ataxingmatter

Tax evaders (and those who aide them), not regulatory complexities, cause tax evasion

The July 24 New York Times Magazine carries an article by Adam D entitled My Big Fat Belizean, Singaporean Bank Account.

The author shows how easy it was for him to establish a secret offshore bank account that would allow him to evade US (and other nation's) taxes with ease.  It only cost around a thousand dollars, and the firms that do this for a living can set you up with a fake corporation in one tax haven and a real bank account in another, both of them sworn to secrecy about your identity as a US citizen and complicit in aiding wealthy taxpayers in avoiding required reporting to the IRS.

And that means a lot of moolah gets stashed abroad, and a lot of taxes remain unpaid.

The Tax Justice Network, a global research firm that advocates against such havens, suggests that the amount hidden offshore is between $21 trillion and $32 trillion. If properly taxed, that could yield more than $200 billion in revenue around the world. Furthermore, because a 2010 McKinsey & Company report estimated the world’s financial assets at about $200 trillion, somewhere around 10 percent or more of the world’s wealth is effectively invisible. And it’s also almost certainly in the hands of the people and institutions that most actively influence major investment decisions.  Id.

So far, so good.  But where the author goes wrong is in his ruminations about the reasons such shenanigans go on.  He thinks it is because regulations and tax laws are so complex.

One often-overlooked lesson of the financial crisis is that shenanigans don’t happen in the absence of regulation; they happen when regulations are exceedingly complex and involve confusing, overlapping regulatory authorities.

Pshaw.   This is, quite simply, garbage regulatory mythology.  Shenanigans happen in brute force capitalism--the kind we've had in place for the last few decades--until there is one dominant beast who controls everything.  Regulations ain't the cause. 

Every simple rule becomes an opportunity for "inventive" tax lawyers and those with wealth desirous of hiding it or evading taxes on it to come up with "creative" solutions that skip around, over, or under the law.  When tax administrators find out what is going on, they can sometimes take immediate steps.  Often it requires legislation and regulation, and in the time it takes to create the lock on the door that the evaders broke through, lots of taxes have been evaded.  And as soon as the lock goes on, the inventive tax lawyers and wealthy tax evaders get busy at their manipulative game again.  So there is a spiral of complexity to deal with the problem caused by sophisticated taxpayers seeking sophisticated help to avoid or evade taxes.

This "regulations and complexity are the cause of offshoring and tax cheating" nonsense sounds about like the 2001 arguments made by many on the corporatist right for reducing tax rates.  First, the proponents of lower taxes noted that there was a considerable amount of cheating via tax shelters by the wealthy and big corporations.  Then, the illogical next step was taken: if only the wealthy just had to pay a little less in taxes, they'd be good citizens and quit using tax shelters, the Republican head of the Joint Economic Committee opined.  HA.  If you lower the rate today, the greedy ones just demand a lower rate than that the next day.  We've seen that play out as the corporate lobbyists got a twenty-year-long wish list fulfilled in the 2003 Bush tax cuts, then came back for more the next year and the next (and are still demanding even more today).

Income and Wealth Disparity Measures--are the richest of the rich hiding their wealth abroad?

In the US today, the maldistribution of resources continues unabated.  The wealthy take in a larger and larger share of the income, while the rest stagnate or sink into poverty. See, e.g.,  Dave Gilson & Carolyn Perot, It's the Inequality, Stupid, Mother Jones (March/April 2011) (a great set of charts illustrating the income and wealth disparity in America).   As studies by Piketty and Saez (mentioned here in earlier posts on income inequality) indicate, the income for the top 1 percent more than doubled between 1980 and 2010.  See Piketty & Saez, Income Inequality in the United States, 1913-1998, 118 Quarterly Journal of Economics 1-39 (2003) (tables updated to 2010 in excel format, March 2012, and available at Saez website, here).  Average incomes for the very top 0.01 percent grew at an even faster pace--in 2010 they were more than 4 times what they were in 1980, having grown to an average of $23.8 million annually!. The Great Recession "has hit bottom 90% incomes much harder than the 2001 recession" while the top decile "remained virtually constant."   Saez, Striking it Richer: The Evolution of Top Incomes in the United States (Updated with 2009 and 2010 estimates) (Mar. 2, 2012).    

What was going on in this period?  The extreme anti-government, pro-elite right wing and its Friedmania economic ideology were the essential driving forces.  Reaganomics became the dominant creed--the more it actually failed, the more its adherents favored doubling down on the medicine of privatization of essential government functions; deregulation of banks and other important quasi government functions, militarization (including huge increases in military expenditures and fabricated rationales for going to war to create a justification for continuing them; and the related goals of cutting earned benefit programs for the vast majority of ordinary folk accompanied by decreasing tax revenues through tax cuts for the rich, pushing so-called "free trade agreements" that furthered the multinationals' globalization goal and allowed them to take their active businesses abroad without paying any penalty, with the result of offshoring jobs and the elite's resources. CEOs decided they no longer needed to feel bad about getting their buddies on the boards to pay them obscene salaries at 3 or 4 hundred times what an ordinary worker made while workers were left without any of the productivity gains that their labor provided.  Banksters took over the economy, combining reckless speculation with offshoring, tax shelters, and computerized trading that insured they could trade a step ahead to profit off their customers' orders.  All of these ills that led us to the financial crisis and the Great Recession, and the lowered economic expectations of ordinary folk in America can be traced to the so-called "reaganomics revolution" and the hawking by purported think tanks of the free-trade ideology.

Saez points out that the recovery from the Great Recession was uneven in the same way that the decades since Nixon have been.  While the botton 99% saw an increase in their incomes of 0.2% by the end of 2010, the top 1% grew by 11.6%!  Corporate profits and dividends grew strongly in 2011, while wages and salary accruals grew "only modestly" and unemployment stayed very high.  Id.

The top 1% clearly control most of America's assets.  See, e.g., the following chart from Dave Gilson, Who are the 1 Percent?, MOther Jones (October 2011.

According to the Levy Institute, which does considerable work tracking wealth, there has been more of a gain in wealth at the top than among the vast majority of Americans.  See Edward Wolff, Recent Trends in Household Wealth in the United States: Rising Debt and the Middle-Class Squeeze--an Update to 2007, Levy Economics Institute (March 2010). 

From 1989 to 1998, mean wealth continued to surge while median net worth rose at a rather anemic pace. Indeed, the only segment of the population that experienced large gains in wealth from 1983 to 1998 was the richest 20 percent of households.

At the same time, however, it doesn't appear--at least at first glance--that the wealth gap has been consistently tracking the income gap. Wolff notes that the reasons are not clear for why there was not as much an increase in net worth inequality as there was in income inequality between 2004 and 2007.  Id. at  13.    But clearly, between 1983 and 2007, those at the top gained the most.

[T]he largest gains in relative terms were made by the wealthiest households.  Thye top 1 percent saw their average wealth (in 2007 dollars) rise by over 9 million dollars or by 103 percent.  The remaining part of the top 1quintile experienced increases from 81 to 142 percent and the fourth quintile by 71 percent.  While the middle quintile gained 50 percent, the poorest 40 percent lost 63 percent!  By 2007, their average wealth had fallen to $2,200.  Id. at 13.

[T]he top quintile collectively accounted for 89 percent of the total growth in wealth, while the bottom 80 percent accounted for [only] 11 percent.  Id at 14.

A blog (toomuch online) looks at these statistics, and the CRS study on wealth distribution   [see Linda Levine, An Analysis of the Distribution of Wealth Across Households, 1989-2010, Congressional Research Service (July 17, 2012) (based on Federal Reserve data)]   and asks why wealth inequality appears to grow significantly less than income inequality. 

The CRS study shows "no significant expansion in the gap between the wealth of the awesomely affluent and the rest of America."  Mitt's Offshore Shenanigans: The Bigger Story, Toomuchonline.org (July 21, 2012), though the top 10% continue to own almost 75% of the total wealth and "net worth has become more concentrated in recent decades."  CRS study, above, at 4.

The share of wealth held by the top 10% of wealth owners grew from 67.2% in 1989 to 74.5% in 2010. Declines occurred in the remaining 90% of households. The share of total net worth owned by households in the 50th to 90th percentile of the wealth distribution fell from 29.9% in 1989 to 24.3% in 2010, and the share of households in the bottom half fell from 3.0% to 1.1%.  CRS study, at 4.

How could anyone have thought it would be otherwise?  After all, millionaires with ample savings fared better than ordinary folk who lost their jobs and blew through their meager savings.  Clearly, these super-wealthy do not spend all their increased income.  It is extraordinarily hard to spend twenty-three million dollars annually year after year.  

 So what accounts for the fact that we don't see evidence of a huge increase in wealth disparity paralleling the huge increase in income disparity?

Maybe the wealth of the super-wealthy isn't being counted in the CRS study?  Sure enough, says Too Much, one group isn't included at all--the wealth of the Forbes magazine list of the richest 400 in America, which in 2010 was $1.37 trillion (not chicken feed). See  Mitt's Offshore Shenanigans (referencing CNN Money 2010 story referring to Forbes richest 400).  And it appears that much of the wealth of the wealthiest elite may not be counted in those statistics because it is being hidden offshore.  See, e.g., Stewart, 13 trillion [UK Pound] hoard hidden from taxman by global elite, The Guardian (July 21, 2012).

A global super-rich elite has exploited gaps in cross-border tax rules to hide an extraordinary £13 trillion ($21tn) of wealth offshore – as much as the American and Japanese GDPs put together – according to research commissioned by the campaign group Tax Justice Network.

James Henry, former chief economist at consultancy McKinsey and an expert on tax havens, has compiled the most detailed estimates yet of the size of the offshore economy in a new report, The Price of Offshore Revisited, released exclusively to the Observer.

He shows that at least £13tn – perhaps up to £20tn – has leaked out of scores of countries into secretive jurisdictions such as Switzerland and the Cayman Islands with the help of private banks, which vie to attract the assets of so-called high net-worth individuals. Their wealth is, as Henry puts it, "protected by a highly paid, industrious bevy of professional enablers in the private banking, legal, accounting and investment industries taking advantage of the increasingly borderless, frictionless global economy". According to Henry's research, the top 10 private banks, which include UBS and Credit Suisse in Switzerland, as well as the US investment bank Goldman Sachs, managed more than £4tn in 2010, a sharp rise from £1.5tn five years earlier.

Let's recap.  Income inequality has grown, so that those at the top of the distribution average in one year what most Americans don't see in a lifetime.  Wealth disparity has grown, but official studies like the CRS study don't seem to show it growing quite as fast as income inequality.  However, those studies are based on Federal Reserve data, which are understandably incomplete.  They don't count the richest 400, and they don't count assets that may be hidden in offshore jurisdictions where they have been protected by banking secrecy.

If we understand the way disparity has grown during the last decades of policies that have heavily favored the rich, then we have the basis for a conversation about what kinds of policies make sense--and specifically, what kinds of tax policies make sense.  The philosophy of democratic egalitarianism suggests that those policies should strive to reduce the gap between classes rather than supporting increasing the gap, based on the recognition that large income and wealth gaps among citizens destabilizes democracy and pushes towards oligarchic/plutocratic forms of government.  Estate taxes that recognize death as the appropriate time to tax the ultra wealthy who generally can avoid taxes in life are a start.  Increasingly higher rates on top incomes so that the top rate continues to increase proportionately to the outside incomes of the super-elite would be another.  Cracking down on offshore assets--through elimination of the idea that a company in the Caymans is anything other than a sham--would be another important step.

 

Senate Votes at 4 today (7/25) on Obama Tax Cut Proposal

After threatening to filibuster the Obama tax cut proposal, Mitch CcConnell pulled back.  See Lori Montgomery, McConnell pulls back from filibuster on Senate tax-cut vote, Washington Post, July 25, 2012. The Republicans want to pass a deficit-expanding tax cut for the wealthiest Americans who have garnered the most from this lopsided economy in which companies lay off workers to diminish service but achieve ever greater (short-term?) profit margins for those at the top. 

(Aside:  That's not the only way that megacorporations are trying to syphon off all the productivity gains for the few at the top.  See the story about a bank analyst's conclusion that Wells Fargo was making more money for shareholders by providing lousier service to its customers.  Nathaniel Popper, Bank Analyst Sees No Payoff in Customer Friendly Focus, New York Times (July 24, 2012).)

If the Bush tax cuts were to be extended without modification (as the GOP proposal would have it), the average reduction in taxes for Americans in the three lower quintiles (who make less than 75 thousand a year) would be considerably less than $1000.  See Citizens for Tax Justice, U.S. Taxpayers and the Bush Tax Cuts: Obama's Approach vs. Congressional GOP's Approach (July  2012).  So the typical American who earns between 40 and 50 thousand dollars a year will get less than a thousand dollars from an extension of the Bush tax cuts. 

Compare the result for the wealthiest Americans under the GOP proposal.  Another year of the Bush tax cuts for the wealthiest taxpayers in the richest 1% would give them an average tax cut of about $71,000.  See Citizens for Tax Justice, U.S. Taxpayers and the Bush Tax Cuts: Obama's Approach vs. Congressional GOP's Approach (July  2012).   That means that the Republican plan gives a 7000% larger tax cut to the wealthy than to those ordinary folk making 40-50 thousand. 

Note that the wealthy still get a tax cut of about $20,000, even under Obama's plan to cut the additional breaks at $250,000.  That's because of the way the graduated income tax brackets work.  Everybody--rich or poor--is taxed at the 10% rate on the first $17,400 of income in 2012.  Everybody, rich or poor, is taxed at the 15% rate on any income they earn above $17,400 up to $70,700.   The rate increases to 25% for income in excess of $70,700 up to $142,700 (already in the upper middle class quintile) and to 28% for income above that up to $217,m450, with the rate going to 33% on the excess up to 388,350 (obviously now we're talking about only the marginal income earned by the wealthy) and then 35% on the excess above that, to whatever millions or billions it may reach.  Accordingly, the very wealthiest millionaries would get the same tax break ordinary folk do on the income they receive in the lower rate brackets up to $250,000.  And as a result, only 1.9%--the very few richest Americans in the ultra-elite--would have less of a tax cut than otherwise under the Obama proposal.

The tax-cut logic that is being proposed by the right-wing extremists is absurd.  They complain of a deficit but then work to skew the tax laws to favor the ultra wealthy.  Most of the big tax expenditures that make tax laws more complex for individuals are either subsidies primarily for activities of the ultra wealthy or anti-abuse provisions that are needed because of the aggressive anti-tax behavior of the ultra wealthy.

I hope that the Senate will have enough sense today--and stamina, and ability to resist the plutocratic pressure from the donor classes--to vote for the Obama proposal rather than agree to the right -wing pressure to pass yet another tax break for the wealthy.  Progressives already caved on restoring the estate tax to 2009's more sane levels--because of that, heirs of billionaires will continue to get even more of a windfall receipt that they haven't earned and that gives them an unprecedented advantage in the unlevel playing field that has become the US economy.

 

What's Romney Got to Hide? (Part III)

In the last two posts, I explored a number of fairly simple questions that might be raised about Romney's activities that would be clarified by seeing multiple returns (hobby versus investment/business losses; business versus passive activity losses; amounts of preferentially taxed income; income reported from Bain Capital and/or from foreign accounts) and some of the "squirrelier" possibilities that tax experts have raised (potential that Romney participated in the IRS voluntary disclosure "amnesty" program for reports on offshore accounts after the initiation of unraveling of Swiss banking secrecy as a result of the UBS scandal, in order to avoid weightier penalties, including potential criminal charges; contributions to IRAs that were undervalued, possibly by claiming zero value for partnership interests; use of aggressive tax sheltering transactions to 'create' capital losses to offset substantial capital gains, resulting in the net capital loss carryforward on the 2010 tax return).

Ed Kleinbard, a former partner at Cleary Gottlieb who served as chief of staff for the JCT and is now a law professor at Southern California, has joined with Peter Canellos, a prominent tax practitioner and former chair of the prestigious New York State Bar Association Tax Section, to address these issues regarding the importance of seeing multiple past years of Romney's tax returns.  See Kleinbard & Canellos, Why won't Romney release more tax returns?, CNN (July 18, 2012).  Hat tip Calvin Johnson.

So what do Kleinbard and Canellos add to this debate?  Perhaps most importantly, they note the importance of transparency in the vetting of presidential candidates :  as they say, "[t]he U.S. presidency is a position of immense magnitude and requires a thorough vetting." (emphasis added)  Accordingly, they point out the advantage to the American public of the disclosure practice initiated by Romney's father George Romney four decades ago and .

Since George Romney inaugurated the practice more than 40 years ago by releasing 12 years of tax returns in his bid for the Republican Party nomination, presidential nominees have been transparent with voters about their personal finances. For this reason, we have not suffered a significant tax scandal involving a nominee or sitting president since President Richard Nixon's abuse of the tax code.

***

Disclosure goes to the heart of the truthfulness with which a nominee engages the American people, and it assures us that he in fact has comported himself before the election with the high moral character we associate with a future president.

***

 What the American people deserve is a complete and honest presentation by Romney of how his wealth was accumulated, where it is now invested, what purpose is served by all the various offshore vehicles in which he has an interest and what his financial relationship with Bain Capital has been since his retirement from the company. These are all factors that go to the heart of his character and values.

Like the rest of us who have discussed this issue, Kleinbard and Canellos note that it is Romney's abject refusal to follow his father's example and disclose a decade's worth of returns that "undermines the assumption" that would otherwise apply "that there cannot be any tax skeletons in his closet."  Our only tool is to "reconstruct his financial record" from what he has released.  And that leads us to "red flags that raise serious tax compliance questions with respect to his possible tax minimization strategies in earlier years."  Disclosure, they note, could "replace speculation with truth-telling."

Kleinbard and Canellos go on to discuss some key issues (some already addressed in prior posts)

• the Swiss bank account: Why would a presidential nominee be betting against the US dollar by speculating in Swiss Francs?  The account was closed in 2010, but was its income reported on earlier returns and were the FBAR reports timely filed as required? Did the Romneys participate in the 2009 partial tax amnesty for unreported offshore accounts?
•  the $100 million IRA: How could an account restricted to annual contributions of $30,000 grow to $100 million? Does it represent "unprecedented prescience in ... Romney's investment choices" or does it mean that "Romney stuffed far more into his retirement plans each year than the maximum allowed by law by claiming that the stock of the Bain company deals that the reitrement plan acquired had only a nominal value" (relying on a safe harbor rule about taxation of service partner's receipt of such interests that is, however, inapplicable to contributions of those interests to a retirement plan)?
• the Romney family trusts:  "Did Romney report and pay gift tax ... or did he claim similarly unreasonable valuations, which likewise would have exposed him to serious penalties if all the facts were known?
• the complexity of Romney's assets:  even multiple years of returns won't answer all these questions given the "complexity" and "arcane" and "opaque" nature of Romney's financial affairs, so disclosure about specific issues, such as the $100 million IRA, will be needed
• the low Romney tax rate:  a tax rate of 13.9% on $22 million is exceedingly low--lower than the rate paid by ordinary American wage-earners making 40-50 thousand a year.  How can we trust Romney to enact wise policy--which the vast majority of tax experts concur is to remove the super-preferential rate on the compensation income of private equity fund managers?  "Romney has not explained how, as president, he can bring objectivity to bear on this tax loophole that is estimated as costing all of us billions of dollars every year."

Will Romney respond to these continuing calls for full disclosure about how his wealth has been built, where it is invested, and just what purpose the various offshore entities serve?  If he does not, we can only think the worst. 

What's Romney Got to Hide? (Part II)

In a post yesterday, this blog discussed some of the obvious issues that might be clarified by seeing multiple past years of presidential candidate Mitt Romney's tax returns.  See What's Romney Got to Hide? (July 17, 2012).  This post explores some of the other questions, somewhat more complex and more difficult for ordinary taxpayers to understand, that are raised by what we know so far about Mitt Romney's wealth, the way he holds it, and the lack of tax returns for critical past years.  [Hat Tip to Ken Thomas, is the noose closing around Romney's tax returns, Middle Class Political Economist blog (July 17, 2012) for further drawing my attention to these discussions, which I am sure their authors did not entertain lightly.]

Dan Shaviro, a tax prof colleague who posts on his "Start Making Sense" blog and often contributes to discussions among tax professors, makes three important points that are worth considering if one is asking whether there is any obligation on Romney's part to make more of his returns available for voters to draw their own conclusions about his wealth and related tax issues. See Why won't Romney release his tax returns?, Start Making Sense (July 16, 2012).  Shaviro notes the importance of seeing the 2009 returns:  2009 was the last year of certain Bain "retroactive retirement" payments (possibly quite high) and 2010 shows a "net capital loss carryforward from 2009 AFTER zeroing out positive capital gains including his Bain carried interest amount in 2009.  To Shaviro, that raises the concern that Romney might have engaged in an aggressive tax shelter to produce useful losses that allowed him to zero out his significant capital gain income.

We know from attachments to the 2010 return that some of his "blind trusts" were engaged in transactions identified by the IRS in Notice 2002-35, which pertains to fake loss-generating scams that involved abusing and misinterpreting the notional principal contract regulations.  So far as the blind trust aspect of that is concerned, note that Romney himself once called blind trusts an "age-old ruse."  But I am unclear about how much to make of the 2010 disclosure, given that it would have undermined expecting to get the tax benefits if the deals at issue were complete scams.  So it has struck me as conceivable that the blind trusts did something in the ballpark of required 2002-35 disclosure but less extreme and more legally defensible.

Still, willingness to do extremely aggressive tax sheltering (such as through loss generation from circular flows of cash) in 2009 would not come as a huge surprise, even though it seems like a dumb idea if you are preparing to run for president again.  I wonder if the very fact that he was running for president might have led him to figure that he was audit-proof, on the ground that the IRS would look too political if it started challenging things.  Id.

Another issue that makes the 2007-8-9 returns and disclosure forms particularly interesting for someone like Romney with millions of financial assets and known offshore bank accounts is the Foreign  Bank Account Report (FBAR) disclosure required for Americans who hold assets abroad and the IRS crackdown on noncompliance by thousands of wealthy Americans.  The UBS disclosures,and the initial breach in the rigid wall of Swiss banking secrecy, have permitted the IRS to find out about many Americans who had, prior to 2007, been able to avoid taxes on offshore funds with impunity.   The FBAR enforcement initiative has led to a program that pushes people to seek amnesty under the various "voluntary disclosure" (with penalties) programs the IRS has put forth--the choice is to seek amnesty and pay the taxes and penalty now, or face the potential of criminal charges (and significantly worse penalties) later.  Is it possible, Matt Yglesias asks, that Romney took advantage of the amnesty program to clean up past failures to disclose, and wants to avoid the political fallout that revealing that would cause?  See Matt Yglesias, Did Mitt Romney Take the 2009 Swiss Bank Account Amnesty?,  Slate (July 17, 2012).

 

   

What's Romney Got to Hide? It's past time for financial and tax transparency

As everybody who has followed anything about this election cycle knows, Mitt Romney--likely the wealthiest man to run for president, the only bankster/private equity fund founder (sole shareholder, CEO and manager) to run for president, and probably the only person with multiple multi-million dollar accounts stashed away in tax havens like Bermuda, Cayman Islands and Swiss banks to run for president--still thinks the kinds of information that one can glean from full disclosure of tax returns isn't relevant to his attempt to gain the presidency.  He has reiterated his refusal to release more than the 2010 and (estimated, at this point) 2011 returns.

Yet there are many questions voters can legitimately ask about Romney's finances and tax returns, questions that cannot be answered with certainty without seeing multiple years of returns.  Let's consider the most obvious ones.

1. Offshoring of assets:   It is clear from the paucity of return information we do have that the Romneys hold a considerable portion of their assets offshore.  It is not unreasonable to wonder why someone who desires to be President of the US would find it necessary or even reasonable to put so much of his (or their) assets offshore, taking them out of the US.  Clearly, offshore assets are harder to trace, harder to account for, and possibly easier to hide from tax administrators but one would certainly hope that wouldn't be the reason behind a very wealthy candidate's use of offshore accounts.  Just as clearly, the fact of offshore multimillion dollar accounts does not establish tax avoidance, since Romney could be appropriately reporting and paying taxes on all of his foreign holdings.  Yet the fact that it is not illegal per se to hold assets offshore begs the question that does count-- why is he holding so much in offshore accounts?  What's the benefit to him?  If he is as patriotic as he claims, why doesn't he show that by putting his assets in the US, in essence "putting his money where his mouth is"?  If he can't clearly explain to voters what the reasonable benefit to him is of having assets stashed offshore, then voters may draw the conclusion that he has something to hide.

2. Hobby horses?:  Like many of the ultra wealthy, the Romneys have enough money to engage in whatever pastimes and pleasures they like--they can own an expensive horse, arrange for it to be pastured and cared for near one of their many multimillion-dollar residences, and even ship it overseas (costing tens of thousands of dollars) for participation in sporting events.  The question this raises for ordinary Americans is how do the Romneys treat this activity on their tax returns, and is that treatment justifiable under the rules?  There are rules for activities that are "not engaged in for profit" under section 183 (generally called the hobby loss provision), that allow participants to deduct hobby expenses only to the extent of income from the hobby activity.  Activities engaged in for profit include active conduct of businesses and investment activities.  Everything else falls under this hobby provision, which amounts to a truly generous provision for mostly wealthy households who can afford to buy expensive toys that allow them to sometimes earn related income--Ie, this provision covers consumption that one engages in for personal enjoyment rather than for the potential profits.  There is a test requiring profits in 3 out of 5 years  (4 out of 7 for activities involving horses) to escape the hobby provision.  So voters can rightly wonder whether the Romney's treat their costs for their horseshow competitions as a business.  (This is the same question tax experts had about Todd Palin's claim that his snowmobile racing was a business even though there appeared to be a good deal of circumstancial evidence that it was instead merely a pleasurable sports activity/hobby.)   To know whether not treating such activities as hobbies under section 183 is correct, one needs to see at least 5 consecutive years of tax returns:  there simply is insufficient information without that. 

3.  Passive activities?  The same type of activities that raise questions about the categorization as hobby or business/investment also potentially raise questions about the passive activity rules. Section 469 limits the ability of taxpayers to use "passive activity losses" against other income, such as that from businesses actively conducted by the taxpayer (including salaries from the business of being an employee).  Generally, losses from passive investments are "schedularized", meaning that they are generally allowed only against passive income (there are exceptions).  It would be useful, again, to see multiple years of returns in order to reach a comfortable conclusion about the way the Romneys' various activities fall within these rules (or not).  

4. Retirement accounts?  One question making waves is how a retirement account for which strict contribution limitations apply could possibly have a value of more than $100 million today if only about $30,000 of assets was put in just a decade ago.  See, e.g., Felix Salmon, Opinion: Did Romney put Bain Capital shares in his IRA? Reuters, July 16, 2012 (noting comments by Bill Cohan, Nicholas Shaxson).  We all know that our retirement accounts (generally created with cash contributions from our salaries) have tended to lose money, not gain--and certainly most Americans' retirement accounts haven't gained at those astronomical levels.  So voters could reasonably ask what assets were added to that account that could have increased in worth so significantly in such a short period of time.  Without the release and more disclosure of such information, voters might reasonably be suspicious that assets were knowingly undervalued upon being added, with the knowledge that their actual fair market value would show significant amounts attributable to earnings within the account. 

The Salmon article cited above mentions a theory that the retirement accounts were "pumped with risky A shares in Bain, that "often had aggressively low valuations when they were first issued" and could "create issues at an IRS audit."   Salmon proposes instead that Romney loaded his IRAs  with his own shares in Bain, of which he remained sole owner and CEO until 2002.  Salmon seems to be suggesting it was not just at the beginning, when he could likely reasonably claim a zero value, but annually thereafter:  he notes that "Romney would have had every incentive to keep the official valuation of Bain Capital low for many years, since the lower Bain Capital was wroth, the more of it he could put into his retirement accounts every year.  Again, the IRS might well be interested in the valuation techniques Romney used for  the purposes of his retirement account contributions.  And then ... when Romney left Bain, he would have switched from minimizing Bain Capital's official value to maximizing it."  Id. 

Another theory mentioned in the article is the tendency of investors in partnerships to undervalue interests when first putting them into an IRA, under the argument [labelled as "dubious" by Salmon, since all securities represent future income] that partnership interests merely represent future income, not current value.  Salmon notes that an "aggressive tax lawyer" might make such an approach "possible."

 It is likely that the retirement accounts were funded early on with Romney's shares in Bain, before it was obvious for tax purposes that it would be a hugely profitable enterprise.  Thus, it would seem that Romney would benefit measurably from transparency here, since there is otherwise reasonable cause for continuing speculation about potential intentional undervaluations of contributed assets.

There are many other questions voters could reasonable explore about the way such an ultra wealthy presidential candidate shares the burden of taxation with ordinary voters, such as how much of Romney's income is consistently earned in carried interest, dividends, and capital gains, all of which enjoy an extraordinarily favorable preferential tax rate under the Bush tax cuts, or how much of Romney's income is outright excluded under generous tax expenditure provisions governing certain financial products purchased primarily (or exclusively) by the rich, such as muni bonds.  A voter might also like to see how the 1999 through 2002 tax returns show income from Bain Capital, during the period that Romney remained CEO and signed off on important SEC and tax documents but now claims he was retroactively retired and therefore completely out of the loop on the very deals and decisions he was signing off on.  (Would you want to invest in that business if you knew that about it at the time?) 

 Romney says he won't release any more tax returns.  His adviser says no matter how many he released, it wouldn't be enough.  See David Muir, Romney Adviser: No Matter How Many Tax Returns, ABC News.com (July 16, 2012).  That excuse for nonrelease is clearly just that--an excuse.  Nobody demands a lifetime of returns.  Romney's father set a good precedent with 12 years, which would be especially reasonable here since it would show Romney's returns for those disputed turn of the century years.  

Romney seems to be saying just "trust me" that everything is above board and everything filed correctly and that voters have no reason to be interested in any of the details of how he holds his assets or how he manages them or what he claims about his various activities on his tax returns.  But that's a little like his assertion that voters don't have any reason to have questions about his "retroactive retirement" from Bain Capital, for which he signed federally required SEC and tax forms as sole shareholder and CEO for years after he now claims he had quit paying any attention to company decisions.  Clearly, voters should have an interest in assessing for themselves the extent of Romney's offshoring, the way he has filed on his expensive hobbies, and whether those filings--even if they are entirely accurate, as hopefully they are-- give him tax advantages that ordinary people have no access to.  

It is telling that even staunch right-winger George Will "slammed" Romney on this issue, saying "Romney 'must have calculated that there are higher costs in releasing them.'" George Stephanopoulos, George Will, Matthew Dowd Blast Romney for not Releasing Tax Returns, ABC News.com (July 15, 2012).

After all, in 2008 McCain apparently requested--and received--two decades' worth of Romney tax returns as part of the Veep vetting process.  George Stephanopoulos, George Will, Matthew Dowd Blast Romney for not Releasing Tax Returns, ABC News.com, July 15, 2012 (noting that Romney reportedly provided 23 years of tax returns to the McCain campaign in 2008).  The fact that McCain commented today that his choice of Sarah Palin over Romney had nothing to do with anything on the returns but rather with Palin's superior candidacy is irrelevant, since we cannot know whether the campaign could or did make a thorough analysis of those returns or how they weighed any issues they saw (or didn't see).  See  McCain: Palin was better VP choice than Romney in 2008, CNN, July 17, 2012.   What any voter can reasonably say is this:  If it was reasonable for McCain to view more than a couple of years of tax returns to reach an assessment of potential issues that might affect the electibility of the man (presumably issues relating to character, honesty, business and investment skills, philosophy, and patriotism), then it is also reasonable for American voters to do the same.

Tax Policy Center on Cutting Tax Preferences to Lower Tax Rates (aka Romney's "plan")

As the campaign heats up and the Congress continues its inability to set partisanship aside to consider the well-being of the country, we can expect continued emphasis on tax rhetoric without much tax substance. 

On the one hand, Obama appropriately argues for higher taxes on the well-to-do, but doesn't seem to be making much use of the bully pulpit to help Americans understand the importance of that approach.  Obama  ought to be arguing for elimination of the capital gains preference across the board, but he is already losing out on fundraising amongst the banksters, so that argument is not likely to be made. 

On the other hand, Romney says he is going to solve all of our problems by lowering taxes even more on his peers, the wealthy, while paying for it by eliminating unnecessary tax expenditures.  The tricky thing about "lowering rates, by eliminating tax preferences" is that you have to decide (1) who gets lower rates and (2) which tax preferences get cut.  Without that info, you've just got an abstract theory about tax reform, not a real proposal.  And of course, if you cut tax rates at the top, thus favoring the wealthy, while not eliminating the tax preferences that are most beneficial to them, you upend the progressivity of the income tax system at the same time.  So specifics really matter here.

Thankfully, there's a new study that sheds some light on the tax preferences/rate cut scenarios.  The Tax Policy Center issued a new report , prepared by Hang Nguyen, James Nunns Eric Toder and Roberton Williams, on July 10 entitled "How Hard Is It To Cut Tax PreferencesTo Pay For Lower Tax Rates?"   The abstract makes clear that this is not the easy solution so often claimed.

 

Some political leaders have proposed to lower individual income tax rates and make up the lost revenue by eliminating tax preferences. To help inform the discussion of such proposals, we examine illustrative revenue-neutral combinations of lower rates and cuts in tax preferences and their effects on the distribution of tax burdens. We conclude that paying for lower rates would require substantial reductions in broadly-used and popular preferences. In addition, requiring that changes maintain the current progressivity of the federal income tax would make it much harder to find a politically acceptable mix of preferences to curtail.

 

The article starts out with a typical "efficiency" oriented statement about taxes.

 

"High tax rates reduce incentives to work, save and invest, encourage tax evasion and avoidance, and magnify the distortions caused by the myriad tax preferences in the current income tax. An enduring goal of tax reforms has consequently been to broaden the income tax base to pay for lowering tax rates."  Id

 

But guess what.  That statement isn't clearly true.  The idea that taxes "reduce incentives" to work, save, invest" and "magnify distortions" and therefore an appropriate goal is to lower tax rates rests on  economic models about market efficiencies that are, quite simply, unproven.  If taxes are so terrible, we should have terrible economic results in periods of high tax rates and much better economic results in periods of low tax rates.  Of course, we can't ever undertake an experiment to prove or disprove this, since there are many other variables--including how those taxes are spent in furtherance of a more vigorous and sustainable economy-- and those are impossible to control.  But we can look to historic evidence to see if high tax rates have correlated with poor growth and low tax rates with high growth, which would tend to prove the statement.  MIke Kimel's book on Presimetrics examined a wide range of correlations, and showed the statement doesn't hold--high tax rates, in fact, have correlated with good growth.

That doesn't mean that broadening the base by getting rid of wasteful or distributionally unfair tax preferences wouldn't be a good idea.  Many of these preferences are of the most value to the wealthy, and mean very little to ordinary taxpayers--such as carried interest capital gains rate for private equity fund managers.  Many of them are outdated, representing old industrial policy that should have given way to newer ideas long ago--such as the various subsidies in the system for natural resource extraction (favoring Big Oil).  Many of them are examples of the worst of crony capitalism, such as the charitable contribution deduction for the value (not investment) of stocks that only the very rich receive much benefit from (because they own most of the financial assets).  Some of the worst tax preferences are those that favor the wealthy--the capital gains preferential rate, that provides a tax break to the wealthy who can structure their income in ways unavailable to ordinary folk and who own most of the financial assets (and so get the lion's share of the capital gains rate benefit).

The Tax Policy Center study suggests it would be fairly hard to get more than a trillion out of eliminating tax preferences if tax rates are cut at the same time, for the following reasons:

1) if you lower tax rates, the savings from eliminating tax preferences is reduced, since the biggest cost of preferences is to those at the top of the rate scale.

2) even if you know that a tax preference "should" be eliminated, you are likely not going to be able to eliminate it because the interest group benefited by it will protest, loudly (the charitable contribution deduction for stock contributions, for example), or because it is administratively impractical to impose tax on the preference item (home rental value, for example)

3) if you eliminate a tax preference and lower the rate, you may shift more of the tax burden to groups that shouldn't bear it (the lower income classes, for example, in the case of the Earned INcome Tax Credit or the Child Credit)

4) If you repeal existing preferences without transition rules, you change economic outcomes in ways that may be resented, but if you transition in gradually over time and without complete repeal, you will likely not get the revenue gains desired to support cutting rates.

The report looks at three scenarios: 

• "current law" (in which the Bush tax cuts end at 2012 year-end--39.6% on ordinary income and dividends and 20% on capital gains and where the personal exemption phase out and limitation on itemized deductions increase revenues from higher-income taxpayers);
• "current policy" (in which the temporary rates in effect today--35% top rate on ordinary income and 15% preferential rate on capital gains and dividends and the AMT exemption indexed for inflation); and
• "current policy with reduced rates" (in which ordinary rates are cut further to a top rate of only 28%, the capital gains and dividend preferential rate is retained at 15%, and the AMT is repealed--i.e., Romney's tax proposal as to rates, except that he would also repeal the estate tax, reduce the corporate tax rate, make the corporate tax system territorial, and have a zero rate on capital gains and dividends for those with incomes below $250,000--though he has not identified which tax preferences he would eliminate in order to make such a drastically reduced tax intake revenue neutral). 

The report notes that the differences in rates under each of these approaches is significant. 

 

The difference between effective tax rates under Current Law and under Current Policy and Current Policy with Reduced Rates generally increases as income rises (Chart 4). For example, the difference in ETRs for the lowest quintile under Current Law and Current Policy is 2 percentage points, while the difference for the highest quintile is 3.4 percentage points and that for the top 0.1 percent is 4.5 percentage points. That increasing reduction in effective tax rates across income categories indicates that the tax system becomes increasingly less progressive across the three tax laws.

 

 The report considers the 173 tax expenditures in four groups based on prevalance of proposals for repeal and limitation and administrative feasibility:

(a) itemized and above-the-line deductions, non retirement fringes and small credits;

(b) investment and retirement income (items that favor saving by individuals);

(c) child, work-related, and social security benefits ("provisions that primarily help low-income households, families with children, and low-to moderate-income Social Security beneficiaries");

(d)  Other preferences (various exclusions from taxable income such as capital gains at death and on home sales; imputed rent; cash benefits for low-income families; veterans' benefits; inside buildup of life insurance). 

The report doesn't consider business tax expenditures and doesn't consider payroll taxes.

 

They conclude that

Current Policy with Reduced Rates could meet the Current Policy revenue target with a significant curtailment of some of the largest tax expenditures, such as mortgage interest, charitable contributions, and employer-provided health insurance. However, these are widely used and popular provisions, so sharply limiting their value could prove difficult. Further, this combination of lower rates and a broader base would cut taxes substantially for high income taxpayers, resulting in a less progressive tax system than under Current Policy.

 

With sufficient base broadening, tax rates under both Current Policy and Current Policy with Reduced Rates could raise the same amount of individual income tax revenue as Current Law. However, meeting that goal under Current Policy would require a sharp curtailment of mortgage interest, charitable contributions, and employer-provided health insurance. Hitting that revenue target under Current Policy with Reduced Rates would be even harder. It would require curtailment of these same popular tax expenditures as well as substantial reductions of additional tax expenditures, such as the special rates for capital gains and dividends, the exclusions for retirement contributions and earnings, and possibly such items as the earned income tax credit (EITC), the Child Tax Credit, and the exclusion of some or all Social Security benefits for low- to moderate-income beneficiaries. From a political perspective, matching Current Law revenue would be difficult, if not impossible.

 

 

ASIDE:  Meanwhile, Romney continues to clam up about his failure to release more than one tax return and the fact that even tax experts cannot get much of an idea why he has put so much of his fortune in offshore tax havens (Bermuda, Caymans, Swiss banks).   Then there's the question of how an IRA got to be worth $102 million in such a short time--without seeing 10 years of tax returns, it is hard to say how that could be and easy to question whether there some slippery manipulation of asset values at the time of putting them in, so that it looks to have gotten super-extraordinarily splendid returns.   One of the problems of having a presidential candidate with so much wealth is that he (1) is great friends with the banksters and thus able to use all the tricks of the trade --which may or may not be legal but one has to question their advisability for a president; and (2) is so accustomed to getting his own way that he is tone deaf to the justifiable interest that Americans have in how he made so much money and what he chooses to do with it. 

Not to mention, of course, his inability to explain away his signing off on SEC and other federal forms as sole shareholder, CEO and manager of Bain Capital through 2002, while claiming to have exited Bain in 1999 so as to avoid blame for the even worse leveraging carried on by the private equity firm, which resulted in a good deal of outsourcing and US job losses.  His way of dealing with that was to call Obama a liar by raising the issue, but that doesn't fly, since the issue is there and should be dealt with head on by releasing tax returns, among other efforts towards transparency.

 

 

 

 

Tax Foundation Misses the Ball (again) in its analysis of Supreme Court Health Care Ruling

The Tax Foundation pretends to be non-partisan.  Of course we all know that is pretense.  Look at the way it has pushed its concept of the so-called "tax freedom day", which misleads everyday Americans into thinking that they are working for months and months to pay taxes, based on the use of "average" tax burdens across every American from Bill Gates to Joe Unemployed and a good deal of uncertainty about just who pays what taxes (like the corporate taxes).

They've done it again in their analysis of the health care decision.  See Richard Morrison and Joseph Henchman, Tax Foundation, Guest Opinion, The Tax Flaw in Health Care Ruling, The Hearld News (July 3, 2012).

1.  The Tax Foundation builds its conclusion into its description of the givens.

They start out with their conclusion--a definition of taxes as items whose intent is "raising revenue for government spending" and of a "penalty" as "imposed for the purpose of punishing an individual for an unlawful act."  Based on that conclusory definition, they conclude unsurprisingly that the ACA's individual mandate is not a tax, because it is a penalty.  That kind of argument has the cart leading the horse.

Taxes do increase revenues, but that doesn't mean that they cannot also be used to modify behavior, which is what penalties do.  The obvious type of taxes that act as penalties are excise taxes. There is considerable discussion about "sin taxes"--taxes on cigarettes, alcohol, and other commodities or behaviors that are disliked.  If the person engages in the 'bad' behavior, the person pays the tax penalty and at least the government gets some revenue from the misbehavior.  If the person is discouraged from engaging in the bad behavior because of the tax penalty, the penalty has done its job and there is more of the desired good behavior.  Tax penalties also exist in our current income tax laws--the "singles penalty", as mentioned in a prior post, causes a single person to pay more tax than that person would if married, thus penalizing the person for failure to marry.  (Conversely, in situations where there is a marriage penalty, the tax causes a married person to pay more tax than that person would if single, thus penalizing the person for failure to divorce.)  And there are many credits and other items that can be seen as simply notational variations on a penalty.  For example, the greater tax that childless couples pay than couples of the same income with children pay can easily be viewed as a tax penalty for not having children.

2.  The Tax Foundation tries to raise fears of a bad impact for states

The Tax Foundation's next argument is the old "slippery slope" problem (and depends on the success of their first, unsuccessful, argument).  Since it claims the tax versus penalty distinction is "vital", and there are local and state government revenue sources that are not generally thought of as taxes, the Foundation also claims that the Supreme Court's purported broadening of the concept of tax could mean those state and local items must also be treated as taxes for state law purposes, and this could mean that they will be subject to different procedural rules for taxes rather than the procedural rules under which they were passed.

This appears beyond silly.   What it does mean for states is that a state like Massachusetts, that had already passed a state health care law with a mandate similar to the ACA's mandate, can rest assured that it is not an unconstitutional form of tax.

3.  The Tax Foundation misunderstands the relationship between the Commerce Clause and the Taxing Power

The Foundation didn't want the mandate upheld, and the right-wing is fighting hard for a much narrower view of the Commerce Clause with the idea of preventing progressives from undertaking needed national policies.  The Court found the Commerce Clause didn't extend to the mandate, a conclusion which seems extraordinarily weak to me and which I predict will be overturned by another Court within thirty years.

But the Commerce Clause doesn't decide the case, because the taxing power is even broader than the Commerce Clause power.  And Roberts rightly recognized that.  This was not a "twisting [of] the traditional and historic meaning of a tax" but rather the expected and predictable analysis based on the traditional and historic understanding of the taxing power.

4. The Tax Foundation raises the "direct" tax issue

Tax academics have devoted a lot of discussion to consider what would be a direct tax that had to be apportioned among the states.  Calvin Johnson, Professor at the University of Texas,  wrote an interesting book looking into the history of the Constitutional Convention as motivated in large part by a desire to get around the weak taxing power of the ARticles of Confederation, which required requisitions from the states to allow a strong taxing power in the federal government.  the passage of the income tax amendment--contravening any need for apportionment--pretty much left the direct/apportioned taxes as an archaic category.

The article cclaims that the mandate can't fall within the income tax since it is a flat tax.  But of course everyone knows that the Tax Foundation and every other right-wing organization thinks that a flat tax on income is constitutional. 

The Tax Foundation is quite simply wrong in suggesting that this is a "new" definition of tax.

(By the way, the Tax Foundation also attributes the entire opinion (and the purported "new definition") to Chief Justice Roberts.  He was the author of the opinion for the Court, but the opinion represents the views of a majority of the Supreme Court Justices.  It is not just Roberts' opinion. )

Paul Moreno's "short history" of the taxing power

At the May meeting of the American Bar Association Tax Section, Jaspar (Jack) Cummings  (a well-renowned tax practitioner who has written extensively on the Supreme Court's tax jurisprudence) and I gave a joint keynote speech for the Tax Section's Diversity Committee.  Our address covered various aspects of Supreme Court jurisprudence past, present, and expected future.  While we disagreed on many interpretative details, there was one thing that we were both quite clear on:  the insurance mandate in the Affordable Care Act should (and, we predicted, would) be upheld as a constitutional exercise of the taxing power. 

Today's Wall Street Journal ran an op-ed by Paul Moreno, titled "A Short History of Congress's Power to Tax" (July 7, 2012).  The problem with the history is that it mentions a few items from the Constitutional Convention history, and then selectively wanders through a few Supreme Court cases.  It ultimately asserts that Robert's opinion for the majority on the health insurance in the Supreme Court's decision on the constitutionality of the Affordable Care Act in NFIB v. Sibelius was "dangerous to constitutional government" because it supported an "unlimited taxing power."

Maybe historians (Moreno is a historian at Hillsdale College) should leave tax analysis to tax experts.  Let me say this here for the record:  the Supreme Court would have looked utterly foolish if it had failed to uphold the mandate as an exercise of the taxing power.   As noted by another commentator, failure to recognize the mandate's legitimacy under the taxing power would suggest that it was unconstitutional to tax to insure those under age 65, while Medicare is constitutional for taxing those at 65 or over.  Further, it would make an impossible distinction between the insurance mandate's penalty provision and what could be called the Internal Revenue Code's marriage mandate penalty provision".  That is, the income tax sometimes taxes singles more than married couples, resulting in what is called a "singles penalty"--higher taxation on earnings to a single person than would result for that person in a married couple.    (There is also sometimes a marriage penalty.  All this depends on how the progressivity of the Code rate structure interacts with the fact that we don't treat every "tub on its own bottom".)

 

July 4th--a time to think about genuine personal liberty for all individuals, whether gay or straight

It is fitting that the Obama administration is asking the Supreme Court to rule on DOMA (the notorious 'defense of marriage act' that recognizes only marriages between heterosexual men and women for federal law purposes).  See AP, Supreme Court Asked to Rule on Marriage Act, New York Times, July 3, 2012, at http://www.nytimes.com/2012/07/04/us/supreme-court-asked-to-rule-on-marriage-act.html. 

As noted in the article, the Justice Department has asked the Supreme Court to take up an appeal of the lower court rulings overturning parts of DOMA, so that the (un)constitutionality of DOMA can be  settled once and for all.  This is important, because federal agencies--such as the IRS--are required to continue to follow DOMA, even though the Obama administration has determined that the law is unconstitutional and therefore it will not defend the law in court.  IN the meantime, gay couples who are married under state law cannot be assured that their marriages will be respected in other states and must continue to file their federal income tax returns as single individuals rather than as married couples--married for state law purposes but not for federal law purposes. 

 It would be fitting if the Supreme Court took on this appeal and ended the peculiar institution of religiously motivated marriage discrimination against homosexual individuals in this country. Surely we are beyond the stage where we consider such travesties of common justice reasonable under a Constitution that purports to support individual rights.  I don't care whether some churches refuse to conduct gay marriages--that's for their decision-making bodies to decide.  But the fact that some people in this country "believe" that "God" doesn't want gay people to be able to marry doesn't give them the ability to enact legislation carrying out their discriminatory purpose.  The states, and the federal government, must ultimately recognize for legal purposes unions between gays just like unions between straights.