The Tax Foundation Can't Win for Losing

Even when I somewhat agree with the Tax Foundation, I am somewhat astonished by their cavalier abuse of the facts. Case in point: The recent post Is Maryland Gambling on Gambling to Balance the Budget?

I agree with the Tax Foundation that funding government via a state operated gambling operation is poor tax policy. My primary objection is that the revenue garnered through gaming operations is, in effect, a regressive form of tax. However, I would not say, as the Tax Foundation does (quoting an article from the Lottery Post),that:

The lottery's diminishing contribution to the state budget is one of many reasons why Maryland is facing nearly $8 billion in deficits over the next five years, analysts say.

That's a great point. It is, alas, basically not true. In the last six fiscal years, the gross revenue and net revenue (after expenses) from the lottery to Maryland's treasury were as follows:

Year	Gross Sales	Net Revenue
2001	$1.2 Billion	$407 Million
2002	$1.3 Billion	$443 Million
2003	$1.32 Billion	$445 Million
2004	$1.395 Billion	$458 Million
2005	$1.485 Billion	$477 Million
2006	$1.561 Billion	$501 Million

Source: The Maryland Lottery Agency.

As shown in the above table, the total net revenues over the six year period from the lottery increased by about 25%. Maryland State's expenditures over that period increased by less than 29%, that is, a percentage that is only slightly more than percentage growth of the lottery. Thus, while it is literally true that the lottery's contribution to the state budget has been "diminishing," neither the rate nor amount of decline could be said to materially contribute to a looming $8 billion budgetary shortfall (in a budget that, in FY 2006, was slightly less than $26 billion). (Note: The shortfall is projected over a 5 year period. My back of the envelope estimation tells me that the shortfall will be about 6% of the budget. That's a problem, but hardly a catastrophe.)

Note to The Tax Foundation: Even good arguments are undermined when their proponents substitute truthiness for truth.

Net Neutrality

Net neutrality explained:



Misleading mumbo jumbo on net neutrality:



If you still can't figure out what net neutrality is all about, follow the Ninja:

America's Pastime

Apparently the Boston Red Sox will, on their own, cause approximately a 0.1% increase in the U.S. trade deficit in the month of December.

In October, the U.S. trade deficit was $58.9 billion. The $51.11 million that the Red Sox have to pay to the Seibu Lions by December 21 for for negotiating rights to Japanese pitching ace Daisuke Matsuzaka will therefore constitute a measurable portion of the December deficit if the December figure is in approximately in the same range as the October amount.

Of course, the foregoing calculation does not include the bats, gloves, shoes, etc., that the Red Sox and other Major League teams will purchase from offshore suppliers.

Update

A commentator pointed to a discussion in The Hard Times which stated that:

Okay, no one is going to bid $51 million to negotiate with a player just because they think he’s good. Obviously, the Red Sox expect that signing Matsuzaka will give them marketing inroads in Japan, and make them a lot of money in the Far East. How much can they expect to make?

I’ll start off by saying that I have no idea, but we can still try to generate an estimate. There have been two situations in the past similar to this one: The Mariners’ signing of Ichiro Suzuki and the Yankees’ signing of Hideki Matsui. Why not examine how much money they made from that?

Unfortunately, there are no direct numbers on the teams’ revenues in Japan, so the only estimate we can make is going to be based off indirect evidence. Using Forbes reports on team revenues for the past seven years, here is what I found:

* In 2001, Ichiro’s rookie season, the Mariners made $27 million more than they had the previous year. The five teams closest to Seattle in revenues in 2000 increased their income by an average of just $6 million.

* In 2003, Matsui’s rookie season, the Yankees increased their revenues by $8 million. The five teams closest to the Yankees in 2002 revenues upped their earnings by an average of $4 million.

* Between 2000 and 2006, Seattle’s revenues have increased by $67 million. The five teams closest in revenues to Seattle in 2000 have seen their income increase by an average of $54 million.

* Between 2002 and 2006, the Yankees’ revenues have gone up $62 million, versus an average increase of $21 million for the five teams closest to them in revenues in ’02.

If average all of that together, we can estimate that signing a Japanese star player is worth something like $9 million a year. But wait, we’re not done. $9 million in 2001 is not the same as $9 million in 2007. Adjusting for inflation (in baseball, inflation has held at a pretty steady 10% a year), we find that the Red Sox should expect to see their revenues in 2007 to increase by about $14 million should they sign Matsuzaka. That’s a sizeable chunk of change.

In other words, by selling additional products, media rights, etc., back to Japan, the balance of trade flow moves in the other direction, back to the U.S.

I don't know enough about the overall economics of baseball to tell whether the Matsuzaka deal is good or bad. However, I still think that its overall effects on the balance of trade are likely to be negative.

Presence

The case of Tax Commissioner of West Virginia v. MBNA America Bank, N.A. is a very big deal. In that case, the Supreme Court of West Virginia held that the state could impose a corporate income tax on MBNA even though MBNA had no physical presence in West Virginia.

A state cannot impose a tax on a business engaged in interstate commerce unless, inter alia, the business has a substantial nexus with the state. In the sales tax area, in Quill Corp. v. North Dakota, the U.S. Supreme Court has held that there is such nexus only when the seller of taxable goods or services has a physical presence in the state attempting to impose the tax. The question remains open, however, whether substantial nexus sufficient to support the imposition of income tax requires the physical presence of the taxpayer.

In MBNA, the West Virginia Supreme Court held that the actual physical presence of a taxpayer was not required to allow the state to impose income tax. The money quote is the antithesis of the doctrine of original intent:

[P]rior to concluding, we simply wish to acknowledge the great challenge in applying the Commerce Clause to the ever-evolving practices of the marketplace. James Madison, Benjamin Franklin, and the other Framers at the Constitutional Convention who adopted the Commerce Clause lived in a world that is impossible for people living today to imagine. The Framers' concept of commerce consisted of goods transported in horse-drawn, wooden-wheeled wagons or ships with sails. They lived in a world with no electricity, no indoor plumbing, no automobiles, no paved roads, no airplanes, no telephones, no televisions, no computers, no plastic credit cards, no recorded music, and no iPods. Likewise, it would have been impossible for the Framers to imagine our world. When they fashioned the Commerce Clause, they could not possibly have foreseen the complex and varied ways that commerce is conducted today, especially via the internet and electronic commerce. It would be nonsense to suggest that they could foresee or fathom a time in which a person's telephone call to his or her local credit card company would be routinely answered by a person in Bombay, India, or that a consumer could purchase virtually any product on a computer with the click of a mouse without leaving home. This recognition of the staggering evolution in commerce from the Framers' time up through today suggests to this Court that in applying the Commerce Clause we must eschew rigid and mechanical legal formulas in favor of a fresh application of Commerce Clause principles tempered with healthy doses of fairness and common sense. This is what we have attempted to do herein.

Since I represent clients in this area, I will not offer any editorial comment on the West Virginia opinion. I would note, however, that the Court's holding is diametrically opposite to the holding of an intermediate appellate court that considered the same issue and was presented with essentially the same facts. See J.C. Penney Nat'l Bank v. Johnson, 19 S.W.3d 831 (Tenn.Ct.App. 1999). My guess is that this case will either go to the Supreme Court or it will set off a chain reaction of tax litigation in other states that will ultimately have to be resolved by the Supreme Court.

Hat Tip: The Tax Foundation's Tax Policy Blog which criticizes the MBNA opinion.

Why Bloggers Are Not Enough

Today, the Baltimore Sun published an article on statutory ground rents, a form of real estate interest little-known outside of the Baltimore area. The thrust of the article was that, as real estate prices in Baltimore City have risen, there has been a dramatic increase in homeowners being ejected from their property due to delinquencies in their payment of ground rents.

I am not certain that the situation is as much of a public policy problem as the article contends. However, the article sheds some light on the continued need for and vitality of newspapers. It also shows how newspapers can produce an important product in the age of cyber information.

As to the first point, the article online omits a sidebar that was presented in the print version of the paper. That sidebar gave some background on the manner as to how the article was prepared. It is obvious that the Sun put substantial resources into the piece. I would ask anyone who contends that blogs could displace newspapers as a primary source of news whether any blog could muster the resources necessary to research and write a similar article.

As to the second point, it is of some interest that the article was designed with web-multimedia in mind. In addition to the text that appeared in the print version, on the web there are two video presentations and two audio presentations. It appears that the Sun understands that it can't limit itself to producing a print product.

Finally, it is worthy of some note that the subject of article is inherently local. At one time, the Sun was truly a national newspaper. That is no longer the case because it can't compete with WaPo, the NYT, the WSJ, the LAT, etc. However, there is still important work to do locally and it's comforting to see that the Sun remains committed to covering local stories in a serious way. Of course, it remains an open question as to whether papers such as the Sun can make money with this more narrow focus.

New Blog In Town

I am pleased to announce the creation of a new weblog, Maryland Courts Watcher, that I will edit along with a number of other people.

Maryland Courts Watcher will post synopses of all formal opinions issued by the Court of Appeals and Court of Special Appeals of Maryland and synopses of selected opinions from other courts in Maryland. It will not contain any editorial comment, but will link to commentary posted on other blogs.

The blog is designed both to alert readers to new developments in Maryland courts that they may be interested in and to also provide a research tool outside of the commercial services. Thus, all postings can be searched through a Google custom search and each entry has subject tags.

He is the Walrus

The following headnote is from Judge Charles Moylan's opinion in the case of Nils, LLC v. Antezana:

Confessed Judgment - Purchase of Residential Property - The Provisions for Payment - Partial Defaults of Payment - The Attorneys' Negotiations - The Confessed Judgment Notes - Confessed Judgment - The Allocation of the Burden of Proof - What is a Meritorious Defense? A Question of Law for the Court - A Meritorious Defense to What? - The Antecedent Debt - Section 14-1315 Applies - Late Fees - Of Ships and Shoes and Sealing Wax . . .

(Emphasis added.)

The Front (Climate Not Warming Division)

Larry Ribstein has been carrying on a virtual one-man jihad against NYT's Gretchen Morgenson. (Start here and just work back.) I have absolutely no intention of getting caught in that crossfire. However, when he takes off as a defender of the "rights of corporate free speech," well, that's a little much.

The occasion was a letter written to Rex Tillerson, the CEO of ExxonMobil by Jay Rockefeller (D. W.Va.) and Olympia Snowe (R. ME). The letter attacked ExxonMobil's past efforts as a leader of the global warming deniers and the Senators urged Tillerson to lead ExxonMobil to:

end its dangerous support of the "deniers" . . . . [and] to guide ExxonMobil to capitalize on its significant resources and prominent industry position to assist this country in taking its appropriate leadership role in promoting the technological innovation necessary to address climate change and in fashioning a truly global solution to what is undeniably a global problem.

Ribstein cheered the WSJ editorial that characterized Rockefeller and Snowe as "bullies." According to Ribstein:

The letter doesn't threaten explicitly. But if a 300 pound bouncer is standing over you and asking you pretty please to stop, no explicit threats are really necessary. These are two prominent senators and, as the WSJ editorial points out, there's any number of things the government can do to a corporation.

A few points:

First, Rockefeller and Snowe are not the "government." They are two senators, one from each side of the aisle. Thus, their actions differ significantly from, for instance, the last six years of Rove-lead shakedown of corporate interests to fund the partisan advantage of the Republican party. (An effort, by the way, that the WSJ editorial board joined in as cheerleader-in-chief.)

Second, ExxonMobil does not attempt to speak to these public issues directly. Rather, it hides behind front groups that it funds lavishly.

Third, ExxonMobil does not fund science. It funds pseudo-science designed to advance its short-term economic interests at the expense of the commonwealth. Between 1998 and 2005, it gave over $2 Million to the Competitive Enterprise Institute ("CEI"), a right-wing think tank. See here. Further, according to Rockefeller and Snowe:

A study to be released in November by an American scientific group will expose ExxonMobil as the primary funder of no fewer than 29 climate change denial front groups in 2004 alone. Besides a shared goal, these groups often featured common staffs and board members. The study will estimate that ExxonMobil has spent more than $19 million since the late 1990s on a strategy of "information laundering," or enabling a small number of professional skeptics working through scientific-sounding organizations to funnel their viewpoints through non-peer-reviewed websites such as Tech Central Station.

It is a false analogy to compare, as the WSJ editorial does, ExxonMobil's and CEI's efforts to those of "the Pew Charitable Trusts, the Sierra Club, [and] Environmental Defense [sic]." These organizations have no predetermined economic interest in taking one side or the other in any scientific dispute. Obviously, that is not the case with respect to ExxonMobil. The recipients of its largess are intended to merely mouth the party-line.

Senators Rockefeller and Snowe have it precisely right:

ExxonMobil and its partners in denial have manufactured controversy, sown doubt, and impeded progress with strategies all-too reminiscent of those used by the tobacco industry for so many years.

And, one could add, all-too reminiscent of those used by the lead mining industry, the asbestos industry, etc.

Let's be candid here: ExxonMobil is not funding the "other side" in some spirited and free scientific debate. Rather, ExxonMobil is engaged, as the Senators say, in a campaign of misinformation designed to support its narrow economic interests.

In an amicus brief in the case of Commonwealth of Massachusetts v.EPA, climate scientists David Battisti, William E. Easterling, Christopher Field, Inez Fung, James E. Hansen, John Harte, Eugenia Kalnay, Daniel Kirk-Davidoff, Pamela A. Matson, James C. McWilliams, Mario J. Molina, Jonathan T. Overpeck, F. Sherwood Rowland, Joellen L. Russell, Scott R. Saleska, Edward Sarachik, John M. Wallace, and Steven C. Wofsy, stated that:

The evidence of . . . changes [such as rising global temperatures, the shifting of plant and animal ranges, the global retreat of glaciers, and the retreat of arctic sea ice, with sea levels rising and oceans becoming more acidic], though attended by the uncertainty or caveats that appropriately accompany scientific knowledge, is nonetheless so compelling that it has crystallized a remarkable consensus within the scientific community: climate warming is happening, and human activities are very likely a significant causal factor. The nature of this consensus may be obscured in a public debate that sometimes equates consensus with unanimity or complete certainty.

To be blunt, large corporate interests are simply too well-heeled to allow them to have free rein in their efforts to influence the public debate, camouflaged by front groups. As we've seen with tobacco, lead, asbestos, auto design, and in so many other cases, the outcome of allowing this "corporate free speech" is all too often massive injury, sickness, and death.

Focused Searching Update, III

The following blogs have been added to the Tax and Business Law Commentary Google Co-Op search engine:

Professor Bainbridge's Business Association Blog

The Wilmington North Carolina Business Law
and Litigation Attorney Blog

Rubin on Tax

Texas State & Local Tax Law Blog

The Journal of the Business Law Society

Cases and Materials on Business Entities Update

The Tax Foundation's Tax Policy Blog

OMB Watch--Reg Watch

OMB Watch--Budget Blog

Gina's Tax Articles

Taxable Talk

I remain open to suggestions of weblogs and related sites to add to the search engine.

Comment on the 2006 Elections

There has been a lot of hoo-ha in the media about how the voter shift to the Democrats was not nearly as great as is typically the case in mid-term elections. Just to check, I compared the overall vote for the House of Representatives in 1994 with the vote this year.

In 1994, allegedly a banner year for the Republicans, the Republicans got 51.5% of the popular vote for members of the House compared to 44.7% for the Democrats, a little less than a 7 point spread. See here.

This time out, the percentages were 57.7% for the Democrats and 41.8% for the Republicans, a little less than a 16 point spread. That is, better than double the spread of the Republicans in 1994. See here.

However, the total seats won by each party in the two elections were virtually the same, with the Republicans getting 230 seats in 1994 (and with 1 independent) and the Democrats getting 232 (with no independents) this year. The reason that the heavily Democratic vote did not translate into more seats is, no doubt, a testament to the improvements over the last decade in the art and science of gerrymandering.

Limited Liability and Its Discontents (Gilbert and Sullivan Edition)

Apparently, critics of limited liability have been around for a long time. From Gilbert and Sullivan's Utopia, Limited, the song Limited Liability:

MR. GOLDBURY.
Some seven men form an Association,
(If possible, all Peers and Baronets)
They start off with a public declaration
To what extent they mean to pay their debts.
That's called their Capital: if they are wary
They will not quote it as a sum immense.
The figure's immaterial--it may vary
From eighteen million down to eighteen pence.
I should put it rather low;
The good sense of doing so
Will be evident at once to any debtor.
When it's left to you to say
What amount you mean to pay,
Why, the lower you can put it at, the better.

CHORUS.
When it's left to you to say,
What amount you mean to pay,
Why, the lower you can put it at, the better.

MR. GOLDBURY.
They then proceed to trade with all who'll trust 'em,
Quite irrespective of their capital
(It's shady, but it's sanctified by custom);
Bank, Railway, Loan, or Panama Canal.
You can't embark on trading too tremendous--
It's strictly fair, and based on common sense--
If you succeed, your profits are stupendous--
And if you fail, pop goes your eighteen pence.
Make the money-spinner spin!
For you only stand to win,
And you'll never with dishonesty be twitted.
For nobody can know,
To a million or so,
To what extent your capital's committed.

CHORUS.
No, nobody can know,
To a million or so,
To what extent your capital's committed.

MR. GOLDBURY.
If you come to grief, and creditors are craving,
(For nothing that is planned by mortal head
Is certain in the Vale of Sorrow-saving
That one's Liability is Limited),--
Do you suppose that signifies perdition?
If so you're but a monetary dunce--
You merely file a Winding-Up Petition,
And start another Company at once!
Though a Rothschild you may be
In your own capacity,
As a Company you've come to utter sorrow--
But the Liquidators say,
"Never mind--you needn't pay,"
So you start another company to-morrow!

CHORUS.
But the Liquidators say,
"Never mind--you needn't pay,"
So you start another company to-morrow!

Hat Tip: David Culpepper

Knaves--Airbrush Edition

"As a result of Stalin's purges, and later destalinization, many photographs of officials from the periods show extensive airbrushing, often entire people have been removed. The term 'airbrushed out' has come to mean rewriting history to pretend that something was never there."

Just in case you've forgotten what this election is about.

Hat tip: Brainshrub.com and Eric.

An Aside on Employment Numbers

In a recent post, I commented on two articles in the WSJ, one in the news section and one on the Op-Ed page. The employment numbers used in the Op-Ed piece seemed to me not to be credible. After some investigation, I discovered that the Op-Ed piece used the so-called "household survey" which reported significantly greater employment growth than the "payroll (or establishment) survey."

In yesterday's WSJ, Greg Ip focused on the two surveys and their divergent numbers (Divergent Data Raise Questions About Labor Market's Health). In reviewing the article, Dean Baker comments:

I looked at the data more closely and must come down on the side of the establishment survey. The simple arithmetic looks like this. Social Security tax collections were up 5.35 percent in fiscal year 06 compared to fiscal year 05. The average weekly wage rose by 3.9 percent, which implies job growth of 1.4 percent. Reported job growth in the establishment survey matches this closely, at 1.44 percent. However, we know that the Labor Department will add in 810,000 jobs to its March 2006 number in its benchmarked revision (these additional jobs are wedged in over the prior 12 months). When the data is adjusted for these additional jobs, the establishment survey shows job growth of 1.9 percent for the fiscal year, substantially more rapid growth than is implied by the growth in Social Security tax receipts.

There are complicating factors here -- self-employed workers pay SS taxes, but are not counted in the establishment data, many government workers don't pay into SS -- but these are not likely to change the basic story. It is implausible that the establishment survey is understating job growth, and it may well be overstating it.

Smoke! Smoke! Smoke! (That Cigarette)

At least as long ago as 1947, it was widely known that cigarette smoking was unhealthy, hence the caption on this post from the title of a famous popular song of that year. Apparently, the people at the Tax Foundation haven't figured out that this represents a public health issue. They oppose an increase in cigarette excise taxes because of a perceived spur to the criminal enterprise of cigarette bootlegging. (And see here.)

As long ago as 1981, the cigarette industry realized that:

Given a prince elasticity of -0.4 for total cigarette sales and -1.2 for teenage smoking participation, a 25 percent increase in the excise tax could be expected to reduce industry sales to about 1.2 percent below what would be expected in the absence of such an increase, and to reduce the number of teenage smokers to 3.5 to. 4.0 percent.

As even the Tax Foundation admits, cigarettes are highly addictive. The ability to quit is related to the age at which one begins smoking--it's easier to quit the later you begin. Although I've seen no specific studies on this, one must assume that price elasticity is even more pronounced among younger teens. Thus, it makes good public health policy to increase the cost of cigarette consumption by increasing excise taxes. Thus, increasing excise taxes will have its greatest impact on those physically most at risk and will have positive effects for years going forward.

The Cato study cited by TF is fairly irrelevant. It deals with cigarette smuggling into New York state and New York City which had high excise taxes relative to the rest of the country. The conclusion, that excise taxes always increase bootlegging, is simply not supportable. The correct conclusion is that excise taxes that are higher than those in jurisdictions that smugglers can easily travel to and from (e.g., North Carolina) can trigger an increase in criminal activity. However, that is not likely to be the case if, for instance, taxes are increased by a majority of all taxing jurisdictions. Moreover, to the extent that high excise taxes, coupled with a variety of other anti-smoking programs, reduce teen smoking, over time the demand (and the profit in smuggling) will decline. In fact, that's exactly what's been happening for a number of years.

Just because a tax (or, for that matter, any enactment) has negative effects is not, in and of itself, a basis for opposing the tax. One has to weigh the negative impact (e.g., smuggling) against the positive effects (e.g., reduction in teen smoking, leading to a long-term, overall reduction, leading to a reduction in cigarette smuggling). TF offers only a one-eye view of cigarette excise taxes.

Finally, in 2003, a California study concluded that "[p]reviously published studies that analyzed data from various time periods between 1950 and 2000 have estimated that 2% to 6% of cigarettes are smuggled within the United States" and that "the tobacco industry exaggerates smuggling claims." Thus, it's not at all clear that any increase in cigarette bootlegging is a major criminal problem.

Focused Searching Update II

Today, I added four sites to the Google Co-Op search engine.

Two are tax specific, Tax Playa and Andrew Mitchell International Tax Services. (The Andrew Mitchell site has the incredible collection of tax flow charts that Jim Maule, justifiably, raves about.)

The other two, Docuticker and Open CRS Network, have a large amount of research material. While the majority of the material on those sites is not tax or business related, the quality of what can be found there makes it almost imperative that these sites be included in the search engine.

Focused Searching Update

I've added several more blogs to the Co-Op Search:

California Estate and Business Law Blog
Business Law Prof
Delaware Corporate and Commercial Litigation Blog
Florida Asset Protection Blog
and
Ideoblog (Larry Ribstein)

Again, any suggestions as to additional blogs or websites is welcome.

Focused Searching

You can now find on the right side of the page a search box below the title "Search Tax & Business Law Commentary Google Co-op Search Engine." This will allow readers to conduct Google searches that are limited to various tax and business blogs and other related sites. Thus far, the search engine is limited to searching the following sites:

TaxProf
ataxingmatter
Death and Taxes
Mauled Again
Roth & Company, P.C.
Center for Tax Studies
Taxalicious
The Tax Foundation
Citizens for Tax Justice
Start Making Sense
Unincorporated Business Law Prof
and of course
Tax and Business Law Commentary

The purpose of the co-op search engine is to allow searches on tax and business law topics where the sites that will be searched are narrowed even before the search is initiated. I will be adding additional sites as time goes on and suggestions are appreciated.

Taking Credit Where No Credit's Due

On Monday, Maryland Governor Bob Ehrlich's office issued a press release trumpeting "Governor Ehrlich Cuts Unemployment Insurance Taxes by $95 Million--Millions in Reduced Taxes Go to Maryland Employers." In other words, the Governor implied that he engineered a tax decrease.

He didn't.

To understand what actually occured, one has to know a little bit about unemployment insurance and the Maryland Unemployment Insurance Trust ("UIT").

Unemployment insurance is funded by a payroll tax. The tax is earmarked for a fund, the UIT. Financial demands on the UIT increase when unemployment rises and decrease when it falls. During recessionary periods, when unemployment is high, these demands threaten the solvency of the UIT.

In order to avoid a situation where the UIT became exhausted and could not pay unemployment insurance benefits, the General Assembly enacted a supplementary surtax that kicked in whenever the reserves in the UIT fell below a designated level. This determination was made every September 30. If on that date the reserves had fallen below 4.7 percent of the previous year's state-wide taxable wages, the surtax was triggered. The surtax applied to wages paid beginning in January of the following year. Due to sluggish labor market growth, the surtax was in effect for 2004 and 2005.

Maryland's method of funding the UIT had been criticized for a number of years. Among the criticisms was the fact that the surtax was triggered during times when the labor markets were under the greatest pressure. Because the surtax raised the cost of labor, it created a disincentive to hiring and wages at a time when tax incentives should have been pulling in the opposite direction. See here.

In 2003, a special task force was created to revise the way the UIT was funded. As a consequence of that task force's efforts, a comprehensive change in the funding mechanism was enacted by the General Assembly, Ch. 169 Laws of Maryland, 2005. That statute established a single experienced tax rate system to replace the previous experienced rates and flat-rate surcharge system. Six tax rate tables were established. The table used for a particular year now depends on the UIT balance from the preceding September 30 as a percentage of total taxable wages. The rate tables can be found here.

Gov. Ehrlich did not cut taxes on September 30. What actually took place was that the Division of Unemployment Insurance followed the mechanical procedure that had been mandated by Ch. 169 as enacted by the General Assembly in 2005. When it utilized this mandated formula, employers' were required to make unemployment insurance contributions based upon a lower rate table. The change in the formula used was due to the improvement in the labor market as the country came out of the recession: more money flowed into the UIT because of the increase in employment due to the (shallow) recovery and unemployment rates fell slightly, reducing demands on the fund.

Front Page News

TaxProf takes note of two pieces in today's WSJ. One was an interview, on page 1 (i.e., a news page), of this year's winner of the Nobel Memorial Prize in economics, Columbia University professor Edmund Phelps. The other was an op-ed piece by Brian S. Wesbury, the chief economist at First Trust Advisors L.P. The two pieces clashed, with Prof. Phelps suggesting higher taxes ("[I]t would be a good thing for the federal government to raise taxes and run big surpluses until we have retired the public debt. In the short run the higher tax rates might be unpleasant. But in the long run, with the debt reduced or eliminated, incentives to work or to advance in the world would be enhanced, because after-tax pay rates as a proportion of wealth would be higher.") and Wesbury recommending that we stay the Bush tax cut course.

Presented in this way, it would appear that there are merely two economists who simply reach different conclusions after reviewing the same data. However, further investigation of one portion of the Wesbury piece exposes his essential intellectual dishonesty. Specifically, he states that:

During the 12 months ending in September 2006, the [Bureau of Labor Statistics] household survey reported 2.54 million new jobs. Going back 24 months shows 5.5 million new jobs, an annual average of 2.75 million. This exceeds the booming 1995-2000 average of 2.34 million new jobs per year. The household survey, in contrast with the establishment survey, has consistently signaled a resilient economy. And it continues. In the past two months, the household survey has expanded by 261,000 per month, while the establishment survey rose by an average of just 120,000.

While it is a little wonkish, there are good reasons why economists typically do not use the household survey, but instead rely upon the indice known as the "Employment, Hours, and Earnings from the Current Employment Statistics survey (National)." Barry Ritholtz explains the reason that the household survey, unadjusted, was misleading. His conclusion:

Let's see who has the intellectually honesty to step up to the plate with a big mea culpa. You may assume any of the original advocates of this now totally untenable position [that the unadjusted household survey is more accurate] who adhere to it are little more than partisan hacks, and disregard them as appropriate.

Just so the record is clear, here's the Employment, Hours, and Earnings from the Current Employment Statistics survey (National) on a monthly basis from January, 1992, through September, 2006:

(Click to enlarge.)

Do the math: During the 96 months of the Clinton Administration, the country added 22,635,000 jobs or almost 236,000 jobs a month. By contrast, during the 79 months of the Bush Administration, the country, on a net basis, has added only 3,109,000 jobs, or just a shade under 40,000 jobs a month. Even isolating the most recent 24 months, as Wesbury does, we find that only 4,026,000 jobs have been added or an average of just 167,750 per month. In other words, even when rebounding from a recession, job growth during this Administration is just over 70% of what it was during the Clinton Administration.

(Wesbury also wrongly states that the "the booming 1995-2000 average [was] 2.34 million new jobs per year." In fact during the 60 months from January, 1995 through December 2000, a total of 16,428,000 jobs were created, an average of 273,800 jobs per month or 3,285,600 jobs per year.)

In the end, the Nobel guys tend to shoot straight. They get on the first page of the WSJ. On the other hand, "partisan hacks" are relegated to the knave opinion page.

The Sweet Science?

The Journal of Law and Policy at Brooklyn Law School has an interesting student note by Joshua A. Stein, Hitting Below the Belt: Florida's Taxation of Pay-Per-Pay Boxing Programming is a Content-Based Violation of the First Amendment. Stein concludes that:

Florida is one of numerous states to authorize a tax specific to telecasts of boxing. As these taxes are specific to a type of television programming, they should be held by courts to be content-based restrictions on speech. However, boxing and other sports have been denied the protections of the First Amendment because they are deemed to be non-expressive. An historical and literary analysis of boxing demonstrates that the sport satisfies the Spence test because boxers intend to express particularized messages which are understood by their audiences. When strict scrutiny is applied to taxes on boxing telecasts, the state's interest in raising revenue is outweighed by boxers'—and their promoters'—freedom of expression.

Stein quotes Norman Mailer at length in an attempt to show that "[a]lthough the expression inherent in boxing cannot be neatly categorized, it is expressive conduct that conveys a specific message that has a substantial likelihood of being understood nonetheless."

Somehow, I can't buy the argument the two guys beating their brains out is an exemplar of "expressive conduct." However, I am sensitive to the argument that (i) there's a potential slipperly slope here and (ii) the power to tax is the power to destroy. For instance, if the state can tax boxing while exempting other sorts of content, what's to stop it from imposing a tax that is so high that it would, in effect, ban any show with any erotic material (however loosely defined) from the cable-ways.

Ultimately, of course, the state's efforts in this regard will fail. As I noted earlier, once the internet pipes get big enough, the broadcasters of internet content will be beyond the reach of state sales tax assessors. Anyone who doesn't think that boxing matches can't be moved offshore simply does not remember "The Thriller In Manilla"


or the "The Rumble in the Jungle."


Hat Tip: DocuTicker

Rollin' (Part II)

In August, I commented on the creative tax planning efforts of Congressman Gary Miller (R. CA). Representative Miller rolled over the profits from real estate sales not once, but twice, pursuant to the provisions of IRC §1033. He claimed that the properties were sold under threat of condemnation, even though he faced no actual threat of condemnation. To bolster his reporting position, he asked Monrovia, California to provide him with "a letter that talked about eminent domain."

Last week, on similar facts, the Sixth Circuit, in U.S. v. Harris, affirmed a conviction for tax evasion. The pertinent portions of the opinion (which begin on page 77 of the slip opinion) should make for chilling reading by Rep. Miller:

The evidence against Kotula [one of the defendants] on the tax-evasion count is not overwhelming, either in absolute terms or compared to the conspiracy evidence against him. But it is sufficient to support his tax evasion conviction under the very deferential standard for reviewing jury verdicts.

In 1998, Kotula sold his own land to Ashtabula County, Ohio for $425,000. The sale contract recited that Kotula was selling the land to avoid eminent domain. Kotula made a $382,000 profit on the sale, on which he owed federal income tax of $82,000. The parties agree that Kotula did not list the profit on his 1998 federal income tax return.

The government charged that Kotula's failure to report the land-sale gain in that year constituted willful attempted evasion. Kotula's defense is that 26 U.S.C. § 1033 allows a taxpayer to defer gain from a sale made under threat of eminent domain if they use the proceeds to buy replacement property within a certain period of time. As Agent Fisher testified, if the taxpayer meets the requirements, he is not required to report the gain in the first year following the sale.

The government alleges that "several Ashtabula County officials" testified that the land-sale agreement's references to eminent domain were a "sham," but the government fails to point to particular testimony using that word. The government relies on the testimony of current and former county commissioners that the county never suggested that it was considering using eminent domain to take Kotula's land, that it was Kotula alone who insisted on inserting the eminent-domain language, that the commissioners knew eminent domain was unpopular and so would not use it lightly, and that the county had probably not used eminent domain in the twenty years prior to the county's purchase of Kotula's land.

* * * * *

On this record, a reasonable factfinder could find that it was not reasonable to fear eminent domain under the circumstances. With or without such a finding, the factfinder could conclude that Kotula did not actually have a good-faith belief (reasonable or otherwise) that his property was threatened by eminent domain so as to trigger the deferred-reporting provision of IRC §1033.

Incredibly, as near as I can determine, Miller is running unopposed.

Importance of Immigration to Population Growth

A report by the Pew Hispanic Center, From 200 Million to 300 Million: The Numbers Behind Population Growth, underscores the point that underlay my comment on Thursday. Specifically, the report finds that:

Immigrants and their U.S.-born offspring accounted for 55% of the increase in [U.S.] population [from 200 million to 300 million] since 1966-67. 3 Within this group of 55 million, Latino immigrants and their offspring were by far the largest, representing about 29 million persons, or 53% of the addition due to immigration . . . .

Strikingly, Hispanics constituted only 4.25% of the U.S. population in 1966. In the last 40 years, that figure has grown to 14.9%. The percentage of Americans classified as "White" has fallen from 83.6% to 67% over the same period.

How Many Times Have I Heard That Before?

From a report, Investigation of Jack Abramoff's Use of Tax-Exempt Organizations, by the Minority Staff of the Senate Finance Committee:

The documents reviewed by the Minority staff raise several issues with respect to [Americans for Tax Reform]’s compliance with current tax laws. As a threshold issue, many of the activities alleged in the e-mails reviewed by the Minority staff indicate that ATR may not be primarily operating to further social welfare purposes, which is a necessary condition of tax-exempt status as a section 501(c)(4) organization. In addition, the documents raise questions whether ATR should have reported income from some of its activities as taxable income. Finally, the e-mails raise questions as to whether insiders at ATR, including [Grover] Norquist, used ATR primarily for their own or Mr. Abramoff’s private benefit. Violations such as these could, under certain circumstances, result in penalties under current law, including excise taxes on officers of ATR, revocation of ATR’s exempt status, and even criminal tax fraud penalties.

Where have we heard this before? Well, here, here, here, and here.

Equal Protection Under State Law: Very Big Deal in America!

Today, the Maryland Court of Appeals issued an opinion in the case of Ehrlich v. Perez that illustrates that (i) in some cases, rights that we tend to think of as being rooted solely in the U.S. Constitution (in this case, the right to equal protection under law), can also find alternative bases for support in state constitutions and (ii) the Republican Party is doing its best to run headlong off of a demographic cliff.

At issue in the case was a preliminary injunction forcing the state of Maryland to provide medical assistance benefits to resident alien children and pregnant women who immigrated to the United States on or after August 22, 1996. A federal law, The Personal Responsibility and Work Opportunity Reconciliation Act of 1996, generally know as the "Welfare Reform Act," was enacted in 1996. As described by the Court of Appeals:

The [Act] states: "An alien who is a qualified alien (as defined in section 1641 of this title) and who enters the United States on or after August 22, 1996, is not eligible for any Federal means-tested public benefit for a period of 5 years beginning on the date of the alien's entry into the United States with a status within the meaning of the term 'qualified alien.'" 8 U.S.C. §1613(a). Among the provisions of the W elfare Reform Act was the elimination of all benefits for illegal immigrants and other "non-qualified aliens," with a few limited exceptions such as emergency medical care. 8 U.S.C. § 1613. In doing so, Congress divided the two qualified alien categories into two subcategories: (1) qualified aliens who have resided in the U.S. since a time prior to August 22, 1996. . . .Some states were required to provide funding to the first subcategory of qualified aliens. . . . However, a period of five years residency in the U.S. was required for the second subcategory. . . . Congress then authorized the States to enact any law after August 22, 1996, should they choose to compensate this newly designated class of ineligible aliens, provided they use only State funds.

(Some internal citations omitted.)

In 1997, the Maryland General Assembly enacted Md. Ann. Code, Health-General Article §15-103(a)(2)(viii), which provided "comprehensive medical care and other health care services for all legal immigrant children under the age of 18 years and pregnant women who meet [Medicaid] eligibility standards and who arrived in the U.S. on or after August 22, 1996." In 2006, however, Governor Ehrlich cut funding coverage for this part of Medicaid in the budget that he submitted to the General Assembly. (In Maryland, the General Assembly cannot add or increase funding beyond what the Governor has proposed.)

The Circuit Court for Montgomery County issued a preliminary injunction ordering that the state (i) provide Medicaid coverage for all those within the ambit of §15-103(a)(2)(viii) and (ii) reimburse recipients for the benefits that had been denied to them before the date of the order. The injunction was based on the equal protection provisions of Maryland's constitution set forth in Article 24 of Maryland's Declaration of Rights.

On procedural grounds, the Court of Appeals rejected that part of the Circuit Court's order requiring reimbursement of past benefits. The vacation of that part of the order was based solely on the fact that the preliminary injunction remedy is designed to maintain the status quo. An an order that requires payment for benefits provided before the dispute came before the court is equivalent to a judgment in favor of the plaintiffs prior to a complete adjudication of the dispute. However, the Court upheld the injunction insofar as it requires that, while the litigation process is ongoing, the state must continue to provide benefits.

The holding of the case is narrow. If the federal statute had explicitly required that the states deny non-qualified aliens Medicaid benefits, the exclusion would likely have been upheld under the Supremacy Clause. Under those circumstances, the question would have become whether there was a rational basis to conclude that statute furthered the exercise of a particular federal power, namely the power to control immigration. However, because there was no federal mandate prohibiting the states from providing benefits, the more stringent "strict scrutiny" test was applied to determine whether the budgetary exclusion denied the plaintiffs their Equal Protection rights. And, by bottoming its opinion on a provision of the state constitution, the Court of Appeals precluded any Supreme Court review of the Equal Protection question. (Although, various other questions, e.g., a somewhat different "Supremacy Clause" issue raised by the state, could theoretically be appealed to the Supreme Court.)

The opinion comes a day after a story in the Baltimore Sun, Latinos' power in numbers-Naturalized citizens are becoming a political factor in Maryland that demands to be recognized, highlighting the growing political importance of Hispanic voters in Maryland. Those voters will presumably remember that Ehrlich's attempt to cut benefits to pregnant women and children was nothing more than a gratuitous slap at immigrants. As the opinion notes, this budget cut would only achieve "a cost savings of seven million dollars . . . of the four billion dollar budget appropriated for medical assistance health care costs generally."

I suspect that, in the short term, Republicans can mine anti-immigration sentiment to their electoral benefit. In the long run, however, the children and grandchildren of immigrants will remember the nativist enmity stirred up by Republican politicians. That will ultimately crush the party.

Movin' On Up?

There's been a debate, of sorts, between Grover Norquist's Americans for Tax Reform and the folks over at Citizens for Tax Justice over the question of whether state tax rates cause individuals to migrate from higher tax states. The ATR paper is here and the CTJ argument, linked to three studies of specific states, is on its weblog here.

The ATR analysis is singularly unconvincing. It includes a nifty chart sourced to "Vedder" with no additional information that would allow one to verify the chart's accuracy or to make a separate analysis to determine whether other factors were at work. (Presumably, "Vedder" is Richard Vedder of Ohio University and the Heartland Institute.)

The CTJ web posting cites three studies, from the Iowa Policy Project, New Jersey Policy Perspective, and Policy Matters Ohio, respectively.

The Iowa study was rather narrow in scope. It was designed to address an argument made in support of a particular piece of legislation before the Iowa legislature that would have provided various income tax exemptions to the elderly. The study showed, convincingly I think, that Iowan income tax rates did not cause significant out migration of the elderly from the state. However, the paper did not fully address the more basic question: Do taxes, in general, cause emigration from high to low tax states?

The New Jersey study dealt with the broad question of whether income tax caused net emigration from that state. It concluded:

It is impossible to tell from the IRS data the reasons why people leave or come to a state. However, the numbers for New Jersey would seem to suggest that the regional and national economic situation is an important force, especially in view of the fact that in most years outflow and inflow either rise together or fall together.

But it is equally impossible to interpret the data as in any way showing that changes in New Jersey's income tax rate-up or down-have an impact on whether high income families-or any families-choose to come to the state or to leave it.

One could just as easily, and perhaps more plausibly, conclude that the tax driving people out of New Jersey is the local property tax, since this tax takes a higher percentage of the yearly income of low- and middle-income families than it takes from the wealthiest-so that an increase of even a few hundred dollars is more noticeable to those families than an income tax increase that amounts to a relatively smaller percentage of a wealthy family’s income.

Finally, the Ohio study also limited itself to the affect of income tax on migration and concluded that "migration does not appear to be linked to income tax policy. Policymakers seeking to prevent outward migration should look to policy other than income-tax policy to alter the trend."

Clearly, taxes do have some effect on interstate migration. For instance, I know from my practice that state estate and inheritance taxes will cause some high wealth individuals to relocate. However, it would be virtually impossible to design a study that could isolate and measure the effect that these taxes have on migration. There are likely to be a large number of other factors at work and, more importantly, the number of people affected by these taxes is statistically small.

One of the problems with all of the studies is that there are generally so many factors that bear on an individual's decision to relocate it is virtually impossible to isolate the affect attributable to taxes. For instance, do people move to low tax states to avoid taxes in their state of origin, to enjoy a warmer climate, or to take a job at a non-union factory because work at older, union manufacturers has dried up? And, to the extent that the move is motivated by tax considerations, to what extend are the emigrants fleeing property tax assessments that fund primary and secondary education? If this last factor proves decisive, to what extent are the emigrants really defaulting on their responsibilities (i.e., "The state already paid for my kids' education. The hell with the next generation.")

It is anticipated that Maryland will have a huge increase in population over the next 10 to 15 years caused by the expansion of Aberdeen Proving Grounds, the NSA facility at Fort Meade, and the military's biological research facilities at Fort Detrick. Under these circumstances, unless Maryland's tax system becomes outright confiscatory, there will be little, if any, affect on immigration to the state. The population will increase because there are good, well-paying jobs available.

I think that, in general, similar, non-tax forces are at work causing either immigration to or emigration from various states. With some isolated exceptions (Nevada comes to mind), I think that the amount of taxes imposed on individuals is of little moment in determining emigration or immigration. But, as yet, I have little to go on in reaching that conclusion other than my own intuition.

Taking a Bite at the Apple

Russ Fox of Taxable Talk reports that New Jersey has extended its sales tax to cover music downloads. Following the links back, you get to this April 13, 2006, story in CNET, The Tax Man Cometh After iTunes. According to CNET, at the time of publication, 14 states and the District of Columbia imposed sales tax on music (and, presumably, software) downloads. New Jersey would be the 16th jurisdiction to do so.

The Supreme Court's holding in Quill v. North Dakota poses a significant hurdle to the states' efforts to impose sales tax on electronic media of any sort. In essence, that opinion requires that there be some significant physical contact with a state before the state can establish sufficient nexus to impose a sales tax. With respect to iTunes, the states probably can effectively impose a sales tax because Apple has sufficent contacts with almost every state to meet the nexus requirements of Quill. However, that is principally because Apple sells and services its computers and MP3 players throughout the country. If Apple were merely in the business of selling the music, it would likely not have a physical presence in any state that imposed sales tax on electronic media. Effectively, the states could not tax these sales.

However, as Apple's relative market share declines (it now controls about two-thirds of the market), the ability of the states to collect tax on the sale of electronic music will also decline since market share will inevitably be gained by companies whose only business is the sale of electronic media over the internet. (Note: Theoretically, the states would lose nothing since consumers who fail to pay sales tax are required to pay use tax. Consumer self-reporting and payment of use tax is, for all intents and purposes, however, non-existent.)

There have been bills introduced in Congress that would overide Quill and allow states to impose sales taxes on internet sales. While such legislation might work with respect to internet sales of tangible property, intangibles, such as software and electronic music downloads, would still be problematical. After all, so long as the servers that provide the downloads are located outside of the U.S., the purchase of downloads would still be sales tax free.

Of course, I once again have a good excuse to post a link to my favorite tax song, "Sales Tax," performed by the Mississippi Sheiks. Since the download is free, it is not subject to sales tax in any state.

Deja Vu All Over Again--WSJ Edition

Today's WJS editorial page touts the decline in the size of the budget deficit from the amount previously projected. Iit, correctly, attributes the decline of the deficit to increases in tax revenue. (The CBO press release on the deficit number is here.) However, it incorrectly finds that the Bush tax cuts are the underlying cause of the increase in tax revenue.

Jim Maule figured out that the WSJ editorial was baloney three months ago, before it was even published. He said then:

Members of the Administration are touting the revised deficit estimate, and its cause, as a sign that tax cuts are working as intended. Excuse me, but that makes no sense. Without the tax cuts there would be little or no budget deficit. So we're supposed to cheer because the mess isn't quite as bad as it appeared to be? I'd be impressed if the revision showed a budget surplus, because THAT would demonstrate the validity of the "cut taxes, double revenue" nonsense spouted by the "I refuse to pay taxes because I'm special" crowd and the "I cannot pay taxes because I'm selfish" group.

A closer look at the source of the increased tax revenue is most revealing. A significant chunk of it reflects increased corporate taxes, a natural consequence of the huge increase in corporate profits during the past half-year. Most of the rest reflects taxes on high-income taxpayers who have received bonuses. The Washington Post article goes into greater detail on these points. It also explains that taxes on wages are barely increasing, because wages are increasing only slightly. In other words, the tax revenue increases are consistent with the shift of income gains away from the middle class and toward the very top of the income and economic ladders. The rich get richer ....

Making the situation worse are the allegations that the Administration initially overestimated the deficit so that it could return and claim that it deserved kudos for reducing it. That's a ploy not unlike the child who says to a parent, "Would you be upset if I told you I broke the heirloom vase?" only to follow-up with the following comment to the rattled parent, "Well, I didn't. It's just that the picture window is broken." There's one word to describe this approach: manipulative.

The CBO report explicitly notes that:

Steady growth in corporate profits probably explains most of [the increase in tax revenues in September, 2006 from those in September, 2005], although some of it likely stems from settlements of past years’ taxes and a recent change in tax law that required large firms to accelerate some payments from 2007 into 2006.

Paul Krugman also pinpoints a different cause for the growth in corporate profits (behind Times Select Paywall), than that offered by the WSJ:

[A]fter-tax corporate profits have more than doubled, because workers' productivity is up, but their wages aren’t — and because companies have dealt with rising health insurance premiums by denying insurance to ever more workers.

This, of course, would also explain another "surprise" the WSJ editorial focuses on--the fact that the top 1% of all income earners account for 37% of revenue receipts from the individual income tax.

Angry Bear also anticipated the WSJ editorial when he published this chart from the CBO's August, 2006, estimates and made the following comments:

(Click to enlarge.)

But look at the on-budget deficit for 2006. It shows a small improvement over 2005, and then the CBO projects the on-budget deficit to worsen in fiscal 2007.

But compare 2006 to the earlier CBO estimates - 2006 is a complete disaster. And the bad news is another bubble is bursting right now (the housing bubble), and IMO the CBO estimates are once again ignoring the budget implications of that bursting bubble.

So when the Bush Administration touts their budget progress in the coming weeks, remember where we were just a few years ago. And remember where the budget deficit is likely to go. They call that progress?

Well, the WSJ editorial board certainly does.

Hat Tip: TaxProf

Premier Kissov

The BBC is reporting that CBS's Sixty Minutes will report this weekend that a "US no-fly list used to try to prevent terror attacks [created after 9-11] includes the names of 14 of the long-dead 11 September hijackers." However:

[T]he names of the 11 British suspects recently accused of a plot to blow up airliners flying to the US were not included on the list.

Cathy Berrick, director of Homeland Security investigations for the General Accounting Office told CBS that this was due to concerns that the list could end up in the wrong hands.

"The government doesn't want that information outside the government," she said.

As Dr. Strangelove once pointed out, some things have to be made public in order to work:

Yes, but the... whole point of the doomsday machine... is lost... if you keep it a secret! Why didn't you tell the world, eh?

Thing are not nearly as bleak as they may first seem, however. I have obtained a photograph of one of the people on the list, Robert Johnson:

Be on the lookout!

Hat Tip: beSpacific

Ok. Now back to work.

Grab and Leave

This post has nothing to do with (now former) Congressman Mark Foley. Rather, it deals with the conclusions of a report, When Knowledge Is an Asset: Explaining the Organizational Structure of Large Law Firms, by James B. Rebitzer and Lowell J. Taylor. They conclude that:

From the property rights perspective, large law firms are poorly suited to sustaining employment relationships because they have no enforceable means of controlling the firm's key knowledge asset—client relationships. The up-or-out partnership systems that have evolved over time in these firms offer an awkward but workable resolution to this problem. By restricting partnership size to maximize surplus per partner and by making senior attorneys residual claimants, law firms limit the opportunity for sub-groups of partners to grab and leave with the firm's clients. This action, however, creates additional demand for inexperienced associates who serve as (imperfect) substitutes for their more experienced counterparts. The result is that more associates are hired than can be promoted into a stable partnership. Those associates who do not succeed outgoing partners will be dismissed before they acquire sufficient client knowledge to themselves pose a threat of grabbing and leaving. That law firms find it worthwhile to commit to the costly practice of firing qualified attorneys in order to retain control over client relationships points to the general importance of control over assets in more conventional employment relationships.

The authors study available data to determine whether the data can justify alternative theories, such as the "dual incentive" theory. "According to this [theory], law firms create incentives for associates to invest in firm specific skills by promising a valuable promotion to some or all of the associates who undertake the investments. It is difficult, however, for outsiders to monitor whether the associates have actually met the firm's requirements. This gives the employer an incentive to cheat the associate by denying promotion even when the associate has performed as the firm desires. Since the employees anticipate cheating by the firm, no investments in firm specific human capital are made."

Ultimately, they reject the dual incentive theory because the alternative "grab and leave" "model predicts that large law firms, with long-standing relationships to important corporate clients, would implement a kind of legal production technology that would keep non-partners at arms-length from clients." The authors' examination of the increasing amount of time attorneys spend on client contact as they move up the seniority ladder leads them to conclude that the grab and leave model is in operation at large firms.

Hat Tip: Docuticker.

Housekeeping Update

I have deleted the Bloglet subscription box and terminated this weblog as a covered weblog under Bloglet. I imported all Bloglet subscribers, except those whose subscriptions were anonymous, into FeedBlitz.

My understanding is that Bloglet's performance was spotty at best and, in any event, does not deliver the postings with HTML format as does FeedBlitz.

Will I Know It When I See It?

One would think that most fundamental questions in tax law were settled. For instance, when is an organization a partnership for tax purposes? Unfortunately, that is not always (or even often) the case.

Brad Borden of Washburn University School of Law will publish The Federal Definition of Tax Partnership in an upcoming issue of the Houston Law Review. The paper is now posted on SSRN. As Borden explains in the abstract:

[C]ourts, Treasury, and the IRS generally have not considered the purposes of partnership tax law in the more than 150 instances they have interpreted and applied the definition of tax partnership. As a result, those efforts have produced ten separate tests for defining tax partnership, perpetuating the definition's uncertainty. This Article identifies and evaluates each of those tests and recommends abandoning tests that do not incorporate the purposes of partnership tax law and consolidating the remaining tests. Based on that consolidation, the Article proposes a new definition of tax partnership. The proposed definition incorporates the purposes of partnership tax law, and, because partnership tax law was intended to govern substantive-law partnerships, it includes some aspects of the substantive-law definition. Nonetheless, by using tax-specific terminology and relying on the purposes of partnership tax law, the proposal clarifies the definition of tax partnership and moves away from the substantive-law definition.

The simple definition:

A tax partnership is two or more persons, at least one of whom provides significant services, who have (or will have) common gross income.

It probably comes as a great surprise to non-tax practitioners, but the question of whether an arrangement is or is not a partnership for tax purposes arises fairly often. While obviously borne in academe where Borden currently resides, the article provides useful guidance to work-a-day practitioners.

Blackwhite

From the WSJ:

Republicans also deserve credit for financing the war, which is more than many Democrats say they'll do if they run Capitol Hill. The extension for two more years, through 2010, of the 15% rate on dividends and capital gains will also help sustain the economic growth that is throwing off record revenues to pay for the war even as the budget deficit declines.

Let me get this straight: The Republicans financed the Iraq War by failing to finance the Iraq War?

From the Center on Budget and Policy Priorities, we find this graph which exposes the WSJ's editorial bull:


As with almost all Republican argument today, Orwell is the best reference:

"The key-word here is blackwhite. Like so many Newspeak words, this word has two mutually contradictory meanings. Applied to an opponent, it means the habit of impudently claiming that black is white, in contradiction of the plain facts."

Hat Tip: Brendan Nyhan.

Looking for a One-Arm Economist

A recent CRS report, Running Deficits: Positives and Pitfalls, makes two points about federal budgetary deficits. Maybe.

First, deficits paid by younger generational cohorts to finance benefits for older generations may be justified. Thus:

Some shifting of resources to older generations . . . can be justified on the basis of equity. To the extent that technological change leads to greater prosperity over time, future generations will have access to higher standards of living. To the extent that population growth increases the size of the economy, the burden of financing pay-as-you-go retirement systems is reduced. If some of those gains are shifted from younger to older generations, then incomes and levels of well-being would be more equal among generations. Furthermore, a fiscal policy that shifts some resources from younger to older generations can raise living standards of all following generations by transferring a portion of the benefits of future economic growth into the present.

Or, perhaps not:

The possibility of raising standards of living by shifting resources from younger to older generations has its limits. The example above relies on the assumption that the policy continues indefinitely into the future. With a finite ending point this policy would be unsustainable because some young cohorts near that end point would be made worse off and would be unwilling to give up resources.

On this point, the report's conclusion takes an "on the one hand, on the other hand" approach:

Despite the projected magnitude of these intergenerational transfers [Social Security and Medicare, particularly Part D], younger generations might not be worse off than their parents if economic grows at a sufficiently swift pace.

These generational transfers are largely driven by the growth in the number of beneficiaries of entitlement programs relative to the work force, as well as by rapid increases in health care costs. The possibility that some future generation may eliminate fiscal policies that it perceives will lower its standard of living introduces political risk into social insurance programs funded by a pay-as-you-go mechanism. If a generation anticipates that a younger generation will stop contributing to a pay-as-you-go social insurance program, then it may decide to end the program itself. A generation whose descendants are unwilling to finance its benefits would have little to gain, apart from altruistic impulses, by continuing its contributions.

However, when it comes to the question of permanent structural deficits, the report has only one arm:

A government that runs deficits and is unwilling to raise taxes or cut spending faces three choices. First, domestic borrowing can be increased at the cost of crowding out domestic investment. Second, a government can borrow from foreign investors and governments. Borrowing from the rest of the world prevents deficits from crowding out investment. That is, foreign investors can provide financial resources now in exchange for future interest payments and profits. As foreign investors accumulate larger portfolios of stocks, bonds and other assets, the flow of interest payments, dividends and repatriated profits abroad increases as well. Third, a central government can print money to reduce the real value of debt denominated in domestic currency.

All three options have unpleasant consequences. Over time, each can seriously damage national economies. Simple supply and demand theory implies that a smaller supply of savings for private investment will lead to higher interest rates and lower growth in private capital stocks. Lower stocks of private capital threaten economic growth, and slower economic growth translates into lower average living standards in the future. Borrowing from the rest of the world permits higher levels of investment and faster growth at the cost of sending a higher fraction of earnings abroad. If foreigners lend capital by purchasing stocks and bonds rather than by building auto plants, for example, they may decide suddenly someday to take their investments elsewhere. This could strain domestic and international financial systems, thus constricting firms' and households' access to capital. Finally, inflation caused by printing money distorts the flow of information generated by the price system and disrupts financial markets. Investors, if they wish to avoid capital losses in real terms, demand higher interest rates when they see signs of inflation. A major reduction in the real value of the federal debt would require a significant acceleration in inflation. Few economists believe that the restrictive monetary policies needed to squeeze rapid inflation out of an economy would not require substantial economic disruption, at least in the short run.

On the other hand, reducing government deficits can improve economic performance in at least three ways. First, paying off government debt increases the supply of investment funds available for domestic investment. Second, paying off government debt held by foreign governments or investors reduces the amount of interest payments going abroad. Alternatively, paying off debt held by domestic investors gives them the opportunity to rebalance their portfolios by buying foreign assets, which offsets some of the flow of dividends and profits going abroad, or by buying domestic assets that otherwise would have been bought by foreign investors. Third, scaling down the federal debt decreases the temptation to reduce its real value by printing money, lessening the possibility of a major acceleration in inflation. Finally, most economists believe reducing government borrowing lowers interest rates, which in turn have positive effects on investment and growth.

(BTW, talk about samizdat. I had to call my Congressman's office for a copy of the report. It was faxed to me, which explains the poor reproduction quality. As soon as I get a better copy, I will scan it and replace the fax version.)

Ungrateful Deadweights

The Tax Foundation takes, ah, dead aim at the issue of tax expenditures and is somewhat off target. That is, the criticism does score some points, but does not hit the bull's-eye.

The TF discussion was triggered by the appearance in public web access of a CRS report, Tax Expenditures: Trends and Critiques. (Why CRS reports remain a sort of public policy samizdat is beyond me. The report in question had actually been posted by TaxProf two weeks ago, but only this week became widely available via Open CRS. But that's a rant for another day.) Tax expenditures are "those revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability."

A good deal of the Tax Foundation's criticism is well founded. For instance, the posting states that:

Because tax preferences are less visible to voters than direct spending programs, they reduce the transparency of the nation's fiscal system. That's bad policy because—as we've learned from recent debate about problems with congressional "earmarking" — lack of fiscal transparency inevitably promotes wasteful spending, shielding ineffective programs from the cleansing power of public scrutiny and budgetary daylight.

Recently, Linda Beale commented on a hearing held by:

[T]he Subcommittee on Federal Financial Management, Government Information, and International Security of the Senate Committee on Homeland Security and Governmental Affairs. . . . The hearing was titled "Deconstructing the Tax Code: Uncollected Taxes and Issues of Transparency." The hearing was "to examine uncollected taxes and issues of transparency relating to deconstructing the tax code, focusing on the 2006 updated estimate of the tax gap by the IRS, examine IRS efforts to close the tax gap as well as legislative solutions to increase taxpayer compliance, and explore the transparency of the tax code."

(Link omitted.)

She concludes by saying that:

Any discussion of tax expenditures should result in greater transparency, not to the misleading ploys evident in the FY 2005 budget [where the reduction of tax rates on dividends from 35% to 15% was not defined by the Bush Administration as a tax expenditure]. Further, Congress should take care that discussions of tax expenditures do not act merely as an entree to renewed discussion of further revenue reductions rather than a genuine effort to make relevant tax information more accessible to ordinary Americans.

It is here that the Tax Foundation comments miss the mark. Their posting states that:

[E]very additional tax expenditure carves out a portion of the nation's income tax base, forcing up tax rates to compensate. And as any economist will testify, higher marginal tax rates aren't bad simply because they make taxpayers "pay more." They're bad because they reduce the efficiency of the complex web of plans, contracts and relationships we call "the economy."

Economists teach that the "deadweight losses" of taxes—that is, the pure economic waste that occurs as a side-effect of every tax—rise as the square of the tax rate. Here's what that means. If tax expenditures erode half the nation's tax base, and tax rates are doubled to raise the same revenue, the economic costs of the tax system don't simply double as well. They rise by four times in those markets that remain in the tax base.

(Some links omitted and emphasis added.)

The first paragraph in the TF posting is completely correct. The second paragraph is not.

The first link that I have left in goes to a Wikipedia entry that merely defines and discusses the concept of "deadweight loss." The second link goes to a Wikipedia entry that discusses the "Economics of Taxing a Good." But, in dealing with the question of whether or not to increase or decrease income taxes it is simply wrong to assume that all taxes create the same deadweight effect. Brad DeLong addressed this issue in January, 2005:

Now there are two analytically distinct claims there at the end of the first paragraph I quote, the first of which--for which I have a good deal of sympathy--is that our system of taxing income from capital has in all likelihood been very costly in terms of deadweight losses imposed on the economy when measured against the revenue raised and the progressivity gained

The second claim, however, is the problem. The second claim is the old supply-side b.s.: that the growth the tax cuts will unleash means that the tax cuts would more than pay for themselves.

If I were writing about that second claim, I would not say that "most economists typically find this line of argument questionable." I would say that an overwhelming majority of economists find this claim ludicrous.

All taxes have some deadweight effect. But to assume that the deadweight effect of all taxes is the square of the tax rate in all cases is to fall into the fallacy that all tax cuts will pay for themselves.

Finally, an examination of two charts in the CRS report are particularly revealing with respect to who benefits from tax expenditures, a point that the TF ignores. Chart 4, below, shows various various tax expenditures and, for each, shows a measure of progressivity, the Suits index. (The Suits progressivity index varies between — 1 (completely regressive) to +1 (completely progressive). The Suits index is negative if the benefits from the program are received predominantly by families in the upper part of the income distribution.)

(Click to enlarge.)

In other words, the tax expenditures shown are, as a group, not particularly progressive and, in some cases, are downright regressive. In contrast, direct expenditures are fairly progressive:

(Click to enlarge.)

Taxes are not an unalloyed good. They have undesireable economic side-effects. However, they are, as Justice Holmes reminded us, the price we pay for civilization. The key is not to oppose all taxes, but to design a tax system that maximizes the benefits to the entire society. Part of that design requires that there be progressivity in the tax system, a requirement that the TF consistently ignores.

Penny Saved, Penny Earned Department

A study from the Employee Benefit Research Institute, Retirement Security in the United States--Current Sources, Future Prospects, and Likely Outcomes of Current Trends, points out that:

In 1990, the projected 75-year actuarial balance for the Old-Age, Survivors, and Disability Insurance (OASDI) program was –0.91 percent of taxable OASDI payroll, meaning that the OASDI or Social Security tax would need to be increased by 0.91 percentage points to achieve actuarial balance over the next 75 years from 1990. This 75-year deficit grew to more than 2 percent of taxable payroll before improving to just under 2 percent by 2005.

In other words, if, in 1990, we had kicked up the FICA tax withheld from employees by less than a half percent and increased the employer share (which, yes, I know, really comes out of the pockets of the employees) by an identical amount, the system would have been guaranteed to be solvent until 2065. Since we've waited 16+ years to take any action (and are likely to wait a good deal longer), the tax needed to assure solvency has more than doubled.

The news gets even grimmer when one realizes that Social Security is now scheduled to pay fewer bucks for the bang:

On top of the projected deficit, the amount of preretirement income a worker can expect at retirement from Social Security at specific ages of commencing benefits is going to decline due to the scheduled increases in the normal retirement age. For those age 65 in 2005 and starting to receiving benefits in that year and having made the equivalent of the average wage index over the course of their working career, the replacement rate of income just prior to turning age 65 from Social Security is 42.2 percent. For those turning age 65 in 2025 with the same earnings, the expected replacement rate is 36.3 percent. The replacement rates from Social Security are lower for higher earners and higher for lower earners.

Of course, THAT'S THE GOOD NEWS! The bad news is that:

The Medicare Hospital Insurance Trust Fund is estimated to be facing an actuarial balance of –3.09 percent of taxable payroll, which is a significant increase from the projected balance in 2002 of –2.02 percent. This means that the payroll tax for Medicare would need to be increased by 3.09 percentage points—or benefits would have to be cut by an equivalent amount—in order for the revenues to match expenses for the program over the next 75 years. This level of tax increase would more than double the current payroll tax rate for Medicare.

The projected growth in these expenditures could present serious issues for the federal and state governments. According to a Congressional Budget Office (CBO) study, depending on the spending path of expenditures for Medicaid and Medicare, these expenditures could amount to from 5.3 percent of gross domestic product (GDP) to 21.9 percent of GDP by 2050. For comparison, Social Security expenditures are projected to account for between 6.3 percent to 6.6 percent of GDP by 2050 under the same sending path assumptions.

Hat Tip: Docuticker.