ataxingmatter

Pratt on Deficits and Dividends; Hill on Norquist and Abuse of Tax Exempt Charities

Deficits and the Dividend Tax Cut: Tax Policy as the Handmaiden of Budget Policy, 41 Ga. L. Rev.  (2006), is Katherine Pratt's analysis of the Bush Administration's centerpiece revenue reduction bill--the cut in the rates on stock dividends to the capital gain rate. The abstract for the Pratt article follows.

"Tax policy has dominated President Bush's domestic policy agenda. The centerpiece of that agenda is the dividend tax cut enacted in 2003. The dividend tax cut is scheduled to expire in 2010, but President Bush continues to urge Congress to make it permanent. President Bush argues that the dividend tax cut promotes long-term economic growth, stimulates the economy, makes the tax system fairer, provides a steady source of income for needy senior citizens, and pays for itself. This Article evaluates the various rationales President Bush offered to justify the dividend tax cut, with an emphasis on the long-term growth rationale. The economic effects of the dividend tax cut, determined without regard to the fact that it was deficit financed, are controversial and the subject of continuing debate among economists. Early evidence suggests that the tax cut increased the size of dividend payouts and the initiation of dividend payouts. Other evidence suggests, however, that the dividend increases may not be as large as some studies indicated, may not be attributable to the dividend tax cut, and may be temporary. Taking into account the deficit financing of the dividend tax cut, the economic effects of the dividend tax cut are clearer. The deficit financing of the dividend tax cut creates negative growth consequences that offset any positive growth consequences of dividend tax relief. The dividend tax cut also is inequitable. It disproportionately benefits high-income Americans but disproportionately burdens low-income and middle-income Americans due to the effects of cuts in discretionary spending, such as the 2004 and 2005 federal budget cuts that stalled necessary maintenance work on the New Orleans levee system before Hurricane Katrina hit. Congress should not make the dividend tax cut permanent and should repeal the dividend tax cut immediately. Cutting the shareholder-level tax on dividends could have been a viable way of reforming the corporate tax if the dividend tax cut had been structured to ensure that corporate income is taxed at least once and Congress had made up the lost revenue in an equitable and efficient manner or had enacted offsetting spending cuts in an equitable and efficient manner. As enacted, the dividend tax cut does not ensure that corporate income will be taxed at least once and was deficit financed without regard for the harmful future economic and distributional consequences of that deficit financing."

This blog has noted, on more than one occasion, that revenue reductions, financed with borrowing that will be paid back by future generations in terms of service reductions or higher taxes, cannot be justified when the primary beneficiaries are the wealthy who own most of the country's financial assets, while the primary bearers of the long-term burden will be ordinary Americans. Theories that revenue reductions will spur sufficient growth to pay for themselves have been shown to be spurious time after time.  It is not surprising that such revenue reductions are often accompanied by gimmicks, like the "sunset" provisions used for the dividend rate cut, that are intentionally adopted to enable proponents of revenue reductions to later accuse fiscally responsible politicians of "raising taxes" when they do not vote to continue to cut taxes.  Sometimes I am convinced that those in Congress who support such ill-conceived fiscal policies must be like Irwin Schiff, the notorious tax protestor who claims that there is no law requiring Americans to pay tax on incomes-- living in a state of denial about the real meaning of their ideas and actions.

If you want to relive political excitement in connection with the passage of the dividend rate reduction measures, read about the wheeling and dealing in this US News "You Gotta Have a Gimmick" story . 

The dividend rate cut, as shown in this ATR press release, was avidly pushed by Grover Norquist, founder of "Americans for Tax Reform".  And of course we have recently learned that Grover Norquist, a very good friend of convicted criminal lobbyist Jack Abramoff, may have used his tax-exempt ATR organization inappropriatlely to further Abramoff's lobbying schemes.  See this Los Angeles Times story on the Senate Finance Committee Minority Staff Report on its investigation into misuse of tax-exempt organizations and Abramoff-Norquist ties.  For a well-written analysis of the broader implications of the abuses revealed by the Senate Report, see today's op-ed "Congress' Charity Cases" in the New York Times by tax professor Francis Hill.

Democratic Leadership Council--tax exempt, or not?

The Sept. 21, 2006 Daily Tax Report (BNA), at G-14, reports that the District Court in Washington, DC will rule soon on the IRS's decision to revoke the Democratic Leadership Council's (DLC's) Section 501(c)(4) tax exempt status. The case is significant, though it involves only a small amount of taxes ($20,083) for 1997 through 1999, because:

(1) The IRS appears to claim that an organization that develops public policy positions that it believes promote the social welfare operates for private benefit (and therefore cannot be a 501(c)(4) organization) whenever its members share a political affiliation that is aided by the development of public policy positions.

(2) That position would seem to prohibit exempt status for any politically oriented group in the business of policy development intended to influence the political party, yet the IRS appears to be applying that position unevenly to groups with similar purposes and operational modes.

Section 501(c)(4) provides tax exempt status for (in relevant part) "civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare..." so long as "no part of the net earnings of such entity inures to the benefit of any private shareholder or individual."  The "operated exclusively" language that appears in both 501(c)(3) and 501(c)(4) is the basis for the "private benefit" theory that requires organizations to operate for the public good and not for private benefit.  See this IRS document (statutory source of theory) and this article by Darryl Jones (extensive discussion of private benefit theory).   The private benefit theory in the 501(c)(4) context  was "developed to prevent section 501(c)(4) organizations from becoming purely member service providers."  DLC summary judgment memorandum.

The government claims that the DLC is not eligible for tax exempt status because it operates for the private benefit of Democratic officeholders and candidates. Specifically, the government's summary judgment memorandum states that

The Service determined, however, that during 1997, 1998, and 1999 the DLC primarily operated to benefit a private group: individuals who might run for office, were running for elected office, or had been elected to office as Democrats, or particularly New Democrats.

DLC, in contrast, argues that the IRS approved its status years ago; its By-Laws do not permit it to take part in campaigns; it has never endorsed any candidate; it is devoted to addressing policy issues of bipartisan concern, such as opportunity, responsibility and community, just as it claimed in its original application; and though it was founded by Democrats, it has no formal connection to the Democratic Party and does not take part in electioneering.

The DLC's application for tax exempt status explicitly acknowledged that its founders were members of the Democratic Party who hoped to address policy issues for the benefit of the party and the public at large.  This is the excerpt provided in the DLC summary judgment memorandum.

The Democratic leadership Council is so named because it was founded by federal and state elected officials who are Democrats and who were concerned with the direction of policy debate within their party, as well as within the country as a whole.  Through the establishment of DLC, these  officials and others with similar interests and goals expected to improve the overall contribution [of] Democratic leaders in the federal and state government[] to national policy debate, and to urge upon both the party and the general public new and innovative approaches to policy.

Similar groups may be much more actively engaged in electioneering.  For example, the BNA article notes that Public Citizen did a report on "Stealth PACs" in 2004 and discussed 26 groups that were linked to the major parties and had actively engaged in activities intended to sway elections.  That report didn't discuss the DLC because it apparently "does not conduct the kinds of direct, campaign-related activities that many other 501(c) groups do."  Groups covered by Public Citizen's report include the AFL-CIO and the U.S. Chamber of Commerce.

The Daily Tax Report further notes that there have been only a few cases involving potential loss of exempt status of 501(c)(4) groups.  Those include the Christian Coalition and Kemp's Empower America organization.  The DLC, it suggests, seems a less likely target because it operates as a policy "think tank".  The DLC's memorandum in support of its motion for summary judgment indicates in fact that "This [version of the private benefit] theory had never before been used by the IRS to revoke the exemption of a section 501(c)(4) public policy organization."  The DLC's complaint lists the Log Cabin Republicans, the Ripon Society and the National Rifle Association (an organization that has specifically supported candidates favorable to its positions on gun availability) as organizations with similar purposes to its own whose status has not been challenged.  The summary judgement memorandum discusses at length Newt Gingrich's organization, that explicitly had partisan goals in its organizational documents yet was ultimately found entitled to 501(c)(4) status. 

The complaint (filed by DLC on May 27, 2005 to recover taxes erroneously assessed and collected), answer, and DLC and government motions for summary judgment and DLC and government responses to those motions are available in BNA's TaxCore.

Buying the Taxpayer Movement: Abramoff and Norquist

This is a different kind of tax scam.  Not the case where a wealthy taxpayer sells a business and wants to avoid tax on a $70 million capital gain so hires a well-known accounting firm to devise a complex transaction using various financial derivatives to generate an artificial loss to offset the real gain.  Not the outright fraud of the shim-sham man who counseled hundreds that the federal income tax applied only to foreigners. 

Instead, this involves buying influence and power over Congress.  It turns out that Jack Abramoof didn't always want it to be clear whose money was going to whom for what.  So the corrupt lobbyist did what most crooks do--he "laundered" the money.  What is interesting here is just who did the laundering.   In effect, some tax exempt organizations served as a hidden part of Abramoff's lobbying empire.  See this AP story on Prob Links Norquist, Abramoff.

Remember Grover Norquist, who consulted with Mr. Bush back in 2003 about the best way to cut taxes for the rich?  Norquist runs Americans for Tax Reform, a group that has aggressively lobbied for estate tax repeal, privatization of Social Security, and consumption-type taxes that exempt capital income from taxation.  Norquist hosts get-togethers in Washington where people of privilege can rub shoulders with high officials in the Bush Administration.  See this item on DailyKos from the National Journal.

Norquist is also an old buddy of Abramoff, from college days, so Norquist's group also served as a conduit for money flowing from Abramoff clients to finance fake grassroots campaigns--Abramoff just needed to remind himself to "Call Ralph re Grover doing pass through."  (That'd be Ralph Reed, the purportedly upstanding leader of the Christian Coalition and now a politico in his own behalf.)  See Susan Schmidt and James Grimaldi, NonProfit Groups Funneled Money for Abramoff, Washington Post, June 25, 2006, at A1 (reporting on the Senate Indian Affairs Committee report on tribal lobbying). 

Abramoff also cautioned Norquist to be discreet, since they wouldn't want to appear to be "buy[ing] the taxpayer movement."  Id.    The article notes that Norquist claimed that his group and Abramoff's gambling clients just happened to share the same anti-tax views and that ATR wasn't concealing the source of funds.

The Senate hearings on the lobbying activity are available at this Indian Affairs Committee site.  The 373-page report, "Gimme Five--Investigation of Tribal Lobbying Affairs" (June 22, 2006), is available in pdf form here.  The report concludes that various tax-exempt organizations were engaging in activities outside their purpose, helping to channel funds to hide their source and/or to evade taxes, and serving as "extensions" of lobbying organizations.  Yet the committee concludes that no further legislation is needed and settles for recommending some "best practice" measures.

I suspect lobbying needs to be more strongly regulated.  How about publicising the time, place and names of lobbyinsts who meet with any government official?  And organizations like ATR that have funneled money from one pocket to another should be denied tax exemption.  These activities of serving as a conduit go  to the core of the purpose of tax exemption--it was not intended to facilitate the Abramoff-Norquist type of influence-peddling.

Seeing Double: Norquist's "Americans for Tax Reform" Entities

Stuart Levine has an interesting post  here on Grover Norquist related to Norquist's connections to Jack Abramoff, the indicted lobbyist whose connections with Republican power centers in Washington run wide and deep.  Levine speculates about Norquist's two "Americans for Tax Reform" organizations--one is a "501(c)(3)" charitable foundation and the other is a "501(c)(4)" civic organization.  Levine describes a Texas Observer story about a $25,000 check that raises some questions about the use of the organizations.

"In October, I asked: Did Grover Norquist Commit Tax Fraud? The information that is publicly available is still too limited to allow one to definitively answer that question. However, the facts that are publicly available point to systematic violations by Norquist of various provisions of the Internal Revenue Code."

"Case in point. In an article entitled The Pimping of the President, the Texas Observer gives a detailed account of how Jack Abramoff and Norquist got paid by two Native American tribes to provide a personal audience with President Bush. There seems to be some question as to who was in attendance, but there is no question that Norquist's organization, Americans for Tax Reform, recieved [sic] a $25,000 payment for Norquist's efforts. (A facsimile of the check accompanies the article.)"

Levine speculates that Norquist's organizations may have been in violation of tax laws in one of two ways.

"First, Americans for Tax Reform may have been engaged in a profit-making endeavor. If that was the case, there was a violation of the rules under Section 501(c)."

"Alternatively, the lobbying was a business activity that Norquist personally engaged in. If that was the case, Norquist would be deemed to have "constructively received" the $25,000 check. In that event, he should have reported the $25,000 payment as income on a Schedule C on his Form 1040 for the year. He would not have been able to claim a deduction for the transfer of the funds to Americans for Tax Reform, regardless of whether the entity that the funds found their way into was the 501(c)(3) or 501(c)(4) entity."

"Let me reiterate: There are not yet sufficient facts on the public record to prove that Norquist engaged in tax fraud. However, it is difficult to believe that the actual transaction reported in the Texas Observer was an isolated incident. Rather, it appears that Norquist, and probably others, used 501(c)(3) and 501(c)(4) entities to engage in the "business" of partisan politics. That business made them money, as their influence and the funding of their controlled 501(c) entities grew."

The rapid growth and complex operations of civic and charitable organizations is another area in which IRS enforcement has fallen behind.  There are simply too few IRS resources to do the job well.  Does that mean that most of these organizations are corrupt or being used for fraud?  Undoubtedly not.  But it does mean that unscrupulous individuals could use tax exempt organizations to bypass the laws on operations of businesses, as Levine has outlined in his speculation about Norquist.  Now that Congress has settled a spotlight on issues connected with tax exempts (including acting as accommodation parties in tax shelter transactions), the IRS should follow up on leads like the Texas Observe story and see where they take it.  If tax-exempt status is being used fraudulently, the IRS should take immediate action to end the special status and pursue those who have benefited.

Church Politics (4)

In earlier posts, I commented on the IRS probe of the All Saints Church in Pasadena California based on a claim that it had exploited its tax exempt status to play politics.  In that case, the church was one with a generally liberal perspective and a pastor had preached a sermon shortly before the election that imagined a debate between Bush, Kerry and Jesus about the Iraq war.

Now there is a claim about partisan politics from the pulpit in two evangelical megachurches.  This claim was not brought by the IRS, but rather by a large group of local pastors who signed a complaint asking the IRS to investigate the two churches to determine whether their tax-exempt status should be revoked.  The churches are World Harvest Church of Columbus and Fairfield Christian Churck of Lancaster.  Further information is available in this story from the Columbus Dispatch.

As noted in the story, the complaint claims that pastors of the two churches used their churches to support "flagrant political campaign activities" on behalf of Republican gubernatorial candidate Kenneth Blackwell, citing nine instances when Blackwell was featured at church events.  Id.  The pastors stressed that they were merely asking the IRS to uphold the law against active political campaigning on behalf of a candidate by tax-exempt religious organizations.

The pastors of the churches purportedly involved in campaign activities insist that their activities are merely values-oriented, not partisan political activities.  See this story in the New York Times.

A particular concern in the All Saints case was that the IRS might be using its audit powers in a heavy-handed and partisan fashion.  It is hard to test that hypothesis, because a letter to a church is not made public unless the church itself releases it.  I argued, as have others, that transparency would help assure Americans that the tax laws are being adminstered fairly.  All such letters should be released, with an adequate description of the behavior that leads to the letter.

The two megachurches raise even starker concerns that tax-exempt status may be misused to further particular candidacies.  Surely merely inviting several candidates should not be sufficient to avoid being treated as supporting the candidacy of a single individual when one person consistently takes part and no others do.  It is too easy for groups to prearrange a date and the mode of inviting the candidate to ensure that only the preferred candidate participates.  One solution would be to bar any appearances in churches or church-sponsored activities by a single candidate for office, unless that appearance is matched by similar appearances of at least two-thirds of the other candidates for that office, either concurrently or at different times that have been fully confirmed at the time of the appearance of the first candidate.  In this way, events at the church could not become candidate-endorsement events by virtue of frequent appearances of a single candidate.  There would always be multiple candidates at events, or multiple events each with different candidates. 

Without some such guidelines, the rules against campaign participation will continue to be honored in the breach.  That is always harmful in our voluntary compliance tax system and in this case it is harmful to our democratic institutions.

The Nature Conservancy as Bad Guy

Those of you who are avid environmentalists may well have shared my disappointment when I learned that the Nature Conservancy, a wealthy conservation group that purchases environmentally important land and then maintains it or arranges for its transfer to appropriate steward organizations, had been subject to an IRS audit. 

The audit was triggered by a report in the Washington Post in 2003 about the conservation organization (followed by an entire series on the organization, here).   The report startled members of the Conservacy by revealing that executives on the board of the Conservanccy had paid millions in environmental fines.   It also revealed close ties to oil and mining companies and chemical manufacturers and mishandled profit-making activities by the Conservancy, including oil drilling and hotels.  Land bought for conservation purposes might be preserved or it might be sold, in part, for development, with some restrictions.  Even worse, the report revealed a tax dodge that the Conservancy had used in some of its land purchases.  The charity would purchase a parcel of land but then sell it at a loss, based on some development restrictions, to a buyer, often one of its own trustees.  The buyer would then make cash contributions to the Conservancy in an amount approximately equal to the Conservancy's loss on the sale.  By arranging the sale and contribution in  this way, the Conservancy would be essentially whole after the transaction, but the buyer would benefit by having a charitable tax deduction for the cash gift.  The ultimate loser was the federal fisc.  See more about these deals and the IRS's response to them in this Washington Post story from 2004.

The IRS's audit of the Conservancy ended in July 2005 and was reported at the ABA's September 2005 Tax Section meeting as having been "resolved favorably."  109 Tax Notes 300 (Oct. 17, 2005).  The group made "substantial changes in its operations" that should prevent future transactions with board members and trustees and their families along the lines of the dodge initially reported by the Post.

It seems that many people who have at their fingertips a way to make more money by taking advantage of the tax system will do it, even if they are part of a charitable organization that ostensibly is working for the common good.   See, e.g, this Washington Post story about various tax abuses in the non-profit sector.

"In some cases fraud and abuse are committed by the nonprofit itself, such as when a charity is established to benefit its main donor; in other cases, the nonprofit acts an enabler for tax-shelter promoters, such as when a municipality or union takes a fee to participate in a deal that allocates "profits" to it and losses to wealthy individuals. "  Id.

......

"We have found that certain promoters encourage individuals to establish purported donor-advised fund arrangements that are used for a taxpayer's personal benefit, and some charities that sponsor these funds may be complicit in the abuse," Everson said.  Supporting-organization abuses include donations of money that is then lent back to the donor, and the possibility of donating assets and then buying them back at a discount, Everson and the CRS observed."  Id.

Since it is the people who are extraordinarily wealthy who are able to make substantial charitable contributions and reap a tax benefit while receiving the personal satisfaction of helping their favored causes, it is especially important that there not be even an appearance of impropriety in the operations of the charities and the availability of charitable deductions.  These organizations should meet the highest standards of ethical conduct, in order to merit our trust. 

The Senate Finance Committee conducted a series of hearings on these issues last year.  See, e.g., this story in the Chronicle of Philanthropy about hearings focussing primarily on the Nature Conservancy and this transcript of hearings.  Those hearings led to Senate provisions in the Senate tax bill (S. 2020) passed by the Senate on November 18, 2005.  Those provisions are not all commendable--one, for example, would permit writers and artists to deduct the full fair market value of their created works when donated, a provision that clearly violates basic concepts of income determination, while another would allow a donation of certain books and food at the lesser of fair market value or double the basis.  Other provisions, however, do counter various abuses, including donor-advised funds and abuses of supporting organizations (such as essentially lending all assets back to the donor who received the charitable deduction for their contribution).  For descriptions of the proposed Senate provisions on tax exempt organizations and charitable deductions, see here and here.  For other details about the Senate bill, see here.

The House tax bill did not include the charity or tax shelter anti-abuse provisions. See this description of various differences.  The Gulf Opportunity Zone provisions were enacted separately.  See here.   It remains to be seen what Congress will do with these tax-exempt organization/charitable contribution provisions and the other tax issues when it comes back this year.