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.

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.

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.

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.

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.

Outsider

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?

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.

Update

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

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.

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.

Advertisement for Myself (and Others)

I will be lecturing at the ALI-ABA course Partnerships, LLCs, and LLPs to be held in Charleston on June 2-4. This course coincides with the 17-day Spoleto Festival U.S.A. 2005 in Charleston, considered by many to be the world’s most comprehensive arts festival.

Anyone interested in attending can find more information here.

Fools and Knaves, Wall Street Journal Edition

I have developed a simple rule of thumb in analysing conservative policy pronouncements, the Knaves and Fools Rule. The rule is simple: Conservative policy pronouncements are made by knaves and then the pronouncements are believed and repeated by fools. It is with some sadness that I have to report that someone who is no fool, Paul Caron, got fooled by the the knaves at the Wall Street Journal.

At his justifiably well-regarded TaxProf Blog, he notes what he feels is a "interesting editorial" in today's WSJ. The editorial is available online only to subscribers, but it's thesis is that "[e]ven the most ardent class warriors have no choice but to concede that the U.S. income tax code is steeply progressive -- that is, that it soaks the rich." The article goes on to quote from a study that purports to support this conclusion. Among other things, the study shows that since 1979, the proportion of the federal income tax burden borne by the wealthiest Americans has grown. (As is shown below, the "other things" that were reported in the study and which were critical to the ultimate conclusion reached by the study's authors were conveniently omitted in the WSJ editorial.)

Caron pulls a table from the study which shows that the percentage of total taxes paid by the really wealthy and the really, really wealthy increased dramatically from 1979 to 1999, and declined thereafter. He is fooled into believing that the chart illustrates that there was a dramatic increase in progressivity in the tax system in the 1979 to 1999 period and then a slight decrease thereafter. Had Caron thought about this proposition for a moment, he would have realized that the chart did not support either his or the WSJ's conclusions. Simply because X pays a higher percentage of all taxes in 1999 than he did in 1979 does not mean that the tax structure has become more progressive with respect to X. It may mean that X is making a whole lot more money in 1999 than he did in 1979. In fact, this is precisely what the study relied on by the WSJ reports.

The study, authored by Michael Strudler and Tom Petska of the IRS and Ryan Petska of Ernst and Young, can be found here. Among the points made in the study were the following:

• Between 1979 and 2002, the threshold for the top 0.1 percent grew from $321,679 for 1979 to $710,661 for 2002, an increase of 121 percent. Similarly, the threshold for taxpayers in the 1-percent group rose from $109,751 for 1979 to $175,618 for 2002, an increase of just over 60 percent. However, the thresholds for each lower percentile class show smaller increases in the period; the top 20-percentile threshold increased only 5.6 percent, and the 40-percent and all lower thresholds declined. In other words, over the period studied, the rich got a whole lot richer than everyone else and began to put real distance between themselves and the middle class.


• The share of income accounted for by the top 1 percent of the income distribution has climbed steadily from a low of 9.58 percent (3.28 for the top 0.1 percent) for 1979 to a high of 21.55 (10.49 for the top 0.1 percent) for 2000. To put it another way, the rich have become real hogs with respect to the portion of the total economic pie they consume.

What is the conclusion of the paper with respect to the increase or decrease of progressivity in the federal tax system? Rather than give you my slant on this, I will just quote the paper's conclusions verbatim:

So what does this all mean? First, the high marginal tax rates prior to 1982 appear to have had a significant redistributive effect. But, beginning with the tax rate reductions for 1982, this redistributive effect began to decline up to the period immediately prior to TRA 1986. Although TRA became effective for 1987, a surge in late 1986 capital gains realizations (to take advantage of the 60-percent long-term capital gains exclusion) effectively lowered the average tax rate for the highest income groups, thereby lessening the redistributive effect.

For the post-TRA period, the redistributive effect was relatively low, and it did not begin to increase until the initiation of the 39.6-percent tax bracket for 1993. But since 1997, with continuation of the 39.6-percent rate but with a lowering of the maximum tax rate on capital gains, the redistributive effect again declined. It appears that the new tax laws will continue this trend. Analysis of panel data shows that these trends are not quite as great as seen by looking at annual cross-section data, but the trends cited above are still apparent.

Contrary to the WSJ's conclusion, overall, the various changes in the tax code since 1982 have made the federal tax system less, not more, progressive. That is, the rich are paying a lower portion of the overall tax burden relative to their income now then they did in 1982 and the system's progressivity is headed for further declines.

The Moral of the Story: Only fools rely on "facts" bruited about by knaves.

Update

TaxProf links to the posting above and also to a previous posting of his that discussed an article, The Matthew Effect and Federal Taxation, 45 B.C. L. Rev. 993 (2004), by Martin J. McMahon, Jr., of the University of Florida, that illustrates that, over the last 25 years, the rich really are getting richer.

I would be remiss if I did not note that Brendan Nyhan was the first to call the WSJ's lie. Kevin Drum also covered the story. His posting includes a nifty illustrated chart.

One question: The WSJ editorial page lead the pack seeking to sack Dan Rather and other CBS editorial personnel when they relied on material they later discovered was false. Shouldn't the unnamed writer and his or her editor(s) responsible for yesterday's piece be cashiered? After all, the article plainly misrepresented (that is, lied about) the study that it discussed.

Just asking.

Timing Is Everything

11 U.S.C. Section 523(a)(1)(A) excepts from discharge under 11 U.S.C. Section 727 any tax liability that would be classified as a priority tax under 11 U.S.C. section 507(a)(8). Section 507(a)(8) states that a priority tax claim involves any tax liability for a tax year in which the tax return, "including extensions" is due within three years before the filing of the bankruptcy petition. The case of Dippel v. U.S, (Bankruptcy Ct. S.D.Fla., March 23, 2005), demonstrates that the early bird does not necessarily get the worm.

In 2001, the Dippels filed for an automatic extension to file their income tax return for 2000, extending the filing deadline within which they could file a timely return to August 15, 2001. They actually filed a return on April 22, 2001, but the Service marked it as being filed on or before April 15, 2001. They filed a Chapter 7 bankruptcy on June 15, 2004, more than 3 years after their 2000 return was filed, but less that 3 years after the due date, with extensions, for the filing of the return.

The court rejected the request for discharge, noting the unanimity of other courts that taxpayers cannot nullify their previously filed requests for extension. One cannot tell from the facts recited in the opinion whether the taxpayers had any ability to defer their bankruptcy filing by 61 days, but if they could have, they clearly should have.

I Stole this Article

Larry Ribstein makes a serious point in his post, Steal this Article, namely that he has "now awakened to the beauties of free dissemination of . . . academic writings." He refers explicitly to his articles, but I understand him to be in favor of free dissemination of a wide variety of academic writings.

While I strongly agree with Larry's position (some time ago I commented on the miracle of the freely available Public Library of Science jounals), I might not have posted about Larry's posting except for the fact that he provides a link to a free download of Abbie Hoffman's Steal This Book. Like Larry, I may be middle-aged (but, unlike Larry, not old), but there's still a little bit of Yippie left in me and it might be quite some time before I can work in a reference to Abbie on this blog, let alone link to a free download of his book.

Power to the People Larry.

Bad Idea for a Good Cause

Jane Galt suggests that one way to avoid the complications of the estate tax is to (i) have all inherited property receive a basis of $0.00, except for (ii) cash that is inherited, which would be taxed as income. Mark Kleiman thinks that this is a good idea. It's not.

I don't know whether there's been an economic analysis produced as to where the tax burden created by such a provision would fall, but I am aware that there have been analyses done with respect to proposals to do away with the estate tax, but which would also do away with the basis step-up rule. (That is, the basis of assets that are inherited are "stepped-up" to their fair market value as of the date of death.) Such a change would be less radical than the rule that Galt has proposed. The analyses that I'm aware of (I'll try to link to some this evening) show that net effect of the repeal of both the estate tax and the basis step-up rule would be to shift the burden of a tax triggered due to the death of the owner of property from families who are in the high end of familial wealth to those who are less wealthy. The reason is that only the very wealthy pay any estate tax when, as will be the case in a few years, the lifetime credit equivalency is $3M, whereas a good number of people, even people of modest means, receive some sort of inheritance. Almost all of these people would be paying additional tax if the basis step-up rule is eliminated.

My guess is that the Galt plan would, effectively, accentuate this downward shift in where the tax burden lands. For instance, in the 2 minutes since I read Galt's posting, I've already thought of a number of ways to minimize the tax bite where the asset is a family business. (I won't share my ideas with you---I consider them proprietary.) In other cases, families with significant wealth could defer the income tax for long periods of time by, for instance, borrowing against the assets. Families with less wealth who need to tap into inherited assets to buy homes, pay for college educations, etc., could not, since they will likely have to sell assets rather than merely borrow against them.

Like I said, a bad idea, unless you want to shift taxes from the wealthy to those less wealthy.

Update

In a research paper published in 2000, The Distributional Burden of Taxing Estates and Unrealized Capital Gains a the Time of Death, James M. Poterba and Scott Weisbenner conclude that:

[A]mong those with small estates ($1 million or less), taxing capital gains at death would collect more revenue than the current estate tax from roughly half of the decedents. For those with larger estates, replacing the estate tax with a tax on unrealized gains at death would result in a substantial reduction in total tax payments.

While the figures used in the report are from 1998, there is no reason to believe that the conclusion does not continue to apply today. In fact, since the unified credit amount has been dramatically increased, limiting the estate tax to taxable estates of over $4M, one would expect that the results today would be even more skewed in favor of the wealthy.

For an excellent primer on various policy questions pertaining to the estate tax, one should take a look at Estate and Gift Taxes: Economic Issues, by Jane G. Gravelle and Steven Maguire for the Congressional Research Service. They discuss a good number of the issues surrounding the estate tax, including how the tax works, whether the tax causes individuals to prematurely sell family businesses and farms (it doesn't, since "one can conclude that most farmers and business owners are unlikely to encounter estate tax liability"), and the claim that the costs of administering the tax eat up the revenue generated (they don't--the costs of administration are approximately 6-9% of the revenues generated).

Peanuts and Cracker Jacks

Via A Taxing Blog, I have come across the important academic paper, Identifying Moral Hazard: A Natural Experiment in Major League Baseball by Professors John Charles Bradbury and Douglas Drinen of the University of the South. The abstract of article is as follows:

In baseball, allowing a designated hitter (DH) to bat for the pitcher creates the potential for moral hazard among pitchers, who may then hit more batters without the fear of retaliation by the opposing team. The use of the DH in only one of Major League Baseball's two leagues provides a natural experiment to test for the existence moral hazard in a controlled setting. We develop a new micro-level dataset of individual plate appearances, which allows us to control for detailed cost-benefit attributes that affect the decision calculus of the pitcher. We find that moral hazard explains 60 to 80 percent of the difference in hit batsmen between leagues and find evidence of direct retaliation against plunking pitchers.

In other words, the DH rule not only does violence to the purity of the game, it also promotes violence on the field by removing disincentives to throwing pitches at batters.

The publication of the article raises once more the question of when that famous scholarly work, The Common Law Origins of the Infield Fly Rule, 123 U. Pa. L. Rev. 1474 (1975), will appear on the web.

Waiting for the Plumber, or Somebody Like Him

I am strongly in favor of the publication of greater numbers of judicial opinions. For instance, I see no reason that the Court of Special Appeals cannot publish all of its opinions on the web in the same way that the Fourth Circuit does, with opinions that the court feels should not constitute binding precedent being denominated as "unpublished.

I am also in favor of specialized courts to deal with serious business disputes. I believe that such specialized courts will lead to swifter and more certain resolution of business disputes, in the long run reducing the economic friction caused by disputes. A recent opinion by the Circuit Court for Baltimore City disappoints on both fronts.

The Circuit Court for Baltimore City publishes, on the web, a number of its decisions. The website is here. That's good. It allows businesses and their counsel insight into how nisi prius courts deal with business disputes and, theoretically at least, encourages settlements by reducing uncertainty. However, the opinion, in the case of Carnegie International Corp. v. Grant Thornton, LLP, is a disaster as a roadmap. It also reveals structural weaknesses in what, in Maryland, are termed Business and Technology Cases, that is, cases specially singled out for special treatment because of the complex business issues they present.

Carnegie is a 63 page opinion. (I read it while waiting for the sewer clearance people from Baltimore County to arrive to clear a sewer blockage at my home. It was a long wait. It is a long opinion.) One has to go at least 7 pages into the opinion to find what may be a concise statement as to the essential claims made by the plaintiff. Even then, it is not clear to me that this description applies to all of the claims, but that appears to be the case. The gist of Carnegie's claims seems to be that Grant Thornton caused Carnegie damage by taking actions or failing to act with the result that the trading of Carnegie stock on the American Stock Exchange was halted. The opinion, which probably reaches the correct legal result, fails as a cogent discussion of the case and the legal issues because it doesn't start with the type of opening that all good essays start with ("Once upon a time . . . .") and doesn't tell a story. As I tell my students, anyone who can tell a good dirty joke, and by this I mean a real joke, not merely a one-liner, can probably write a good brief, memorandum, or contract. Remember, a good joke starts with a factual premise, clearly stated ("A priest, a minister, and a rabbi walk into a bar . . . .") and moves logically forward from there.

What is even more disturbing is that the case reveals that the business and technology track may be certain, but it is hardly swift. The case was filed in May of 2000. The bench trial in the case began on November 5, 2001. It continued through April 4, 2003, and subsequent testimony was presented by depositions. Both parties submitted proposed findings of fact and conclusions of law on June 13, 2003. The opinion was not delivered until April 13, 2005, almost five years after the case was filed and almost two years after the Court had all of the evidence before it. By comparison, the Baltimore County sewer service acted with great dispatch.

Finally, the opinion fails to mention, even in a footnote, the bizarre activities of some of the players in the case, involving cults, alleged aliens, sexual slavery, and attempted contract murders. (If you want the salacious details, see here.) If you have to read a 62 page opinion, it ought to at least be well-written and have something to hold the reader's attention.

A Living Will for Our Times

Lawyers are constantly on the prowl for forms that they can incorporate into their practices. Via The Law Librarian Blog, I've found a great estate planning form designed for use in Florida which, with some tweaking, will probably work in Maryland as well. It can be found here.