a tax increase.  The Obama plan is to make the Bush changes permanent (thus, enacting a tax decrease) except for those at the top end of the distribution, for which rates would be allowed to go back to the 20% rate as the law now provides for the end of the temporary stimulus period. (Same thing is true of the income tax "increases" bemoaned by Mitchell.) 

Second, capital gains aren't really double taxed now, so you can't "increase the double taxation"!  Much aren't taxed at all--charitable contributions of valuable art that was bought years ago at a low price results in a tax deduction of the value, not the actual investment basis, creating a negative rate of taxation on that gain.  Much of the gain in value of corporate stock is simply speculative gain in the markets and of course it hasn't been taxed at all til the shareholder sells the stock--at a time of the shareholder's choosing.  The deferred tax coupled with the pre-sale use of the appreciated value to the shareholder (as collateral for a loan, as power in the community) is a huge boon.   Even if the corporate tax paid affects the value of the shares somewhat, it is not a direct correlation and certainly doesn't amount to "double" taxation.  Many corporations pay no taxes at all or very low taxes (through legitimate and illegitimate tax shelters).   Another of the temporary provisions was to tax dividends at the low capital gains rate--even though dividends are frequently paid out of income that hasn't borne anything like a 35% corporate tax (the statutory rate).  Suppose a shareholder gets a dividend from Google that has been subject to a 7% effective corporate tax rate and the shareholder pays an effective tax of about 12 percent on the dividend (because of the zero rate on the first capital gains received), that combination of the corporate tax and the shareholder tax is less than the effective tax rate paid by many corporate secretaries.   And, like the payroll taxes, there's a fairness issue here.  The wealthy own most of the financial assets, and income from financial assets has been exceedingly lightly taxed under the capital gains preference.  Class warfare is evidenced by the fact that Congress isn't even considering eliminating the capital gains preference altogether so that laborers and capitalists are each paying their fair share of the tax burden, as it did in the major tax reform under Reagan in 1986.

And, of course the proposed change to the taxation of estates left to children and other beneficiaries of the wealthy is not a tax increase either.  It is, in fact, a tax decrease over the current law, which restores the estate tax after 2010 to the 55% rate on amounts above a much smaller exemption.  The current proposal would instead freeze the estate tax at the 2009 45% rate, and provide an exemption of $3.5 million ($7 million for a couple). That's ridiculously generous--most large estates are comprised primarily of financial assets and most of the gains in those assets have never been taxed during the lifetime of the decedent.  Taxing them at death, rather than during life, makes sense.  The beneficiaries haven't earned them and so are not entitled to get them without a fair tax being paid.  We should let current law apply and let the estate tax go back to its pre-2001 change levels.  That would be the fair thing to do, so that big estates would not so easily build family dynasties from the bounty of the U.S.'s stable legal and economic system without contributing their fair share to pay for that system.

Mitchell's tone, through all of this, is one of outrage, pouring on emotions to convince ordinary Americans that they should dislike these reasonable provisions as much as he does.  The next segment, though, is even worse.  Here, he pulls the "socialism" card--suggesting that these reasonable (and small) taxes on the rich will push the United States into becoming a "European welfare state".  Of course, there are many good things to be said about the European combination of democractic processes and social welfare programs for rich and poor alike, but none of that is mentioned by Mitchell.  This is the modern version of the 1950s use of the red scare, only this time instead of pushing ordinary Americans out of their jobs this red scare is intended to keep Americans from adopting reasonable  programs that serve the public interest, like a single-payer public health care option.  We shouldn't be fooled by the red scare again, after seeing what havoc the "free market" alternative espoused by the Cato Institute has done to our financial system, our homes, our jobs, our pensions, and our health care.  The ideological "free market" result, in contrast to the balanced democratic egalitarian result, favors socialization when it benefits the rich (as we've socialized the losses of the bankers in the bailouts), and privatization of gains.

So what are Mitchell's arguments in this segment?  He says that taxing the rich more will result in a gruesome parade of horribles: 

• Higher taxes reduce incentives for productive behavior--more taxes, less entrepreneurship

• Higher taxes, per the Laffer Curve, discourage savings and investment and encourage tax evasion--all of which will result in reduced tax revenues.

• higher "punitive" tax rates on the rich don't help the poor like increases in per capital GDP help the poor (and it's okay if the rich get even richer in the process)

• High tax rates on the rich, in an era of globalization when labor and capital can easily cross borders will just lead to jobs and investment leaving the country;

• High tax rates on the rich will just result in higher taxes on the rest of us--after all, the income tax started out just taxing a few rich people, and now it is a broad-based tax that reaches most Americans.

As to point two, see, again, my analysis of the Laffer Curve videos detailing the lack of evidence for the claim that raising taxes reduces revenue.  In fact, Mitchell admits (almost in a whispered aside) that tax increases in most cases lead to more tax revenues.  The claim has been reduced to--not as much as the politicians expect.   And yes, evasion will go on with slightly higher taxes, but the wealthy who evade taxes do so no matter what the rate, aiming for zero taxation.  The answer to that concern is enforcement, not conceding the ground to the evaders to start with.  And while there may be some short term revenue bumps from tax cuts, they generally are just that.  So the capital gains revenue increases on tax cuts are transitory changes in realizations that can be controlled by the individual taxpayer who decides to sell to take advantage of what he thinks may be temporary rates (because, for example, they are slated to be temporary in the statute).

But consider Mitchell's first point--he claims that higher taxes will cause wealthy Americans to quit investing and quit engaging in entrepreneurship.  He uses the example of sin taxes (where drafters are happy if they raise revenues--because people will indulge in their vices, even if indulgence costs considerably more because of higher taxes--or if they lower use--because vices aren't good for people, so to the extent that the higher taxes keep some from indulging, that too is a public good).  But sin taxes don't prove that activity ceases when it is taxed--sin taxes are good, because the public interest wins both when the activity goes on (higher revenues) and when it doesn't (harmful activity lessened).  As economists will tell you, elasticity is a major issue in determining the result is, and many factors come into play.  Will the rich really quit investing in order not to have to pay slightly more on their investment gains in 2010 than they had to pay in 2007?   They may invest even more in tax shelters and overseas but  what else will they do with the excess millions?  Will the rich quit entrepreneurial activity if they think they will be taxed more on it?  Unlikely.  Some may, but if they are real entrepreneurs, they aren't doing it just for the money anyway.  Of course, most entrepreneurial activity is from small fry who aren't already rich, so this is not a big area of concern to start with.

What about the third point--that growth, per se, is the way to make the world better?  That depends.  As Benjamin Friedman noted some years ago, growth that is concentrated for the benefit of the wealthy doesn't do much for society.  The benefit of growth during the Bush years has gone mainly to the wealthy.  Broad-based growth that results in better pay and more jobs is the kind of growth that is needed, and that growth may be fostered by government spending on human and tangible infrastructure that can be financed through taxes on the wealthy.  That argues for actually increasing the taxes on the wealthy.

What about the flight of the wealthy, the threat in item four that globalization means investment (and job creation) can go elsewhere and America will be less competitive.  Certainly there is some truth to the worries about globalization, but ultimately investors want stable legal regimes and governments that produce the kind of environment that protects property rights, entrepreneurial activity, and new businesses.  That is one of the reasons that the United States continues to attract foreign direct investment.  Some will take their money elsewhere, but there aren't always such good places to invest elsewhere. In fact, one of the issues being discussed is the impact of this Great Recession on globalization.  There is a growing countercurrent to globalization, from "localvore" to "buy American" sentiments.  It will be interesting to see how this plays out, but it is not clear that the wealthy will so easily expatriate themselves (or their cash) to avoid investing in the US.

And that last one?  Yes, we will likely all see some kinds of tax increases.  After all, we live in a relatively low-taxed country where the income tax is the primary tax system, with sales taxes at local levels (including some states).  Other countries add on VATs and complex schemes of taxation.  We will have to pay for the excesses of the Reagan-Bush years of borrowing to cut taxes for the rich and spend on the military, and that will inevitably mean some tax increases when the Recession has begun to recede.  But those increases, if necessary, won't be "because" we first increased taxes on the rich.  (Mitchell says politicians "stick it" to the wealthy as a first step in their plan to tax everyone else more.) Higher taxes will come about because we need revenues to pay for important government programs and to service the immense debt--doubled under Bush II and increased hugely to pay for the stimulus and bailout programs necessitated by the financial crisis.

Dan Mitchell and the CFP hope that ordinary Americans will watch their video and be convinced that taxing the rich at fairer levels will cause all kinds of harms to ordinary people--"economic stagnation" and other woes.  They are willing to misrepresent the facts (letting current law stay in force would result in much higher estate taxes in 2011 than letting Obama's changes take place).  They will use highly emotional wording ("death taxes", "persecution", "sticking it to the rich") in order to trigger worries and concerns.  They will act like the taxes being discussed are not really affecting just the rich (Mitchell uses a tone of voice and statements that suggest that those who earn more than $250,000--the group generally affected by any changes--aren't rich.  Yet they are clearly in the top echelon of American taxpayers.)  And they will apparently spare no effort to keep up the stream of anti-tax, anti-government propaganda that is, ultimately, extraordinarily harmful in destroying the cooperative "we're all in it together" view of taxation that Americans have shared for so long. 

Michigan's taxes and troubles

Michigan, as everybody knows, is a depressed state these days. High unemployment, high foreclosure rates, and even the Red Wings can't win it all.  As two of the Big Three auto companies go into bankruptcy, Michigan is shedding jobs as fast as ice melts on a sidewalk on a hot summer day in Mississippi.  Michigan, in other words, has real problems, and real needs that the state government should address.

My suggestion?  It's time to change Michigan's income tax.  Michigan has its share of very wealthy people--just look at the millionaires' homes in the wealthy suburbs of Detroit, from the Grosse Pointes to those new 'burbs to the Northeast.  But the wealthy in Michigan pay the same flat income tax rate that the middle class pays--4.35%.  A family of four starts paying that on wages above the personal exemption of $13,200 (after other deductions, if any).  But a family of four with a salary of $500,000 pays the same rate. 

Obviously, those few dollars mean a lot to the poor family and hardly anything to the wealthy one.  That's why the federal income tax has had a progressive rate structure since its inception (and, of course, why the wealthy capitalist class has pushed back, especially lately, with demands for zero taxation on capital gains and lower rates with fewer brackets for ordinary income--much of which was handed to them by the Bush Congress in the major tax bills of 2001-2003).  It's also why all but seven states with a broad-based income tax have a progressive tax rate strcuture, generally ranging between 3 and 8 or 9% of adjusted gross income (sometimes as modified under state rules). See this chart from the Federation of Tax Administrators for a synopsis of state rate structures and exemptions. 

Michigan should revamp its tax system--instead of serving the wealthy, with a relatively low, flat tax rate, Michigan should enact a progressive rate structure.  How about a zero bracket for the first $25,000 in income, and then a progressive rate structure moving from the current 4.35% on the first $100,000 above that, to 5.35% on the next $200,000, to 6.35% on the next $400,000, to 7.35% on the next $2 million, to 8.35% on anything above $2,725,000.  (Look at this study, which has information on city and state tax burdens, including income, property and sales taxes,  and you'll see that Detroit has very high tax burdens--because of the flight of its industrial base and the white flight to the suburbs; so most of the wealthy who work in Detroit don't live in the city and don't pay those higher taxes--they live in the surrounding suburbs that can't be annexed to the city.)

Would people move out of Michigan because of the income tax change?  Sure, some in the upper brackets would.  (They're already doing so, of course, because of the Great Recession, which has hit Michigan particularly hard.)  But most other states already have a progressive income tax, often reaching 6% on fairly low incomes--so  many of those states' effective tax rates would be much higher than Michigan's current flat rate and maybe higher than the proposed change.  So those that move  because of the tax would have to choose a state that had a lesser tax than Michigan's new one.  If they move, they might have done so sooner or later anyway,  since that group is by definition adequately resourced to live wherever they want to live and can probably find new jobs (to the extent their income is wages and not capital gains) fairly easily as well.  But a tax of less than 7% on the first $725,000 is very reasonable, and would make a difference in the ability of the state to do more to create a sustainable economic environment through expenditures for human capital infrastructure (i.e., for K-12 through university funding) and public infrastructure of all other varieties.  Not to mention that it would also be much fairer, by taxing people on their ability to pay.

IRS wins case on medical resident FICA taxes

[edited to add Eighth Circuit website link to case]

This issue has garnered a good bit of attention in universities with med schools, and so it is worth noting the outcome in the Eighth Circuit today.  The IRS regulations issued in 1994 (T.D. 9167) say stipends paid to medical residents that work more than 40 hours a week are subject to employment taxes under the Federal Insurance Contributions Act (FICA).  The University of Minnesotta and the Mayo Foundation argued that those regulations were invalid, because of the student exception to FICA.  

The statute taxes wages, which are broadly defined as "all remuneration for employment."  "Employment" is defined as "any service, of whatever nature, performed ....by an employee".  There are a number of statutory exceptions, including one for students. That exception is for "service performed in the employ of ...a school, college, or university...if such service is performed by a student who is enrolled and regularly attending classes at such school, college, or university."  See section 3121(a), (b).

The issue, of course, is whether at medical resident qualifies as a student under this definition.  My daughter-in-law just "graduated" from medical school and has just started her residency in Oregon.  She is delighted that she will now be paid a salary and have some income while she continues learning.  There appears to be a clear status difference between medical students and medical residents, reflected in the salary and in the role of the residents in the teaching hospital.  So the idea of FICA taxes seems to make sense in that context.  I can't fault the IRS for its conclusion as expressed in the 2004 regs--that "[t]he services of a full-time employee are not incident to and for the purpose of pursuing a course of study" and that someone "whose normal work schedule is 40 hours or more per week is considered a full-time employee."

The Eighth Circuit agrees.  Applying the Supreme Court's Chevron doctrine of deference to reasonable agency interpretations of an ambiguous statute, the court upheld the validity of the regulations as interpreting ambiguous terms in the student exception to FICA.  Though there may be a common understanding of "student" in other contexts, the court notes, Treasury Regulations have clearly been upheld that construe a large variety of "words in tax statutes that have a common or plain meaning in other contexts."  The court provides legislative history and court cases relevant to the issue, which the Service also relied on in the notice of proposed rulemaking to conclude that the exception was meant for those who would otherwise have only nominal benefits.  Ultimately, the court concludes that applying the student exception only to those who are not full time employees is a reasonable interpretation of the statute.

The case is Mayo Foundation for Medical Education and Resarch v. U.S., No. 073242 (June 12, 2009) (available here on BNA and here on Eighth Circuit website).

Deficits and the JCT Estimates Revenues for Obama Tax Proposals

The Joint Committee on Taxation (JCT) released its "Estimated Budget Effects of the Revenue Provisions Contained in the President's Fiscal Year 2010 Budget Proposal As Described by The Department Of The Treasury, May 2009," JCX-28-09, June 11, 2009.  The JCT uses different modelling than the Treasury, so its numbers provide somewhat of a reality check on Treasury's calculations--or, at least, a second opinion to be taken into account.  Overall, the JCT concludes that the revenue projections will raise about $50.6 billion less than Treasury projected from changes in rules affecting taxation of offshore profits, and would add about $2.9 trillion to the deficit over a decade.

Republicans are suddenly making noises about deficits.  If you listen to them on the various talk shows, you'd think they'd been the most prudent administrators ever in charge of a government.  Yet today's deficit--like Reagan's and Bush I's and Bush II's--is primarily due to decades of GOP-led borrow-and-spend policies (coupled with tax cuts for the rich, military contractors that are funded by consistently high military spending during war, and privatization of many fundamental governmental services, such as defense).  For years under the Bush Administration, Republicans led a borrow and spend approach to government, with fiscal restraint thrown to the wind.  See, e.g., Robert Kuttner, What Killed Off the GOP Deficit hawks?, BusinessWeek.com, Dec. 27, 2004 (noting the Reagan tax cut-and-spend deficits caused Bush I to have to raise taxes but, as Concord Coalition Bixby commented, "Republicans are the ones making excuses for big deficits").  Supply siders decided deficits didn't matter because tax cuts could raise revenues, and government haters wanted deficits to make problems so that they could end government services. Id.  The Democrats, of course, are emphasizing this imbalance of priorities in their agenda to stimulate the economy, improve human and physical infrastructure, and enact health care reform.  See, e.g., "Democrats are Working to Reverse the Republican Deficit that is Crippling the U.S. Economy", DPC, Apr. 3, 2009.

Just one example of the problem is evidenced by the Bush Congress' handling of the whopping 2001-2003 tax cuts and the AMT:  it intentionally left the AMT positioned to catch more taxpayers because they knew that the cost of lowering the AMT rates to correlate with the lower regular tax rates would be prohibitive.  Yet they intended all along to bear that prohibitive cost, funded by borrowing, by patching or repealing the AMT so that it wouldn't apply to that large group of "just wealthy" upper-class Americans in the $200,000-$500,000 annual AGI range.  See my 2004 article on the AMT, "Congress Fiddles ," still timely and relevant, for a fact-flled and detailed analysis of the budgetary issues, the normative concerns that should govern our thinking about the AMT in the context of the Bush tax cuts, and the best alternatives for AMT reform.  Or you can read the six-part series on the AMT that captures the meat from the article, on the blog: What Should Congress Do About the AMT? (Part I); Part II;  Part III; Part IV; Part V; and Part VI.  Here's my last paragraph on the issue.

[W]e should deal courageously with the problem by thinking about what we want our tax system to do and how we can approach the system that currently exists to best deal with the increasing tax burden on the lower and middle quintiles as well as the increasing inequality between the haves at the top of the income distribution table and the rest of America.  Let's have a regular tax system that can be simplified considerably by using the AMT system to impose a more significant tax on the wealthy investor class.  Let's protect ordinary taxpayers by using a simple income determination to exclude almost all of them from even having to think about the AMT.  Then we can also simplify the AMT by harmonizing it with the regular tax wherever it makes good tax sense, as in the treatment of ability-to-pay deductions.  Finalloy, let's pay for that indexed income threshold  and harmonization by changing the way we tax net capital gains.  Leave them as a preference in the regular tax system, if we must, but add them as a tainted preference requiring adjustment in the AMT system, if we can.  That would be the best way to ensure that the wealthy investor class pays its fair share of the tax burden.  Who knows, with the revenue gains, we might even be able to pay off some of that debt and move away from being the biggest debtor country of the developed world today.

Those borrow-spend (and tax cut) policies of the GOP decades are now coming home to roost, as we deal with the financial crisis from decades of deregulation and privatization as well as the staggering long-term costs of the two Bush wars at a time when we should be devoting resources to repairing aging infrastruture and serving fundamental human needs like health care and education.  The Democrats, of course, are emphasizing this imbalance of priorities in their agenda to stimulate the economy and enact health care reform.  See, e.g., "Democrats are Working to Reverse the Republican Deficit that is Crippling the U.S. Economy", DPC, Apr. 3, 2009.

What ordinary Americans should take note of is the cost of making the Bush tax cuts permanent.  The JCT document (see top) is revealing.  Let's look at the 10-year cost of items that I think are particularly indefensible as part of a normatively sound income tax that treats everyone fairly:

• Even with the slight bumpup to the old 20% CG rate for the highest bracket taxpayers, the low 0%/15% rates for capital gains and dividends enacted under Bush will cost almost $225 billion. 
• The Section 179 expensing provision--claimed to encourage additional investment but most likely only a tax giveaway for investments that would be made anyway--will cost almost $21 billion.
• Retaining the 25% bracket and expanding the 28% bracket will cost almost $449 billion.
• Extending the AMT patch--The JCT doesn't give a number for the ten-year cost of the AMT patch protecting mostly upper-class taxpayers (it is aggregated with numerous other provisions), but we can assume that it would be at least $70 billion a year, or $700 billion over the decade.
• Making the Wal-Mart Estate Tax giveaway permanent (45% rate on nonexempt estates, with exemption at $7 million for a couple) would cost almost $234 billion.

Note that making permanent these Bush changes--which almost exclusively favor the well-off and the extremely well-off--will cost the government a total of at least $1.6 trillion over the decade.  That's enough to make a substantial reduction in the debt or to pay for a number of the substantial human and physical infrastructure projects the country desperately needs.  (The JCT allots more than 2 trillion to making the 2001-2003 tax cuts permanent, but I have selected those that are most egregious because they are almost exclusively targeted at the well-to-do.)

There's another set of tax cuts in the Obama proposals that should be eliminated that would raise another $75 billion for important government functions.  That's the business tax cuts that have never lived up to their promise of stimulating the economy but instead have simply funneled more money to wealthy families and corporations, i.e.:

• eliminating CG tax (and the AMT preference) on small business stock --$6 billion
• making the R&D credit permanent--$67 billion

Another $4.5 billion would be added by not extending the subpart F active financing exception  (this lets Big Banks defer tax on their offseas passive income) and the controlled foreign corporation look-through provisions (this favors the MNEs that operate businesses offshore). 

And let's not overlook the money we could save from not applying the 100 percent-of-net-income limitation on the percentage depletion for oil and gas companies--about 100 million--and all those other Big Oil favorable tax provisions enacted by the oil-friendly Bush regime.  Repealing LIFO accounting has been proposed by the Obama administration, and is priced out here to raise almost $80 billion in revenues.  That's a good provision to enact, and there will be a strong lobbying countereffort that Congress will have to resist.

There are numerous other "extender" provisions that don't make sense and shouldn't be extended--permitting a tax-free distribution of up to $100,000 from an IRA to a charity, enhancing the charitable deduction for computer contributions, 7-year recovery for NASCAR tracks, and similar provisions.

The lesson from these difficult times is that we will need to raise funds to pay for the huge payouts we've made to haul the economy back from the brink to which it was brought by the risky speculation of Big Banks and the aggressive tax avoidance of most multinationals.  Wouldn't it make sense to raise those revenues from provisions that act for the benefit of those institutions, as well as from those wealthy individuals who gained the most from the borrow-and-spend policies of the past?

More on Health Care Reform (3)

There is more and more pressure--from small businesses, from Big Pharm and Big Insurance, from perenially anti-government, pro-business Republicans--to decimate any movement towards real reform of health care.  The goal from the business lobbyists and friends is apparently an expanded version of the private system we have now, with government subsidies to support the continuing ability of private insurance to make lots of money spending lots of time trying not to pay for items that patients thought were covered.

For a smattering of the information about leegislative proposals and thoughtful commentary on the critical issues at this juncture, read some of the following:

Robert Reich, The White House needs to fight for healthcare, Salon.com, June 9, 2009

Reich asks whether the Obama administration will provide the strong leadership needed to prevent Congress from yielding to the various powerful lobbies.  Big Pharm and Big Insurance don't want a real public option, and are pressuring for a watered down version (the trigger, or treating the government as though it were a private insurer):  it is critical that we have a real public option that essentially expands current government health care programs to anyone who opts in.  Similarly, businesses are lobbying for a broad exemption for "small" businesses that wouldn't have to pay or play--if there is a broad exemption, forget universal coverage.  And it's not clear that even the Dems have the guts to make the wealthy forego some of the tax expenditures goodies they've been getting for decades to help pay for this bill--we should either eliminate the capital gains preference or limit the deductions for those with incomes over $250,000 a year.  Get a backbone, Dems, else the people will vote you out of office for caving to the Big Banks, Big Oil and Big Health.  (TheRepublicans would have caved without even trying to put up a fight.  So Dems should get brave, do something real, and then tell the people about it til they understand the great victory they've gotten.)

E.J. Dionne Jr., Harry and Louise Have changed, Washington Post, June 8, 2009.

EJ Dionne explores the reasons that health system players are giving the appearance of public-minded readiness to work with health system reformers.  Everybody knows that the fgovvernment has to intervene, else there will be increasing numbers of uninsured, resulting in increasing premiums and a vicious cycle that repeats til only the wealthy have any coverage.  As Dionne puts it, "Leaders of the health industry know that unless more government money flows into the system, they will suffer along with everyone else" and "the experience of every other wealthy democracy in the world shows that health systems require large-scale government support." 

But of course, we need to ask what do we get for that government money.  If it works like the bank bailouts, where bankers and hedge funds and managers got lots of taxpayer money while taxpayers mostly got left with the (empty) bag, then it won't be a good deal.   We ultimately need a single-payer, single-provider system so that people here will have as good a health care system as most of the other developed nations already have.  Instead, we have a system where insurers make profits by ferreting out ways to deny coverage, and doctors and hospitals are richly compensated but many don't get health care.  The insurance system, and perhaps the tax-exempt hospital system, require major reforms.  Question is whether Congress has the stomach to enact appropriate reforms over the give-me-mine lobbying.

House Democratic Caucus "Key features of the Tri-committee Health Reform Draft Proposal in the House of Representatives" June 8, 2009 (BNA or Download Tri-Comm Health Reform Outline in House. 09-06-08).

This House plan has too much of the "blue dog" Democrats so that it looks like the Republican's ideal, since it doesn't create a genuine public option but essentially perpetuates the same private system with everybody mandated to pay into it.  See, e.g., The House Tri-Committee Bill--the playing field just moved back to the middle, Health Care Policy and marketplace Review (Bob Laxzewski).   A public (in name only) plan will be just one in the marketplace (an insurance "exchange") with private insurers.  Private insurers will, in effect, be bailed out by government support for the health system through a "pay or play" employer mandate, but government will be powerless to set up a truly national public health system at much lower cost.  Wouldn't private insurers, in spite of the benefits of government mandates and the government's taking on of more low-income populations in Medicare and Medicaid (reducing therefore, the real risks that would otherwise add to private insurer costs)  continue to maximize their profits through claim denial, while government wouldn't--and so would have higher costs?  This is not the option we should choose.  Don't let the lobbyists lead you down this dead-end road, Congress.   

Sentate HELP panel, Affordable Health Choices Act and summary (both on BNA).

Meanwhile, the Senate Health, Education, Labor and Pensions committee released its legislative proposal on June 9 that would require pay or play, insurance for all comers without pre-existing condition denials, limited private insurer profits, and a  tax credit for small employers (25 or fewer employees) equal to 50% of the average contribution of small employers for coverage.  See, e.g., Yoest, Sen Kennedy's Health Bill Unveiled, Sees GOP Criticism, Dow Jones Newswires, June 9, 2009; Bolton, Dodd, Kennedy to introduce healthcare reform bill, The Hill, June, 2009; Werner, Kennedy plans to pursue "American health Choices Act", Times Tribune, com, June 6, 2009 (discussing the draft of the draft released by Kennedy's office a few days earlier).  Kennedy had planned a public "affordable access" plan that would offer a public plan option, but the bill, as released, merely has a placeholder requiring states to include a public insurance option in the gateway program but doesn't describe it, leaving it to be worked out "on a bipartisan basis."  Baucus of Senate Finance--almost a right-winger on the question of a public plan-- still wields enormous influence, however, so we can't count on such a public plan.  Note that the Republicans think the Finance Committee is paying more attention to them.  Yoest, above.   

Senate Finance Committee Chair Baucus and Budget Committee Chair Conrad, Patient-Centered Outcomes Research Act of 2009 (S. 1213) (on BNA).

The bill would establish an independent research institute to evaluate heath care treatments, financed by a head tax of $2 per person covered. See, e.g., PIPC supports New Senate Comparative Effectiveness Research (CER) Bill, MarketWatch,June 9, 2009 (press release from Partnership to Improve Patient Care, a group formed in November 2008 headed by former congressman and Democratic strategist Tony Coehlo).

We know that private insurance hasn't worked.  Costs are mounting incredibly fast and tens of millions of Americans are uninsured and essentially at the mercy of hospital emergency rooms.  Insurers make money by denying expected coverage, and weeding out the people that are most likely to need health care services.  Veterans medicine (government-provided) works better. 

We need an option for a real public plan that reimburses doctors and hospitals at a similar rate to Medicare.  Congress just has to summon the guts to do it, and pay for it by adopting Obama's proposal to cap itemized deductions for those with incomes above $250,000.  It's hard for me to see why those who want to get decent health care reform enacted should bother to listen to the "fiscal irresponsibility" complaints of right-wingers (who wrote a letter bemoaning health care reform proposals that would "increase our national debt and undermine our economy").  See Yoest, above.  They simply have no credibility on issues of fiscal responsibility, after causing the country to borrow trillions during the Bush II years to fund tax cuts (mostly for the wealhy and big corporations) and irresponsible war mongering.

More on the Jenkins & Gilchrist/BDO Seidman Tax Shelters

Back in March 2007, I noted the disbanding of Jenkens & Gilchrist after the firm settled tax fraud charges that had been under investigation since 2003, with a payment of $76 million.  See Jenkens & Gilchrist: Settlement and Disbanding of Firm, Mar. 29, 2007.  These were option shelters, like the Boss and Son-of-Boss shelters still in the news.  Then in 2008, I noted the guilty plea of Douglas Steger, the head of American Financial Capital Corporation that promoted tax shelters with Jenkens & Gilcrhist's Paul Daugerdas and others.  See Banks, Law Firms, CPAs--everybody wanted the money from tax shelters, July 10, 2008.  Steger agreed to cooperate, which suggested either more guilty please or indictments would be forthcoming.    Last week, Former BDO Seidman vice chair Charles Bee pled guilty to similar charges, as did BDO former members Michael Kerekes and Adrian Dicker earlier in the year.  Today seven more lawyers, bankers and accountants were indicted in connection with these shelters.  Download Daugerdas et al Press Release, Download Daugerdas et al Indictment.

Today's indictment charges the seven individuals--three from J&G, 2 from BDO Seidman, and 2 from foreign "Bank A" with headquarters in New York--with 27 counts of tax evasion, tax fraud conspiracy and impeding and impairing the lawful function of the IRS over a decade from 1994 through 2004.  They are Paul Daugerdas (former head of J&G's Chicago office), Erwin Mayer (former shareholder in J&G's Chicago tax practice), Donna Guerin (former shareholder in J&G's chicago tax practice), Denis Field (former CEO and board chair at BDO Seidman and former tax practice head), Robert Greisman (former tax partner at BDO), Raymond Brubaker (former investment rep at Bank A in Dallas--presumably Deutsche Bank, see this tidbit on Brubaker and other former Deutsche employees establishment of Bluffview Securities), and David Parse (former investment rep at Bank A in Chicago).  Many of these people had LLM degrees in taxation and were CPAs as well.  They clearly knew what they were doing--at BDO, they first called their group the "tax sales executive group" before tampering it down to "tax solutions group" in 1999.  They charged fees "far in excess" of their normal billing rates for these deals, according to the inictment.

The various option shelters (SOS, HOMER, Short Sales) generated about $7.5 billion in artifical tax losses for hundreds of wealthy individuals.  Several of the indicted group used the tax shelters for themselves, for which they got "free" opinion letters from J&G. Each of the conspiracy charges could land a defendant in jail for 5 years, with 3 years' supervised release and a fine of the greatest of $250,000, twice the gross gain to the defendant, or twice teh IRS loss (as well as costs of prosecution). Add an additional 3 years in jail, 1 year supervision, and the same fine on the charges of corruptly endeavoring to impede the tax laws.  As IRS Commissioner Shulman states int he release, "In today's economic environment, it's more important than ever that the American people feel confident that everyone is playing by the rules and paying the taxes they owe." 

There are two big problems with these tax shelters:  tax laywers who have lost their ethical guidestar, and banks that have seen serving as accommodation parties in shelters as just one more lucrative gig, the public be damned. 

Too many tax lawyers have followed the money for too long--they've lost sight of their obligation as officers of the court to uphold the law, and put service to their clients (and their pocketbooks) above everything else.  That will require toughening of standards and loosening of some of the protections provided currently by evidentiary privileges.  Tax returns are like confessions--the taxpayer is supposed to "fess up" to all income and pay appropriate tax.  I am convinced that attorney-client privilege (or the somewhat less broad section 7525 tax-practitioner privilege) in respect of planning and justification of transaction reporting positions is unjustifiable.  Similarly, work product protection should not be available to documents or materials that form the basis of information reported on returns, including tax accrual workpapers.  The courts don't get work product right--they are extending it, rather than retaining it as a litigation-based doctrine.  So Congress should step in and legislate, in clear language, that opinion letters and other materials related to positions on a tax return are disclosable and not protected by either evidentiary privilege.

Worth noting in addition is the role of big banks in promoting these strategies.  Brubaker's bank worked with J&G to structure and implement the shelters. The indictment also mentions national "Bank B" that had its principal office in Chicago and arranged estate planning and tax shelter strategies for wealthy individuals, include the HOMER deals. (This is presumablly the former Bank One, since acquired by JPMorgan Chase, at which John Ohle worked in the "innovative stragies group" and promoted shelters like HOMER.  Ohle was indicted last November for his tax shelter role--and apparently didn't bother to note that to his malpractice insurance carrier.  See  Insurer Sues Indicted Lawyer, Chicago Law, June 9, 2009.)  So why have we not yet instituted tough regulations on derivatives?  Isn't the bailout from the credit crunch (domestic and foreign banks that weren't direct recipients also benefitted, as they were often counterparties to AIG on credit default swaps or other transactions that paid out when the US funneled money to AIG) and the avarice represented by the participation in the planning and promotion of tax shelters enough to make clear the need to regulate Big Finance?  I'm waiting for Congress to act, but I am worried.  Both Senator Dick Durbin (D-IL) (responding to the failure of Congress to enact the most obvious and likely most beneficial remedy to the pain hitting Americans in the credit crisis--the ability of homeowners to modify their mortgage loans in bankruptcy) and Representative Collin Peterson (in response to the failure of Congress to enact meaningful measures to cut banks and their use of speculative derivatives down to size)  have suggested that the "banks run the place".  See In Crisis, Banks Dig In to Resist New Limits on Derivatives, New York Times, May 31, 2009 (noting the lobbying heft of JPMorgan Chase and others regarding banking and derivatives regulation). 

These events make me wonder whether we can ever have decent legislation--on the financial system, on taxes, or on health care--while Big Banks and Big Pharm wield so much power.

More on health care reform--a public plan, but which one?

Health care reform is on the agenda, but there are two significant questions that will need to be decided.  First, will Congress include a viable public option that permits a national plan, modelled on Canada's, for example, to show what a government health care system can look like?  Second, will Congress provide for reasonable funding options?  The two are closely interconnected.  Reform needs to drive costs down, but our current private insurer system tends to drive costs up without correlated higher costs with better care.

Ezra Klein discusses the various public options that are apparently on the table in his blog at Washington Post, in "Health Care Reform for Beginners: The Many Flavors of the Public Plan", June 8, 2009.  He notes that there is a "trigger plan", a "weak public plan" and a "strong public plan".  The strong public plan is what both Ezra Klein and I would like to see--"Medicare for the rest of us" that would permit government muscle to cut costs in significant amounts for average Americans.  The other two aren't really public plans at all, but ways that Big Insurance stays in control.

Robert Reich notes that lobbyists for Big Pharm and Big Insurance are on the attack to kill the public option, and are advancing by pushing for "legislation that would include [a public option] in name only--he's talking about the "trigger plan" described by Klein.  See Reich, Big Pharma and Big Insurance go on the attack, Salon.com, June 8, 2009.  In both the House and Senate, Reich reports that the big corporate players are pushing the trigger strategy that will allow a public option in the future that can be triggered by failure of the private options to increase participation or reduce costs.  The problem with the trigger is that there are already a few specifics planned that will clearly reduce costs somewhat and expand participation--computerization of records and mandated coverage.  So the trigger would never be satisfied in a way that would put the public option in play.  I agree with Reich--if a real public option isn't included side by side with the insurers, we'll likely never get one and the Big Insurers will go on fattening their purses at the expense of decent health care for all.  The Wall Street Journal calls that mode of health care reform "increased cost sharing" based on individual responsibility.  See "Obama's Health Cost Ilusion," op-ed, Wall St. J., June 8, 2009. 

So that gets us to the funding question.  Will individual decisions about health care based on payment of a greater out-of-pocket share solve the problem, as the Wall Street Journal contends.  I don't think so.  Fact is, those who need health care generally aren't in a position to comparison shop.  If it is an accident, time matters, and the nearest emergency room is the right decision.  At many stages the patient can't choose because there is only one specialist in the vicinity or only one that they can afford to visit.  Most of the enormously expensive care is at the end of life anyway, and again not something susceptible to comparison shopping. 

So how will we raise the additional revenues that will be needed to create decent, universal health care?  The JCT produced a report  titled "Background Materials for Senate Committee on Finance Roundtable on Health Care Financing", JCT, JCX-27-09, May 12, 2009.  The report provides some useful background information, including  the following chart (at 4) on the value of tax expenditures such as the exclusion for employer provided care, which is currently not subject to any cap and hence of most benefit to taxpayers at the highest marginal rates.

Table 1--Selected Tax Expenditures for Health, 2008

Value of Tax Expenditures                                            Billions of Dollars

Exclusion of employer sponsored health care .........................226.2

Income ...........................................132.7

FICA ..............................................93.5

Exclusion of Medicare benefits from income ............................41.8

Hospital Insurance (Part A) ........................21.3

Supplemental Medical Insurance (Part B) ......14.9

Prescription Drug Insurance (Part D) ............4.4

Exclusion of subsidies to employers who

maintain prescription drug plans .....................1.1

Deduction for medical expenses above 7.5% of adjusted gross income .10.7

Self-employed health insurance deduction .....................................5.2

Exclusion of medical care and TRICARE insurance for military

dependents and retirees not enrolled in Medicare ............................2.1

Exclusion of health insurance benefits for

military retirees enrolled in Medicare ..........................................1.2

Health savings accounts ..........................................................0.5

Health Coverage tax credit .......................................................0.1

Clearly, the exclusion for employer-provided health care is a significant entitlement as is, and any changes to that benefit will need to make sense in the overall package.  Reducing that benefit for the wealthiest recipients should be on the table, but it will have to be done carefully and with due regard to our tendency to think we are entitled to benefits we have had in the past.  A June 2, 2009 letter from the JCT to Finance Committee Chair Baucus and Ranking Member Grassley (available on BNA at this link) provides estimates of revenue effects of several proposals to cap the income tax exclusion for employer-provided health care (and for other proposals).   The JCT estimates that a cap on the employer-provided exclusion at the actuarial value of the Blue Cross/Blue Shield standard option for single taxpayers with $100,000 AGI and joint filers with $200,000 AGI would raise $161.9 billion over ten years.  Considerably more could be raised by a much harsher approach: limiting the income exclusion across the board to 50 percent of the premium amount would raise $1,173.1 billion over ten years.  Capping the income exclusion at the actuarial value for all taxpayers (rather than just high earners) would raise $418.9 billion over ten years.  The proposals for a soda tax (3 cents per 12 oz.) and alcohol tax ($16 per proof gallon) would raise 51.6 billion and 61.5 billion, respectively. 

One way or another, there will need to be tax increases to fund a new health care system available to all.   In addition to the above proposals, others on the table include the  Obama proposal for a cap on itemized deductions for the rich.  I was asked for a comment on that, and noted that it wasn't likely to go over well.  But that doesn't mean we shouldn't do it.  Tax expenditures for the wealthy are over the top and capping itemized deductions is a way to cut back on that, without singling out and eliminating any particular itemized deduction.   Such caps add complexity, but complexity for the rich is not worth worrying about--they aren't exactly likely to do their own taxes anyway. Another tax increase that we should put on the table is elimination of the capital gains preference.  If dealing with it directly is too unpalatable, then Congress could reinstate an AMT adjustment for the capital gains preference.   

One way or another, we should legislate a public option for health care and we should pay for the increased costs of the reform through increased taxes rather than simply adding more to the deficit with a promise to try to figure out a way to pay later.   

Standards of tax practice--new focus on return preparers, credibility of non-Treasury ALJs, and a few other matters...

The IRS has announced that it will focus on tax practitioners as a further means of reducing the tax gap.  See

This is a timely announcement, since anecdotal evidence suggests that the tax minimization norm continues to drive practitioners and preparers to make unwarranted assumptions that reduce their clients' tax liabilities, such as guesses about basis, unsupportable assumptions about home offices, and guestimates of expenses that can be deducted for a business.

Of course, attempts to chastise tax practitioners for stepping over the bounds don't always pan out.  The Treasury's Office of Professional Responsibility filed a complaint, under the older version of Circular 230 governing practice before the IRS, to discipline one of the tax advisors in the Long Term Capital Holdings case, 330 F. Supp. 2d 122 (D.Ct. 2004).  The adviser gave a "should" opinion in a transaction that purportedly created  high basis stock in a section 351 incorporation transaction, without providing any analysis and relying on the promoter's claims for issues critical to the analysis. 

A federal administrative law judge decided the case against OPR.  Note that the ALJ is not in the OPR office--ALJs are "borrowed" from other agencies for these opinions in tax, because there is no standing group of ALJs in Treasury to be used for such cases.  That is a serious problem in and of itself, since  ALJs in other agencies don't have any background in tax law or tax standards of practice.  Apparently the ALJ thought it was merely a question of the practitioner having failed to provide an explanation of the background analysis earlier in the process--the opinion was a short form opinion without explanation, one that would not satisfy the current standards for coverred opinions under Circular 230.  The ALJ considered the practitioner not to be disciplinable since he had merely followed the normal standards in the trade of lawyering, as illustrated in a bar report on closing opinions for corporate transactions (quite a different context from tax opinions) that held that "would" and "should" had the same meaning and that "should" did not necessarily reflect a diminished level of confidence in the conclusion. 

This doesn't seem to be a proper analysis for tax, where my experience certainly was that firms  considered it good practice to give an analyses in an opinion that is expressed at any lower confidence level than "will".  It was not unusual to hear lawyers say that qualified opinions expressed with "should" indicate a probability of being correct that is perhaps in the 75% range-- more than the just over 50% probability of a "more likely than not" opinion but less than the near certainty expressed in "will" opinions. 

Further, the ALJ treated IRS Notice 95-53, which warned taxpayers about the LTCH type of tax shelter, as mostly irrelevant, since it merely gave the agency's opinion but did not change the law.  The tax adviser didn't need to discuss the Notice, said the ALJ, any more than he needed to discuss the specific statutes and doctrines he considered in arriving at his conclusion, as long as he reasonably concluded that they "should" give the result indicated in the opinion.  The ALJ similar found no harm in the adviser's reliance on the shelter promoter for assurances about business purpose and profit potential.

The problem, of course, is that the practice of tax is one in which the tax minimization norm is far too predominant, and tax practitioners too easily allow themselves to rationalize an opinion in their client's favor, especially with the low standards for required confidence levels (in nonshelter transactions, "substantial authority" is sufficient to avoid a penalty for understatements even when the position is not disclosed to the IRS).  The need for the covered opinion rules arose because of just these sorts of adviser opinions in tax shelters that assume away critical issues.   Aside from the problem of having ALJs who are not conversant with tax law reaching decisions about reasonable opinion practice based on entirely different areas of the law, this opinion is just one more item supporting the need to focus on taxpayer and tax adviser standards--even nonshelter cases should require a more likely than not confidence level, supported, as required under the new written opinion rules, by a reasoned opinion that does not assume away critical issues.

[description of ALJ opinion draws heavily on RIA Checkpoint, ALJ rejects OPR complaint against long term capital holdings counsel, May 26, 2009]

Health Reform: does limiting the exclusion for employer-provided insurance make sense?

Both President Obama and Senator Max Baucus, key players in the health reform debate, have now indicated that one source of funding for health care reform on the table is a possible limitation in the exclusion from income of employer-provided insurance.  See, e.g., Connolly, President Pivots on Taxing Benefits: Obama is Willing to Consider Move to Gain Health Reform, Washington Post, June 3, 2009.

The immediate reaction (seen in the comments section on the cited article) is rejection of this alternative.  After all,  many of us rely heavily on the fact that we have health insurance through work, and those of us in the lower income brackets probably would not be able to afford health insurance (at least, under the current privatized system) without that benefit.

But is the populist response the right one?  We should not lose sight of the fact that the employer-provided insurance exclusion is the biggest tax expenditure in the Code that, like most tax expenditures, also tends to benefit most the highest income individuals.  The Center on Budget and Policy Priorities has put out a new report titled Limiting the Tax Exclusion for Employer-Sponsored Insurance Can Help Pay for Health Reform that addresses this question directly.  The Center notes that the tax expenditure is "poorly targeted" and benefits most the high income group who "least needs help paying for health insurance."  Lower-income taxpayers get less from the benefit because they may not have jobs, even if they have jobs they may choose to forego participation because of the cost of their share of the premium, and even if they participate, they get less of a benefit (in absolute dollar terms) because their tax rate is lower.

 Here's the graph showing the benefit relative to the income group.

 

CBPP suggests that the exclusion can be reformed without eliminating the value of employer-provided heatlh insurance.  One of the concerns is that employers will no longer provide the benefit if it becomes taxable, but a "play or pay" requirement could discourage that option and mitigate its effects.  CBPP suggests that concerns about a rigid cap that would apply in all cases can be mitigated by adjusting the cap when a firm is relative small (so that more goes to administrative costs) or has more older and sicker workers (so that more health care costs must be covered) and for other, similar issues.  The paper provides three specific alternatives for structuring the limitation in order to promote the goal of universal health coverage. 

Watch What I Do.....

This post is simultaneously posted on Angry Bear.

There has been quite a bit said about Obama's proposals for international taxation. If you read ataxingmatter, you know that I think the proposals to tighten up the way the rules work to prevent abuses are important starts in the right direction. Not surprisingly, multinational corporations have suggested that any change to the international regime that increases their taxes will make them even less competitive internationally (implying that they already have too little money to compete well) and ultimately, even quickly, lead to the demise of U.S. jobs. See, e.g., Donmoyer, Ballmer Says Tax Would Move Microsoft Jobs Offshore, Bloomberg.com, June 3, 2009.

One would think from such talk that US multinationals are just hanging on by the sheerest strings, unable to reduce costs further, leaving very small profits (if any) for their shareholders, and barely managing to pay their managers enough to keep decent talent aboard. But is that what Ballmer really means? Isn't it more likely that it is a question of Microsoft hoping to retain all that money for its managers and owners rather than see a penny of it go to government purposes (like education, basic research)? How do we get any idea about what differences taxes make to companies when what managers say can't really be trusted to shed much light on actual plans for the future?

Well, there is some real data on this issue that comes from the 2004 tax legislation--the corporate pay-back bill that was sold to the public with the same old claim that tax cuts would create millions of new jobs. The 2001-2003 tax bills cut revenues, but primarily lowered tax liabilities for individual taxpayers. (As I recall, Bush himself saw about a $37,000 tax cut from the 2001 legislation and Cheney more than double that.) Corporate lobbyists had agreed to this plan--ram the individual tax cuts through first and then pass a big bill fulfilling the multinationals' wish list. The Bush administration and Congress came through in blazing colors for the corporate lobbyists, passing a host of corporate-friendly provisions under the guise of "job creation tax incentives for manufacturers, small businesses, and farmers." (That's the heading for Title II of the so-called American Jobs Creation Act of 2004. Even the names of the various bills ultimately passed in 2004 represent a veritable smorgasbord of propaganda--the "Homeland Investment Act", the "American Jobs Creation Act", and, the same year, the "Working Families Tax Relief Act". )

The Jobs Act provisions included a host of bad policy choices all in the name of freeing up investment cash so that corporations could invest more in the good ol' USA: even more section 179 expensing; even more accelerated depreciation for leaseholds, restaurants, aircraft, and syndication property; S corporation expansion; AMT breaks; more cross-crediting of foreign tax credits; more tax expenditures for the Big Oil, Big Timber and Big Pharm. And there was one other tax expenditure that was heavily lobbied for on behalf of multinational enterprises--a (purportedly one-time) provision for very low taxed repatriation of foreign earnings, in new section 965 of the Code. The MNEs claimed that the break would permit them to create thousands of new US jobs by reinvesting tax savings in their US businesses--investments that just couldn't be managed under the constraints on the current tax burdens on repatriated cash. Repatriation, on the other hand, was supposed to lead to an increase in capital spending in the range of 2-3% over two years (see NBER paper, below, noting J.P. Morgan Securities' estimate) and firms stated both confidentially and publicly that they planned to use repatriated funds for business purposes like acquisitions, capital spending, R&D, debt repayments rather than to pay out profits to shareholders.

The express purpose of the repatriation tax cut was to increase investment and viability of U.S. operations. Hiring new employees, conducting R&D, increasing capital investment in the US were all good uses, and Treasury guidelines indicated that use to pay executive compensation, dividends or stock redemptions would disqualify the repatriations from the tax benefit.

Did the corporate giants deliver? An NBER working paper by Dhammika Dharmapala, Fritz Foley and Kristin Forbes concludes that they did not. Watch What I Do, Not What I Say: The Unintended Consequences of the Homeland Investment Act, NBER Working Paper No. 15023, June 2009. Here's the conclusion, as stated in the abstract.

Repatriations did not lead to an increase in domestic investment, employment or R&D—even for the firms that lobbied for the tax holiday stating these intentions and for firms that appeared to be financially constrained. Instead, a $1 increase in repatriations was associated with an increase of almost $1 in payouts to shareholders. These results suggest that the domestic operations of U.S. multinationals were not financially constrained and that these firms were reasonably well-governed.

Furthermore, money is fungible. The paper concludes that firms "were able to reallocate funds internally to bypass the publicly stated goals of the Act." Id. at 5. So of the $299 billion that companies brought back from foreign subsidiaries (about 5 times the normally repatriated amount), about 92 percent of it went to shareholders in share buybacks and increased dividends. And interestingly, the firms that brought back the most money under the repatriation scheme were the firms that tended to "shield[] foreign income from U.S. taxation by using tax haven affiliates or holding companies." The study also found that "[f]irms that increased parent equity provisions around the time of the tax holiday ... had significantly higher levels of repatriations. This pattern suggests that the domestic operations of U.S. MNEs were not capital constrained and were instead providing liquidity to affiliates. These firms seem to have taken advantage of the HIA by 'roundtripping,' that is, by replacing retained earnings that would be subject to high repatriation taxes if there were no tax holiday with new paid-in capital." In fact, the paper includes a comparison of MNE and nonmultinationals on financial constraint indicators, showing that the MNEs are less constrained than nonmultinationals under each of the three important indicators.

At least one result was that good guys--the MNEs that didn't use as many tax shelters to shield their foreign income and who regularly repatriated it and paid taxes on it--didn't get nearly as much benefit from this bill as the bad guys--the MNEs that shielded their foreign income as much as they could and held it abroad until they could get this repatriation measure passed through their intensive lobbying pressure. And the bad guys didn't do much of anything in the way of job creation, the political calling card they used to get their special tax break passed.

Seems to me we ought to at least keep this Jobs Act history in mind in the discussion of President Obama's efforts to tighten international taxation rules and the already begun whining by MNEs that they are having such a difficult time competing that any further taxation will force them to move out of the US completely.