Monday, May 30, 2005

Mechanical Ethics

In a recent posting, Carolyn Elefant took issue with Maryland Disciplinary Committee's recent Ethics Decision, Ethics Docket 05-11, Participation in For-Profit Referral Organization with Non-Attorneys. That opinion concluded that it was unethical for a lawyer to join an organization that was designed to facilitate cross-referrals among lawyers and non-lawyers.

Carolyn quite correctly criticized not only the ruling itself, but the general approach of the ethics committee. As she said "Sometimes a bar association issues a decision that's so impervious to the realities of legal practice that you have to wonder whether those who drafted it ever practiced law." Unfortunately, the simplistic and mechanical approach that the committee took in Ethics Docket 05-11 is typical of the committee's general approach to questions that come before it.

For instance, in Ethics Docket 2005-03, the committee was asked to opine as to the ethics implications of a paperless office. Rather than either (i) answering the question directly, (ii) setting forth specific guidance with respect to paperless record keeping that would satisfy the various ethical considerations pertinent to document retention, (iii) suggesting that an ad hoc committee be formed to study the issue, or (iv) asking the individual making the inquiry to outline precisely how he or she proposed to maintain the system and what safeguards against loss of records were built into the system, the committee merely restated the general principles involved with respect to record retention. The opinion then blandly stated, without any discussion, that "We also point out that in view of [the pertinent record keeping standards and principles], we are not as confident as you that the use of a paperless storage system for all files that are more than three (3) years old would be permissible."

The issue before the committee, however, was not their "confidence," but whether the details of the precise system to be used by the inquirer actually allowed the pertinent ethical principles to be effected.

I am currently maintaining my records pretty much on a paperless basis as to ongoing work. (I have not gone back to archive older records, which continue to be retained in paper.) I am willing to bet that I meet and exceed the applicable standards in every respect. Specifically, seven of the eight standards deal with when documents can be destroyed, how they can be destroyed, etc. My system addresses all of the concerns to which these seven principles or standards are directed quite simply: I never destroy documents.

All documents are scanned and saved to a client's file on my computer. Every day the files on my computer are backed up to (i) my firm's server and (ii) my portable hard drive. The server is backed up periodically, I believe weekly. My hard drive is backed up to my laptop every week or so. Thus, generally at the end of every two week cycle, all client files are in up to five different locations. Short of a nuclear attack on Baltimore, they're safe. Try doing that with paper.

But the mindlessness of the committee is deeper than just technological illiteracy. Lawyers are supposed to attempt to provide service to the greatest number of people at the lowest possible cost. My paperless record retention costs about $100.00 a year. Not only does it beat the out-of-pocket costs of paper document retention by a multiple of at least 10, but it has the additional benefit of reducing the labor and time lag involved in record retrieval. In short, electronic record retention has "ethical benefits" that the committee never bothered to examine, since cost savings ultimately redound to the benefit of clients.

This is not merely a rant with respect to the benefits of a paperless office, however. The point is that the committee's decision in Ethics Docket 205-03 is typical of its general approach to problems.

By way of example, the committee regularly disregards the economic consequences of its decisions. Thus, in Ethics Docket 05-11, the committee essentially handicapped potential new entrants into the legal market by putting outside the pale a particular type of networking. The rationale of that opinion only makes sense if (i) the members of the committee don't have any clients or (ii) like Tom Hagen, they all "have a special practice; [they] handle one client." Traditional sorts of networking, (everything from college and law school alumni associations, to country club, church, or synagogue membership, to participation on charitable boards, all well-known networking devices) are apparently okay, but novel methods of networking are not. The result is that the "ins" can retain a competitive advantange against potential new entrants to the market.

The committee's approach descended into absolute arrogance in Ethics Docket 2005-04. There, the committee was asked about the propriety of a solo practitioner, whose practice was concentrated in estate planning and tax advice, partnering with a financial services firm to provide referrals of the attorneys' clients. The attorney would receive a commission based upon the investments the attorneys' clients made with the financial services firm. Apparently, the arrangement would be exclusive, that is, the attorney would not refer to any similar firm.

There is no question but that the arrangement lends itself to potential conflicts of interest at a number of points. However, rather than addressing the substantive issues, the committee simply dismissed the inquiry as merely outlining the inquiring attorney's "many arguments or debating points as to why [the attorney felt] that [his or her] professional independence would not be impaired by forming an association with" the financial service provider. The committee then stated "we [do not] engage in written debates with inquirers over our interpretations of the rules, trying to justify our opinions to the inquirer. "

Why not? One of the purposes of, for instance, judicial opinions is for courts to lay out the intellectual underpinnings of their decisions. This allows those opinions to be discussed and criticized. As a consequence, the judicial decision making process contains within it a potential corrective against the perpetuation of error. This is necessary because judges are mere mortals. I am not certain, but I think that the members of the MSBA Ethics Committee are as well.

The question of whether lawyers should be able to also engage in selling securities, insurance, act as business brokers or real estate brokers, etc., is one about which reasonable people can differ. I think a reasonable argument can be made that by forcing lawyers to "sell" only services, the cost of those services will, over time, escalate so that many people will not have access to legal counsel. (I think that this process is actually ongoing now and is accelerating.) I also see the conflict of interest potential inherent in "cross-practicing." The committee, however, not only sees but one side, it refuses even to discuss whether there is another dimension to the question before it.

The great battle in legal theory of the twentieth century was whether the tenents of law were already in existence and the task of lawyers and judges was to discover them or whether law was a constantly evolving and developing process. Oliver Wendell Holmes' famous dictum in 1898 ("The life of the law has not been logic, it has been experience") summarized the victory of the legal realists that law was a dynamic process, not a static set of a priori assumptions. Since Holmes wrote those words in 1898, one would think that by now the MSBA Ethics Committee would have figured out what they mean.

Hide and Seek

While preparing the immediately preceding post, I attempted to find an independent link to the Congressional Research Service report that I pointed to. (The link in my posting is to the TaxProf website which posted a reprint of the report from Tax Analysts.) Not only could I not find a copy of the report on the CRS website, I couldn't find a CRS website that contained any reports of any kind whatsoever.

The reason is explained by The Memory Hole here:
The Congressional Research Service, a branch of the Library of Congress, provides fact-rich, unbiased, nontechnical reports to members of Congress regarding a variety of issues. The CRS does not distribute these reports to the public in any way. You can't get them online, order paper copies from the CRS, or even read them in the Library of Congress. CRS is not subject to the Freedom of Information Act. The Service's philosophy is that it works for Congress, not the people, so its publications are deliberately made difficult to get.

A few exceptions exist. Some third parties get selected reports through Congressional representatives, then post them online. The State Department's Website contains CRS reports that State prepared. Penny Hill Press provides all CRS reports, but you have to cough up $29.95 for each report if you're not a subscriber ($7.95 is you are a $299-per-year subscriber).

For a while, the Websites of Congressmen Mark Green and Christopher Shays provided a gateway to a CRS internal database, giving us access to a large but still incomplete selection of these reports. (Frustratingly, the CRS database blocked search engines, meaning that the reports never showed up in searches and weren't cached by Google or Gigablast.)

In mid-October, Green and Shays suddenly shut off access. Since theirs were the only doors into the CRS database, all of us lost access to this rich source of information. Luckily, The Memory Hole had copied many of these reports before the curtain came down. Below you will find the four main pages from Green's portal to the CRS database. If The Memory Hole has a copy of any given report, the link "MemHole mirror" appears after the title. We're interested in filling the gaps, so if you have a report that's listed but not mirrored, please send it. And we're especially interested in receiving CRS reports that don't appear anywhere else online.

For more info on access issues surrounding CRS publications, read "Congressional Research Service Products: Taxpayers Should Have Easy Access" from the Project on Government Oversight.
We're not talking here about material that is kept from the public due to national security concerns. CRS produces non-partisan analyses of issues before Congress. In fact, the information is not secret at all, it is merely difficult to access. Apparently, these hurdles to access are created intentionally by the CRS.

Blogs benefit public discourse by widely broadcasting information and opinion. They have natural limitations (e.g., the limitations on the time that bloggers can devoted to any one posting, for instance) and, as a result, blogs often offer secondary comment to more in-depth analyses. Organizations and institutions such as CRS are intended to produce studies that are easily digestible (that is, they're easy to read), yet offer a good degree of depth. The CRS should unlock access to these reports and allow its database to be available on the Web and searchable via the major search engines.

Estate Tax Policy Summary

Via TaxProf, you can download a Congressional Research Service report Economic Issues Surrounding the Estate and Gift Tax: A Brief Summary, by Jane G. Gravelle. The report is short and summarizes the arguments, pro and con, with respect to the repeal of the estate tax. It makes several points that are worth emphasizing:

First, the estate tax adds progressivity to the tax system.

Second, "as is also the case for the income tax, neither economic theory nor empirical evidence clearly indicate that the estate tax reduces savings." (Emphasis added.)

Third, at worst, there is only a minimal negative impact on small businesses and farms.

Saturday, May 28, 2005

A Knave Admits Leading Fools

Via TaxProf, there's a link to the article Estate Tax Repeal: Who Stands to Gain? by Dustin Stamper, published by Tax Analysts. The article not only confirms what I have pointed out here, namely that estate tax repeal will hurt many of those who are supporting it, but that the cheerleaders for repeal are aware that this is the case.

For instance, the article notes that:
Digging down to the essence of estate tax repeal, the debate becomes less and less about how small businesses and farms are affected and more about the fairness of the tax itself. Some of the staunchest advocates are not afraid to admit that many of their supporters, in the end, have nothing to gain.

"For most of you in this room, this is not your tax," [Republican pollster Frank] Luntz said at [a] rally [last week]. "It's a principle and a moral issue."
To the extent that there is some policy reason behind the efforts to repeal the estate tax, it is an intent to distort market mechanisms. Thus:
The Seattle Times Publisher Frank Blethen, a long-time advocate for estate tax repeal, told Tax Analysts that he not only understands that [many small businesses will actually end up paying more taxes under the proposed repeal in 2010 and beyond than they would with the increased exemption proposed to be in effect in 2009], but embraces it.

"This is about holding on to businesses and farms," he said. "If you don't sell, you don't have to worry about basis."
Let's see: Repeal of the estate tax removes a tax burden on the really, really rich and shifts it onto individuals who are not as well off. The policy reason is to distort the market and to encourage families to hold onto their assets even though sound business judgment would warrant that they sell.

Could someone tell me what conservative priniciple Luntz et al. are talking about?


A brief Google search reveals that Luntz has shifted his rationale for attacking the estate tax. As recently as March, 2004, Luntz said:
The most frequent victims of the death tax come from the most credible professions in the country — farmers and small business owners.
Of course, this was untrue, but the falsity of the argument was not widely known. In the 2004 article, Luntz offered a compromise to opponents of estate tax repeal that he suggested opponents could accept:
Set the exemption high enough that virtually all farms and small businesses won’t be affected. Set a rate that simplifies the tax structure and doesn’t force would-be payers to sell their businesses or hire high-priced tax attorneys.
Now, once it has become well known that Luntz's principle argument for abolition of the estate tax has already effectively been embodied in the tax statute, in arguing for complete repeal he is forced to rely on, ah, principle?

My Little Town

I've lived in Baltimore all my life. In my experience, at least, Baltimore has always had a municipal inferiority complex, poorer and less sophisticated than its neighbors to the north (Philadelphia and, especially, New York) and hte south (Washington, D.C.). However, there is clearly a renaissance underway.

Yesterday, the Fitch bond rating agency rated Baltimore's general obligation bonds A+ while raising the general outlook to "Stable" from "Negative". (Free registration required.)

The rating is based upon:
Maryland's (the state) continuing support of city revitalization resulting in tax base growth and stabilized population decline, as well as the city's conservative budgeting practices, moderate debt levels, and its demonstrated ability to deal with ongoing fiscal pressures. General fund operations are tightly balanced, although reserves continue to grow incrementally. The city is undergoing an aggressive plan to revitalize several of the neighborhoods surrounding the successful downtown redevelopment and this effort is likely to lead to continued private investment within the city. Debt levels are moderate, largely as a result of city action to limit borrowing to an affordable level. Capital needs are fairly sizable mostly for water and wastewater projects given the age of Baltimore's infrastructure and are payable from rates and charges on the system's users which extends beyond the city limits.

Baltimore's financial management is excellent, contributing to the steady buildup of reserves over the past decade, even as the city sustained major population and employment losses. The city's more active participation in the management of its school system may prove to be of long-term benefit to the city if it succeeds in instilling tighter fiscal discipline and improving academic achievement, both of which appear to be occurring. The city made an emergency loan to the school system during fiscal 2004 equal to $42 million, or 75%, of its budget stabilization reserve to alleviate cash flow problems.
I wonder whether the changes ongoing in the city will be reflected on The Wire.

Sunday, May 22, 2005

The Unfunded

Brad DeLong takes issue with Daniel Gross's column questioning why GM and Ford are continuing to pay their shareholders substantial dividends. DeLong writes:
According to Gross, Ford has $23 billion in cash and yet a stockholder's total equity value of only $18 billion. If that is true, why not spend $18 billion on a special cash dividend?
The reason is that these figures are essentially incorrect. They are derived from Ford's balance sheet statement that does not reflect liabilities for unfunded pensions and retiree medical benefits. According to a Reuters story on May 5, these liabilities are in the respective amounts of 12.3 Billion and, hold onto your hats, 32.4 Billion as of the end of 2004. One has to dig through Ford's financial statement filed with the SEC to find this bland explanation for the omission of the liabilities from its balance sheet:
Note 10.

* * * * *

Company Contributions

Our policy for funded plans is to contribute annually, at a minimum, amounts required by applicable laws, regulations, and union agreements. We do from time to time make contributions beyond those legally required.

Pension: As of April 2005, we contributed $2.4 billion to our worldwide pension plans, including benefit payments paid directly by the Company for unfunded plans. We expect to contribute an additional $400 million in 2005 for a total of $2.8 billion. Based on current assumptions and regulations, we do not expect to have a legal requirement to fund our major U.S. pension plans in 2005. We also do not expect to be required to pay any variable-rate premiums for our major plans to the Pension Benefit Guaranty Corporation in 2005.

Health Care and Life Insurance: In April 2005, we contributed $200 million to our previously established Voluntary Employee Beneficiary Association trust ("VEBA") for U.S. hourly retiree health care and life insurance benefits.
In other words, these massive liabilities, which would entirely wipe out the shareholder book value of the company if shown on the balance sheet, are simply omitted. Of course, this does not mean that the company has no value. After all, the balance sheet does not reflect the company's goodwill and the stream of Ford's future earnings may be sufficient to take care of these benefit shortfalls. Since Ford has a market capitalization of $18.4 Billion, a figure that presumably factors in the pension and health care liabilities, on one side, and the goodwill value, on the other, the "market" apparently believes that Ford has, all things considered, a positive valuation.

Yet this analysis does not resolve the DeLong/Gross debate, although it would seem that DeLong's glib "why not pay out the entire value in dividends" is clearly unwarranted. The issue is far more complex: To what extent will the payment or non-payment of dividends impair the company as an ongoing operation?

If, for instance, in authorizing the dividends the directors significantly overestimate the company's ability to continue in operation and reverse its current fortunes, the decision to pay dividends could, in retrospect, be deemed to be folly, because, for instance, the payout might impair liquidity just when it was most needed to restructure the business.

On the other hand, it may be helpful to use dividends to keep shareholders relatively contented. A failure to authorized dividends that runs counter to shareholder expectations could be viewed very negatively by the market (such as might be the case if the market concluded that the failure to pay dividends was because the financial condition or prospects of the company were more dire than management had previously let on). A radical drop in market capitalization could, in effect, turn into a run on the bank.

If pressed to take sides, I would go with Gross, but that's only because DeLong is simply too doctrinaire as to the amounts that should be paid out. That being said, however, I am not at all certain that the dividends are entirely too high.

Tuesday, May 17, 2005

It Ain't Me Babe!

I tripped over the following quote in a column in the Chicago Sun-Times:
Stuart Levine may be the first person ever to be both knighted and indicted in the Northern District of Illinois.
The column does not say where donations to the legal defense fund can be made.

Pedigrees and Mutts

Without any doubt, the blog with the most refined and respected intellectual pedigree is The Becker-Posner Blog, co-authored by a Nobel-prize winning economist, Gary Becker, and Richard Posner, perhaps the leading public intellectual on any judicial bench. In a recent posting by Becker entitled Should the Estate Tax Go?, Prof. Becker makes an argument cobbled out of several assertions of fact that, to be charitable, are dubious. In order, they are as follows:

1. There is no convincing evidence that . . . the degree of social mobility across generations [] has been falling during the last couple of decades.

Well, yes and no. According to an article by David Wessel in the May 13, 2005 WSJ (subscription required), "[O]ver the last 10 years, better data and more number-crunching have led economists and sociologists to a new consensus: The escalators of mobility move much more slowly. A substantial body of research finds that at least 45% of parents' advantage in income is passed along to their children, and perhaps as much as 60%. With the higher estimate, it's not only how much money your parents have that matters -- even your great-great grandfather's wealth might give you a noticeable edge today." Strictly speaking, this does not necessarily contradict Becker's assertion, which is that the rates of social mobility are relatively unchanged, but it certainly puts a different spin on it.

In essence, Wessel is saying that we (and here he points to Becker by name) have overestimated the rate of social mobility. (Interestingly, Wessel quotes Becker as follows: "Even . . .Prof. Becker is changing his mind, reluctantly. 'I do believe that it's still true if you come from a modest background it's easier to move ahead in the U.S. than elsewhere,' he says, 'but the more data we get that doesn't show that, the more we have to accept the conclusions.'" The quote seems at odds with Becker's position in the blog posting.)

2. The estate tax brings in only $24 Billion in revenues, but generates costs in professional fees alone of $6 Billion.

Joel Schoenmeyer does a good job of demolishing this assertion. ("There may be 20,000 estate planning attorneys in the country, but very few of them devote all of their time to estate tax issues (in fact, from what I've seen, very few of them devote all of their time to estate planning issues).") As I noted previously, there is already a substantial body of academic study that indicates that the compliance and enforcement costs of the estate tax, while higher than those of the income tax, are not nearly as great as Becker estimates. See here.

3. The estate tax also makes it harder for families to pass successful businesses on to their heirs. Yes, and alligators roam the sewers in New York City. Again, see here.

4. Becker finishes with a real howler: The energy and political capital spent on supporting high estate taxes is better spent on trying to raise opportunities to children from poor families by improving their education, training, and health. Let me see, if we abolish the estate tax, I'll bet that at least half of the $6 Billion in the professional fees paid to avoid the tax will be directed to trying to "raise opportunities to children from poor families." Right.

Judge Posner in his response sees the issues much more clearly, pointing out the faulty "social mobility" assumption that underlies Becker's argument. Posner suggests, for instance, that gift tax rules be tightened to impose a gift tax on private school or college tuition paid by Grandpa or Grandma. (I've often wondered what percentage of high tuition private college charges are paid by the students' grandparents.) He also comments on two points I've previously discussed, namely the effect of the repeal of the "pick-up" tax credit and the effect of the repeal on the basis step-up rules. (However, he does not point out the regressive result of the repeal.)

Let me make a couple of suggestions for reform:

1. The proceeds of policies of insurance in insurance (or Crummey) trusts ought to be subject to estate tax. The current law warps investment decisions away from those that would be dictated by the market to investment in life insurance. Here, I'm ready to trust the market.

2. The rules with respect to discounts applicable to family limited partnerships or family limited liability companies ought to be formalized via statute. Under current law, there is too much incentive to game the system by taking an agressive approach to discounts and then negotiating the issue with the audit agent.

3. The rules with respect to income tax deductibility of charitable deductions if the donor is relatively young (say, below 62) could be loosened. As currently structured, there is too much incentive to wait until death to dispose of assets via charitable donations. This proposal would create incentives for early donation and would assist in reaching a result that Posner favors, to foster "the creation of centers of private power . . . as an offset to growing governmental power."

4. Outlaw dynasty trusts. A full discussion of dynasty trusts is beyond this posting. Suffice it to say at this point that the concentration of income and wealth in this country is growing rapidly and the last thing we need is a new vehicle to accelerate that trend.

Just one mutt's view.

Monday, May 16, 2005

Dancing With Myself?

In the song Dancing With Myself, Billy Idol writes:
Well there's nothing to lose
And there's nothing to prove
I'll be dancing with myself
In Jones v. Novastar Financial, Inc., Judge Albert Matricciani should have taken the lyrics to heart and declined to address at least one question presented to him.

The case involves an LLC that was formed by a Delaware mortgage broker. The LLC had the mortgage broker and the local branch manager as its members. In addition to the operating agreement of the LLC, the mortgage broker entered into a "a branch support and administration agreement." This was presumably an agreement whereby the mortgage broker extended support services to the LLC. The Court determined that the complaint stated a valid private cause of action against the LLC under the Maryland Mortgage Lender Law, Md. Fin. Inst. Code Ann. Sections 11-501 et seq.

The Court then concluded that the mortgage broker could be a co-conspirator with the LLC. This seems to me to be wrong. The mortgage broker was a member of the LLC and, while the operating agreement was not described in any detail, it presumably had management rights with respect to the operation of the LLC. To the extent that it was exercising its rights qua LLC member, the conspiracy claim should have failed.

In any event, however, the conspiracy claim was rejected because the Court did not "find in the complaint allegations of an agreement to carry out unlawful actions outside of the [operating] agreement and the branch support and administration agreement." In other words, there was no agreement to undertake unlawful acts.

The Court should have addressed this issue first and then simply not addressed the issue of whether a party could conspire with an LLC that it was a member of since that question would have been rendered moot.

Sunday, May 15, 2005

The Media and Taxes

Joel A. Schoenmeyer at Death and Taxes--The Blog had some nice things to say about my posting on the WSJ's reporting of the estate tax/basis step-up tradeoff. He then addressed the repeal of the "pick-up" tax credit in 2001. I agree entirely with his comments, but I think that the background of the repeal is worthy of further comment.

In essence, before the massive tax cuts enacted in 2001, the estate tax had a provision that granted a tax credit for state inheritance taxes paid. While there were limits to the credit, in effect it worked as a direct subsidy from the federal government to the states. After all, the states could enact a tax on estates that cost its citizens nothing because the tax paid to the state reduced the federal tax that would otherwise have to be paid on a dollar for dollar basis. At the end of the day, estates were no worse off than if the state had not enacted a tax. Since it cost their citizens nothing, virtually all of the states enacted an estate tax equal to the pick-up credit.

The reason that the credit was abolished in 2001 was that the tax cutters could claim that their bill cut taxes by about $9 Billion a year less than was actually the case. Of course, the $9 Billion came out of the pockets of the various states. (There was some poetic justice: Brother Jeb's state relied on the pick-up tax for about 5% of its revenue. Thus, the tax cuts pushed by Big Brother George forced him to raise taxes on the citizens of Florida.)

Needless to say, none of this was reported at the time by the mainstream (meaning, non-technical) media. Admittedly, in the context of the orgy of tax cutting then taking place, it was fairly small potatoes. Yet, it illustrated the high degree of disingenuousness exhibited by the tax cutters and should have been worthy of mention.

I agree with Schoenmeyer's comments as to the ripple effect that the repeal of the pick-up credit will have, but there's another affect that's important. Specifically, it is relatively easy for an individual to abandon domicile in one state and establish domicile in another. As the states begin to replace the old pick-up tax with a real tax, they will incentivize some of their citizens to abandon their current domiciles and to move to states which do not enact such provisions. Of course, the citizens who will be most significantly affected by such tax enactments are often wealthy and retired, that is, a group that is perhaps the most mobile segment of the general population. By enacting an independent tax on estates, states could be playing with fire because if the well-to-do begin to abandon their (relatively high tax) domiciles with a vengeance, there will be a reduction in income tax revenues as well. On balance, the states could actually end up with reduced revenues on a net/net basis.

Housekeeping Update

I've updated the list of links to other legal weblogs. The list is by no means intended to be encylopedic. While initially, I had links to virtually any legal weblog that I was aware of, the update represents the addition of only legal weblogs that I follow via Bloglines, thus the list, as updated, is heavily weighted toward discussions of tax, business, and technology issues.

There will likely be one further change in the next week when I add icons to allow easy subscription to this weblog via Yahoo and MSN. Any other suggestions as to how the format of the weblog can be improved are welcome.

Friday, May 13, 2005

Late to the Game

In yesterday's Wall Street Journal, Tom Herman's "Tax Report" feature had the headline "Estate-Tax Repeal May Hurt Some." (Paid subscribers only.) In the article, he reported what I had noted last month, namely that people who would not benefit from the abolition of the estate tax would be exposed to tax liability they currently escape due to the operation of the basis step-up rules. The estate tax repeal would likely abolish these rules, thus subjecting capital gains to income tax, in cases where, under current law, the gains would escape tax entirely.

The WSJ is reputed to have a somewhat split personality--outrageously ideological on its editorial page, scrupulously honest in its actual news reporting. Herman's article, which I believe falls into the news reporting category, erodes one's confidence in the reputation of the reporting side.

Start with the headline itself, indicating that the repeal may hurt "some." Wrong: As I pointed out, not some. The simultaneous repeal of the estate tax and of the basis step-up rules would impose a tax on many, offering relief to only a few. Consistent with Republican philosophy, of course, the few are very rich, the many merely the well-to-do and the simply wealthy.

The body of the article gives the impression that the abolition of the basis step-up rules is the product of some arcane statutory fine print. (In fact, the article actually refers to those who are aware of the problem as "tax advisers who have studied the fine print.")

Look, this is not, as one tax expert quoted by the WSJ says, "enough to make your head spin." Rather, it's what the late Charlie Eckman used to say, "It's a very simple game!" A lot of people, including people in the middle class, benefit from the basis step-up rules. As the estate tax law changes currently enacted take effect, only the few very rich will benefit from a repeal of the estate tax. The losers outnumber the winners by at least a factor of 20. The repeal of the estate tax will have the effect of imposing tax on the less well-to-do to satisfy the really, really wealthy. This is not subtle or tricky. Any decent reporter whose beat is taxes should have known about the issue from the beginning.

Thursday, May 12, 2005

Higher Authority? Maybe.
Wrong courthouse? Definitely.

In Union of Orthodox Jewish Congregations of America v. Brach's Confections, Inc., Judge Andre M. Davis addressed a venue question that, if anyone doubted it, settles the issue of whether litigation has to be conducted in a way that is convenient to counsel. It doesn't.

The Plaintiff is a non-profit organization that offers Kosher certification of food. Its trademark signal (that is, its hekhsher) is a "circled 'u.'" (Commonly referred to as the "OH-U" symbol.) Brach's is a Delaware corporation with its principal place of business in Dallas and manufactures and markets confections and candies, including “Star Brites Peppermint.” It seems that the label to the Star Brites appeared to contain the hekhsher.

After what the Court categorized as "an exchange of some rather over-heated emails and letters, in the course of which, in classic 'lawyerese,' Louis Vuitton S.A. v. Lee, 875 F.2d 584, 587 (7th Cir.1989)(Posner, J.), plaintiff threatened to sue," the parties raced to two different courthouses to commence actions against each other. The Orthodox Union filed first, initiating an action in Maryland that it filed in the Southern Division Courthouse. That is, the courthouse closest to its attorney's offices. A few hours later, Brach's filed in the Norther District of Texas where it is headquartered.

Judge Davis had no difficulty in ordering the action transferred to Texas. It seems to me to have been a foregone conclusion since:
It is undisputed that plaintiff is headquartered in New York and that defendant is headquartered in Dallas. The only relevant connection this district has to this dispute is that some of the allegedly infringing products were found on the shelves of one or more retail food stores in Baltimore, and a local rabbi would so testify.
(Emphasis by the Court.)

As best as one can gather, the Orthodox Union wanted to bring the action in Maryland because its counsel, perhaps acting pro bono, was located in either Maryland or Washington, D.C. Thus, proceeding here would have been less expensive for the Orthodox Union. However, since it had virtually no real connection with Maryland, its choice of forum was rejected in favor of the Texas Court in the District where Brach's is headquartered.

The Orthodox Union should not be too dismayed over the outcome of the case, however. There are Jews in Texas.

Wednesday, May 11, 2005

Progressivity/Regressivity Update

TaxProf has a posting entitled "Did NY Times Publish Biased Marginal Tax Rate Table?" The NYT published a chart, which I discussed in my posting here. Apparently, the Times omitted the data from the lowest income levels which highlight the progressive effect of the Earned Income Tax Credit.

What's interesting is that, in some ways, the chart that includes the effect of the EITC highlights the overall lack of progressivity of the system. There is actually regressivity as between very low income individuals and lower-middle income individuals. There is a "notch" that reduces tax rates for some middle income individuals, but there's a steep jump in marginal rates for individuals making just under $100,000 a year. At just over the $100,000 a year mark, the marginal rates turn regressive. While there are some choppy progressive/regressive "spikes" as income moves upward from there, the marginal rates essentially flatten out as annual income hits about $225,000.

Again, as I pointed out, the figures used in both charts are representative of only the Federal tax system, the most progressive part of the American tax system. At least according to the older Pechman studies, state and local taxes tend to be fairly regressive, thus making marginal rates overall fairly flat.

Sunday, May 08, 2005


Via Mark Kleiman, there is this story in the NYT that Britain's leading higher education union has voted to boycott two Israeli universities. In the body of the article, there is this passage:
Omar Barghouti, a founding member of the Palestinian Campaign for the Academic and Cultural Boycott of Israel, which pushed for the union vote in Britain, said comparing Israeli occupation to South African apartheid was a fair parallel. While Palestinians are not officially barred from Israeli universities, they are effectively kept out, he said.
Who is Omar Barghouti? According to a bio that accompanied one of his screeds a year ago, he is a "independent Palestinian political analyst" who is:
a dance choreographer with El-Funoun dance ensemble in Palestine . . . . [who] holds a Masters degree in electrical engineering from Columbia University, NY, and is currently a doctoral student of philosophy (ethics) at Tel Aviv University.
(Emphasis added.)

If Palestinians are "effectively kept out of Israeli universities," how . . .?

Oh, never mind.

Progressivity v. Regressivity

In a previous post/rant, I took a editorial in the WSJ to task for citing an article in support of the proposition that federal income tax rates were becoming more progressive. In fact, the study cited by the WSJ made the point that income tax rates are becoming less, not more, progressive.

Via Brad DeLong, Alex Tabarrok of Marginal Revolution has a chart with this posting that shows fairly conclusively that while there is some progressivity in the federal tax system, the extent of progressivity is fairly choppy and, at certain points, marginal rates are actually regressive. (It is not clear whether the chart factors in FICA/SECA taxes, which are regressive. See the comments by Half Sigma.)

More significantly, I've been unable to find any current information on the progressivity/regressivity of the U.S. tax system as a whole. That is, a study that would factor in the effect of state and local taxes, as well as federal taxes. The only comprehensive study in this area was done several years ago by the late Joseph A. Pechman. I believe that the last year that was analyzed in the study was 1985. Pechman found that the distributional burden of the tax system as a whole was fairly flat since the progressivity of the federal tax was offset by the regressivity of state and local taxes.

If, as seems to be the case, federal taxes are becoming less progressive, it is likely that the U.S. tax system as a whole is actually becoming regressive, since there have been virtually no significant structural changes in state and local taxes in the last 20 years. In fact, to the extent that there have been no increases in state and local income taxes or income tax rates, state and local taxes may actually be more regressive than when Pechman conducted his study since any effective revenue increases at the state and local level have likely come from slightly regressive property taxes and highly regressive sales and excise taxes.

Can someone point me to a study that updates the older Pechman study?

Wednesday, May 04, 2005

Where Have All the Students Gone?
Gone to Careerists Every One

Sunday, I traveled to the University of Maryland in College Park and, with my son, went to hear Tom Friedman give a presentation. Sure, I knew that he was there to flog his new book and I also knew that, since I read his column regularly, I was pretty familiar with what he was going to say. But he was to be joined for a large part of the presentation by Shibley Telhami. Thus, the event promised to be somewhat more than the usual author-speak. And, since it was the last day of Passover, I could always conclude my trip with a pizza from Ledo's (the original, not one of the franchisee pretenders).

Something about the presentation troubled me. It had nothing to do with what Friedman or Telhami said or didn't say. It was the audience. There were few students there, either graduate or undergraduate. By and large, the members of the audience were old. And I don't mean Stuart Levine old. Just by a guess, I believe that well over a third, maybe more than half, of the audience was over 60.

I graduated from College Park in 1972. I won't lie and say that every student was an activist or actively concerned with the issues of the day, but I will tell you that had individuals with the reputation of Friedman and Telhami come to speak on campus, they would have attracted a huge crowd of students, both graduate and undergraduate. Yes, I know what you're thinking: My memory of an intellectually engaged student body is simply a variant on the same sort of nostalgia that my parents exhibited when told me that they had to walk six miles to school every day in blinding snowstorms and through deep snowdrifts. I don't think so.

Something has changed. There is none of that intellectual snap, crackle, and pop that was in the air when I was an undergraduate. (Ok, it's true that today my knees are the principal part of my being that snap, crackle, and pop on a regular basis and maybe my memories have become romanticized, but still.)

I recall reading about students who went to college after World War II on the GI Bill. They were significantly more focused and directed than the other students at the same time who came to college directly from high school. I believe that today's college students are much like that post-WWII generation than mine.

This is both a good thing and a bad thing. It's good because we will likely turn out technically more proficient engineers, chemists, biologists, computer scientists, etc. It's bad because these students have somehow lost their youth.

At least the pizza was as exquisite as I remember it.


Apparently some schools, such as the University of Texas, have more traditional student bodies. See here.

Tuesday, May 03, 2005

No Fraud Here

For some strange reason, I've always had a sneaking suspicion that the statute of frauds tends to be used more to effect fraud or, perhaps more appropriately stated, to protect the perpetrator of a fraud, then it does to prevent fraud. In Salisbury Building Supply Co., Inc. v. Krause Marine Towing Co., the Maryland Court of Special Appeals turned back an attempt to protect the perpetrator.

Prior to the formation of the towing company, its principal, Joseph Krause, and the building supply company signed a document that purported to be a memorandum of understanding between the two companies. The memorandum provided that the towing company would supply services to the building supply company for a period of five years. Shortly thereafter, the towing company was organized as a corporation and for two years it provided services pursuant to the terms of the memorandum. At that point, the building supply company sold substantially all of its assets to a new company and then ceased operations. Neither the new firm nor the old entity honored the arrangement with Krause. Krause then sued the building supply company. Krause produced unchallenged evidence that it suffered lost profits for the unexpired term of the deal in an amount in excess of $165,000 and received an jury award in that amount. Salisbury appealed, contending that the agreement was unenforceable due to the application of the statute of frauds.

Under the Maryland statute of frauds, a contract that cannot be performed within one year is not enforceable unless the agreement "or some memorandum or note of it, is in writing and signed by the party to be charged." The Court stated that "in analyzing whether a memorandum or note is sufficient to satisfy the statute of frauds, courts should focus upon the statute’s purpose, namely, prevention of fraudulent claims" and quoted Williston on Contracts as follows:
In determining the requisites and meaning of "a note or memorandum in writing," courts often look to the origin and fundamental purpose of the Statute of Frauds. In fact, a failure to do so will often result in a futile preoccupation with the numerous and conflicting precepts and decisions involving the clauses providing for a note or memorandum, and a corresponding failure to see the forest for the trees.

The Statute of Frauds was not enacted to afford persons a means of evading just obligations; nor was it intended to supply a cloak of immunity to hedging litigants lacking integrity; nor was it adopted to enable defendants to interpose the Statute as a bar to a contract fairly, and admittedly, made. In brief, the Statute "was intended to guard against the perils of perjury and error in the spoken word." Therefore, if after a consideration of the surrounding circumstances, the pertinent facts and all the evidence in a particular case, the court concludes that enforcement of the agreement will not subject the defendant to fraudulent claims, the purpose of the Statute will best be served by holding the note or memorandum sufficient even though it is ambiguous or incomplete.
The Court allowed the enforcement of the deal the parties had reached even though the memorandum was entered into prior to the date of formation of the plaintiff and it affirmed the judgment in favor of the towing company.

At least in this case, the statute of frauds was not used as a shield to protect the party breaching the contract.

What's Fair?

In Della Ratta v. Larkin, 382 Md. 553 (2004), the Maryland Court of Appeals held that four limited partners had the ability to withdraw from the limited partnership and to recieve the "fair value" of their partnership interest. The case was remanded to the Circuit Court for Anne Arundel County for a determination of what constituted fair value. In March, the Circuit Court rendered its opinion in the case. (The opinion is found on the website of the Maryland Business and Technology Case Management Program.)

The limited partnership had but one asset, a shopping center. The Court first determined the value of that asset. While several points of the Court's discussion of the appraisal issue are of some interest (particularly the Court's rejection of the use of the assessment used to determine property tax), the importance of the case for me is in its discussion of the meaning of term "fair value."

The Court held that the purpose of the statutory provision calling for withdrawing partners to be paid fair value for their interests "is to indemnify the withdrawing partners for the interests that they are giving up upon withdrawal, in the same proportion as the partner[s] would participate in distributions from the partnership." The Court then concluded "that fair value is a legal concept which differs from fair market value." (Emphasis by the Court.) To determine fair value, "the valuation must be viewed from the perspective of the withdrawing partners who are surrendering their interests back to the partnership."

Since there was no direct Maryland precedent with respect to the meaning of the term, the Court looked to the dissenters' rights provisions of the Maryland corporate statute, Section 3-202, et seq. of the Maryland Corps. & Ass'ns Article. The Court quoted Warren v. Baltimore Transit Co., 220 Md. 478, 483 (1959) to the effect that:
the real objective [of the dissenters' rights provision] is to ascertain the actual worth of that which the dissenter loses because of his unwillingness to go along with the controlling stockholders, that is, to indemnify him. The textwriters and cases agree generally that this is to be determined by assuming that the corporation will continue as a going concern – not that it is being liquidated – and on this assumption by appraising all material factors and elements that affect value, giving to each the weight indicated by the circumstances, including the nature of the business and its operations, its assets and liabilities, its earning capacity, the investment value of its stock, the market value of its stock, the price of stocks of like character, the size of the surplus, the amount and regularity of dividends, future prospects of any industry and of the company, and good will, if any.
Most significantly, the Court rejected the use of a minority or marketability discount applied to the partnership interests of the withdrawing partners to determine the purchase price. This is consonant with the theory that the buyout represents a division of the business entity, not merely a purchase of the departing partners' interest in the entity. Thus, the Court found that this case was a
statutory redemption intended to make the withdrawing partners whole by allowing them to "cash out" their interests. If discounts were applied, the remaining partners would end up acquiring the interests of the withdrawing partners for less than they were worth if those interests had remained in the hands of the withdrawing partners . . . [and that] under the circumstances of this case, it is not appropriate to apply such discounts in order to determine the value of the interests of the withdrawing partners.
(Emphasis by the Court.)

The opinion seems to be correct. However, it should also serve as yet another warning that proper drafting of an agreement can control the outcome of a business dispute. Here, the parties had not addressed the possibility of a business dispute in their operative formation documents and, as a consequence, were left with a statutorily mandated result.

Sunday, May 01, 2005

Responsible? Not My Call.

A recent trial court opinion from the Court of Federal Claims, Salzillo v. U.S. goes further than most other reported cases that I am familiar with in absolving an employee who exercised check signing authority from liability under Section 6672.

Salzillo was the Vice President of Finance and Chief Financial Officer of Star Food Processing, Inc. He was at all relevant times fully cognizant of all elements of the financial affairs of Star, including the fact that Star had failed to pay its federal payroll withholding. The IRS had assessed a Section 6672 "responsible person" penalty against Salzillo in the amount of $554,000.

Salzillo's principal contention was that, notwithstanding the fact that he had regularly made checks payable to suppliers and endorsed those checks in his capacity as the CFO of Star, he had no actual discretion to direct payments. In particular, he related an incident where he had paid employee withholding but his decision was countermanded by the CEO of the Company, Robbins. On that occasion, when Robbins learned that a supplier could not be paid because Salzillo had paid the withholding, "Robbins became irate and ordered Mr. Salzillo to wire the money to the meat supplier instead. He admonished Mr. Salzillo never to write a check to the IRS again." Salzillo's immediate subordinate testified that if Salzillo had "made any payments other than those directed to production related costs, Mr. Robbins would have threatened to fire him, but, given the company's dire circumstances, probably would not have done so."

The Court, while recognizing that virtually all company checks in the relevant time period had been indorsed by Salzillo, framed the issue as being whether Salzillo could have "by writing and mailing . . .a check [for the withholding], actually have transferred funds to the IRS in payment of the delinquent payroll taxes?" The Court found that, as a practical matter, he had no power to make payments to the Service.

In this regard, the Court made it clear that merely proving that he had been instructed not to pay the withholding would not have been sufficient to escape the Section 6672 net. Rather, it was the fact that Robbins:
so thoroughly controlled the extraordinarily limited finances of the company as to make it virtually impossible for Mr. Salzillo to send funds to the IRS without his actions being immediately detected and actual payment averted. Thus, the record reveals that, long before Mr. Salzillo became the so-called "chief financial officer," Mr. Robbins was constantly apprised of the company's precarious cash position, and that, as day-to-day needs arose, he allocated the scarcely available funds to maintain and maximize production. As prime indication of the depth and effectiveness of his controls, the record reveals – and IRS records confirm –- that when Mr. Salzillo attempted to pay the IRS $50,000 without obtaining Mr. Robbins' permission, the latter quickly detected the unauthorized use of funds and shifted money from the account in question to prevent the check drafted by Mr. Salzillo from being cashed by the IRS. Given the pervasive nature of Mr. Robbins' control, plaintiff had no reason to believe that subsequent attempts to pay the IRS would prove anything more than a hollow gesture.
The opinion is not listed on Court of Federal Claims' website either as a reported or an unreported opinion. However, I would be surprised if the Service did not appeal the case since it appears to run counter to most other reported decisions in this area. I also believe that, in the main, decisions in this area have been too automatic and reflexive. The true issue should always be the issue that the Court focused on here, namely, whether the taxpayer before the Court could have made a difference in whether the withholding was actually paid. If he or she was, effectively, powerless to act, there should be no penalty imposed under Section 6672. This should be the result even if the individual has check signing authority and actually directs payments to other creditors. The touchstone is whether, when the individual makes those payments to the creditors, he or she has the practical option to direct that the payments go to the taxing authority. If the individual lacks that power, there should be no penalty imposed.

Should the appellate court rule in Salzillo's favor, the practical effect would be enormous since the jurisdiction of the Federal Claims Court can be invoked in any Section 6672 contest once the taxpayer had made a partial payment of the tax due. The opinion represents a fairly taxpayer-friendly application of Section 6672 (which is to say a fairly restrictive interpretation of what constitutes a "responsible person" under the statute) and would likely attract to the Claims Court a fair portion of the contested claims in this area.