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ABA Tax Section Report on the Economic Substance Doctrine

by Linda Beale

ABA Tax Section Report on the Economic Substance Doctrine
crossposted with Ataxingmatter

The ABA Tax Section put together a large working group to write a report on the newly codified economic substance provision–Download ABA Economic Substance. Comments on Notice 2010-62.

The working group was led by several people, including Michael Desmond, who just happened to be at Treasury during the Bush Administration.  (There are lots of people in private practice now, writing reports on government decisions, who were in government under Bush just a while ago.  Is that a good thing?  I suppose it has its pluses and minuses.  On the plus side, it ensures that there are always those in practice who understand how government works and where important decisions can get hung up or expedited.  ON the minus side, the very decisions that were put in place during a person’s tenure in government may be susceptible to persuasive lobbying (using that insider perspective) from those who worked on the provision in government and now comment on it on the outside.)

The practitioner community is generally concerned that the codification of the economic substance doctrine will mean that it will “chill” regular business transactions because of the uncertainty regarding its exact application.  So the report asks for clarification–just what are the transactions that are susceptible to the application of economic substance, what is a substantial purpose, what does it mean to have a potential for profit, how do we know when state tax provisions are related to federal tax provisions, and what, in fact, does “economic substance doctrine” mean.

While the desire for absolute clarity is understandable, I am not sure that it is a desire that the Treasury should attempt to satisfy.  One of the benefits of judicial doctrines, compared to very specific statutory anti-abuse provisions, is their flexibility.  Courts, in the context of particular cases, review the circumstances of a transaction and conclude that it lacks economic substance.  The doctrine has developed as part of the federal common law of tax, and it has gone through periods of being particularly useful in curbing super-aggressive tax avoidance shelters.

For people like me who were worried that codification of the doctrine could lead to its demise by narrowing its scope and defining away its power to adapt to unforeseen abusive pattersn (and to create enough uncertainty among tax practitioners to discourage the most aggressive tax return gambits), the ABA’s demand for “clarification” is therefore worrisome.  If we take Congress at its word, it expected the courts to continue applying the doctrine in the circumstances in which they applied the doctrine before codification.  Codification solves the problem of different tests for economic substance applied in different jurisdictions by settling on one test, but it leaves it to the courts’ careful case-by-case analysis to add more meat to the bones of the test.  This is as it should be.

Practitioners would nonetheless like an “angel” list of transactions to which the economic substance doctrine can’t apply.  Treasury has wisely refused, since the power of the doctrine is in looking beyond form to substance and recognizing that abusive transactions (shelters) are highly innovational within the confines of existing statutory provisions.  The creation of an angel list would be an invitation for creative tax genuises to manipulate code sections to create an abusive transaction out of the angel one.

Let’s be honest.  Many practitioners would also like to see the significant test for business purpose narrowed in scope.  Here too I disagree.  it is important for transactions that are honored in their form for tax purposes to have a significant purpose that is germane to the business and not conjured up solely to achieve favorable tax results.

While some guidance would be helpful, Treasury should be careful not to put the pliable economic substance doctrine into a straitjacket that limits its ability to police aggressive transactions.

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The other measure of income, GDI, shows faster growth and an oversized profit contribution

There are two measures of income: the spending side (Gross Domestic Product, or GDP) and the income side (Gross Domestic Income, GDI). I’d like to see what GDI is telling us about the Y/Y recovery, since it’s a better predictor of turning points, according to FRB economist Jeremy J. Nalewaik.

The chart illustrates the contribution to Y/Y GDI growth coming from each of the main income components. (Click to enlarge.)The series is deflated using the GDP deflator, since the BEA only releases the nominal numbers. All references to GDP and GDI below refer to the real series.

Observations I note:

1. The Y/Y growth rate of GDI surpassed that of GDP in Q2 2010, continuing into Q3 2010. In Q3 2010, GDI grew at a 3.6% annual clip, while GDP marked a lesser 3.2% rate. Don’t know what this means, exactly; but it could imply that the economy is expanding more rapidly than the GDP measure would suggest.

(more after the jump)

2. The Q3 2010 corporate profit contribution to annual income growth, 2.2%, is overwhelming that from wages and salary accruals (labor income), 0.73%. This oversized contribution is rather remarkable, given that domestic corporate profits are just 8% of GDI, while that of wages and salaries is 55%. This will probably even out, though, as history shows a more balanced contribution between profits and wages.

3. The chart illustrates the ‘stickiness’ of labor income. The corporate profit contribution turned negative in Q4 2006, while that of wages and accruals turned negative in Q3 2008. That’s a near 2-yr lag from profits to wages. Wages are recovering now; but there will be further quarters of weak wage growth relative to profits, as claims remain elevated above the 350k mark.

4. The contribution to GDI growth from net interest payments is in negative territory. Low rates are dragging this component.

5. Supplements to wages and salaries – government transfer payments like unemployment insurance, for example – contributed 0.3% to annual GDI growth in Q3 2010. Interesting thing about this, is that the average contribution spanning the 2000-2004 period, 0.5%, outweighs that during the 2005-2010 period, 0.14%. I say interesting because the labor decline was far deeper in this cycle compared to the previous cycle. (See Calculated Risk chart from 12.3.2010)

Overall, the GDI report implies that the economy may be improving more quickly than the GDP report suggests. There’s plenty of room for improvement in this picture, however, as the labor wages remain stuck in the mud with corporate profits strong.

Tomorrow we’ll see the Q4 2010 GDP report – consensus forecast is for 3.5% Q/Q SAAR.

Rebecca Wilder

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Children of Tragedy

Run75441 sends a note and this post: The Bell presents a good read at his blog giving a non-partisan perspective of the tragedy in Tucson AZ and how it may affect our future outlook:

Children of Tragedy
Which Face Will Be Our Face?
Pundits and politicians from both sides of the ideological divide were quick with partisan reactions to the tragic shooting last Saturday in Tucson Arizona. A man shot and critically wounded U.S. Representative Gabrielle Giffords and killed U.S. District Judge John Roll, along with five other people, during an informal town hall meeting by the Congresswoman.

Many liberals condemned right-wing rhetoric for inspiring the attack. Paul Krugman of the New York Times was among the most outspoken. “There isn’t any place [in a democracy] for eliminationist rhetoric, for suggestions that those on the other side of a debate must be removed from that debate by whatever means necessary . . . Where’s that toxic rhetoric coming from? Let’s not make a false pretense of balance – it’s coming, overwhelmingly, from the right.”


Jared Loughner (left), the Tucson
Arizona shooter, and Christina Green
(right), his youngest victim

For their part, conservatives furiously denied any political connections or motivations for the shooting. The Wall Street Journal editorial board maintained, “On all available evidence, [the shooter] is a mentally disturbed man who targeted Congresswoman Gabrielle Giffords and anyone near her in Tucson on Saturday because she was prominent and they were tragically accessible . . . Whatever confused political motives he expressed seem merely to be part of the maelstrom of his mental sickness.”

Conservatives pushed back at liberals, insisting the latter were disgusting in using a tragedy to promote their agenda. “I understand the desperation that Democrats must feel after taking a historic beating in the midterm elections . . . [but they] demonstrate precious little actual concern for America’s political well-being when they seize on any pretext, however flimsy, to call their political opponents accomplices to murder,” wrote University of Tennessee Law Professor Glenn Reynolds in a Journal op-ed piece.

The truth lies somewhere between these two biased viewpoints, as it so often does. Considerable examples of his writings gleamed from the Internet as well as evidence seized from the shooter’s PC and home suggests that Jared Loughner was a deeply disturbed young man. Especially since 2005, he had been concerning family, friends, and classmates with his erratic and sometime violent statements and behavior.

One former fellow student at Pima Community College described Loughner as “an emotional cripple or an emotional child . . . He lacked compassion, he lacked understanding and he lacked an ability to connect.” Another student said Loughner “didn’t have social intelligence” despite abundant academic intelligence.

A former high school friend posted on Twitter that the Loughner she knew was “left wing, quite liberal and oddly obsessed with the 2012 prophecy.” She noted that alcohol and drugs had left him ruined and ostracized.
Yet much of what Loughner posted and talked about in recent years had more of a right-wing flavor, even if he did not intend it as such. In particular, he was passionately distrustful of big government. He seemed to be a sucker for conspiracy theories and wild accusations. He labeled his planned attack on Giffords as an “assassination.”

So while it is disingenuous to suggest that Loughner’s motivations were primarily political, it is equally insincere to assert that he was completely unaware of or insulated from some of the sentiments and insinuations raised in current political debate. The anti-government rhetoric that may have helped reinforce Loughner’s twisted beliefs rests mostly with conservatives. This does not mean they intended to incite violence or even that it necessarily incited violence in Loughner.

Nonetheless, Loughner demonstrates to all of us the tragic consequences when passion overrides reason. He serves as a caution to politicians and pundits alike about the importance of restraint and non-inflammatory rhetoric in public discourse.

Ross Douthat of the New York Times sums it up best. “When our politicians and media loudmouths act like fools and zealots, they should be held responsible for being fools and zealots. They shouldn’t be held responsible for the darkness that always waits to swallow up the unstable and the lost.” However, E.J. Dionne of the Washington Post contributes an important counterpoint. “We must now insist with more force than ever that threats of violence no less than violence itself are antithetical to democracy.”

Some politicians expressed it well too. “An attack on one who serves is an attack on all who serve,” said House Speaker John Boehner. But my favorite comes from Republican Representative Trent Franks of Arizona. On NBC’s Meet the Press, he declared this tragedy “an attack not only on freedom and the country itself; it’s an attack on humanity.”

Among the things that obsessed Loughner was language and grammar. A frequent theme in his writings and rants is the question, “What is government if words have no meaning?” It is a good question, even if he clearly meant it rhetorically. Loughner was sure that government and just about everything else was meaningless. He may well have regarded his violence as just one more casual act in a random existence.

Our Constitution and the other laws of our land are words on paper. They would be nothing more than that but possess meaning because they are living words, lived each day by ordinary and extraordinary Americans. Their devotion gives our government its legitimacy to impose rules and defend rights.
I think of Giffords, a government official who placed herself in harm’s way because she believed in the importance of connecting with the people she represented. I think of Roll, killed on his way home from church because he wanted to stop and shake the hand of a fellow public servant and friend.
I think of Dorwin Stoddard, who died by throwing himself between his wife and a bullet. A pastor at Mountain Avenue Church of Christ, he died demonstrating the Christian ideal that no person can show greater love than by willingly laying down their life for another.

I think of the courageous men and women in the crowd who wrestled Loughner to the ground and grabbed his ammunition as he paused to reload. I think of equally courageous men and women in that same crowd who frantically sought to aid and comfort the dying and wounded.
I think of Christina Green, the nine year old girl killed when she attended a political event. Just elected to her elementary school’s student council, she wanted to see democracy in action. Born on the day of the September 11 attacks, she considered herself a symbol of hope for our nation.

I think of John Green, Christina’s father, who put aside a parent’s crushing grief long enough to utter an almost unbelievably brave assertion of citizenship. Interviewed on NBC’s Today Show, he avowed, “In a free society, we are going to be subjected to people like [Loughner]. I prefer this to the alternative.”

Those who believe words are more real, in some arcane way, than our actual lives are insane. Those who use words to stir up fear and manipulate the lives of others are the problem and the threat. Those who attempt to live the words we profess to hold as our ideals are the hope and the heroes.

The faces of Jared Loughner and Christina Green stare out at us. The first is an emotional child, stunted by his own demons and self-hatred. The second is a bright promise that will now never realize her potential. Both faces have a kind of innocence – one twisted, the other pure. They are the children of this tragedy.

The challenge for the rest of us lies in choosing which one will be the face of our democracy as we seek to grow beyond this moment. The words we choose to use and the meaning we choose to honor will directly influence what our government is in the future.

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Health Care thoughts: The Best Jobs in Health Care

Health Care: The Best Jobs in Health Care

Teaching seminars and advising college students headed for various health careers, I am often asked about the ‘best” health care careers. During a seminar many years ago I came up with a top five, and after some thought I think the list is still valid.

Draw any conclusions you like.

1. Health care transaction and regulatory lawyers
2. Health care consultants (all varieties)
3. Health care executives
4. Health care CPAs
5. Physical therapists

The worst job in health care – Director of Nurses for a nursing home.

(Note: I have been 2, 3,and 4 at various times)

Tom aka Rusty Rustbelt

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One Less Blog to Answer: No More "Girl Economist"

Between deadlines and strange website blockages, I missed this yesterday. Via Steve Randy Waldman (whose “Interfludity” is blocked) and Mark Thoma (whose isn’t) comes Really Bad News:

To all Maxine Udall Girl Economist Readers: It is with great sadness that we bring you the news that Dr. Alison Snow Jones, aka Maxine Udall, Girl Economist, passed away suddenly on Monday, January 17, 2011. “What Price Microfinance” was her last post.

She was in her early- to mid-50s, estimating by her c.v..

Go read what you missed, and what we will all miss going forward. UPDATE: For instance, this post, which is both (1) the only valuable thing ever to be sourced to treating a David Brooks column as if it were rational and (2) a much more generous reflection on economics that the data currently appears to warrant (until you realise the math/model that will be required to reach the goal).

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Tax Rates v. Real GDP Growth Rates, a Scatter Plot

by Mike Kimel

Tax Rates v. Real GDP Growth Rates, a Scatter PlotCross posted at the Presimetrics blog.

This post was submitted by Kaleberg.

In this post, I will look at the relationship between top marginal income tax rates and real GDP growth using a scatter plot.

I am inordinately fond of scatter plots. The nice thing about a scatter plot is that you can present a lot of data in a fairly small space, so rather than just comparing tax rates at time period t against real GDP growth rates from period t to t+1, I can also show real GDP growth rates from period t to t+2, from t to t+3, and from t to t+4. (I.e., the scatter plot shows tax rates at any given time, and the growth rates over one year, two years, three years, and four years.)

The vertical axis is the GDP growth rate, the geometric average for multiple years. The horizontal average is the top marginal tax rate. The one year comparison is shown in dark blue, and each subsequent year is shown with a paler color and a smaller marker.

Figure 1

Data is for the period from 1929 to 2009 (i.e., all the years available from the BEA.)

Lower top marginal tax rates seem to limit economic growth with a rate of about 60% seeming to divide the restricted growth phase from the unrestricted growth phase. There might be a little falloff when the tax rate passes 90%, or there might not. There are lackluster growth rates associated with higher and lower top marginal tax rates. Mediocre growth is not all that hard to achieve. Finally, if high top marginal tax rates had a multi-year effect, we’d see a distinctive pattern in paler blue in this chart, but we don’t. The paler blue, longer term comparisons seem bounded by the single year effect.

The data used in this scatterplot is the same data used to build the bar chart in this this post.

Note from Mike Kimel – as always, if you want the spreadsheet (I have a copy of Kaleberg’s work), send me an e-mail. I’m at my first name dot my last name at, and my first name is “mike.” My last name has only one “m.”

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If Troll Patrol was Just This Easy at AB

Norwegian boy fends off wolves with Creed song

He was listening to “Overcome” by Creed, an arguably Christian rock band, and apparently, the wolves were not fans.

(Initial reports indicated Walter shooed the wolves away with a Megadeth song,)

Ah yes the old Creed vs Megadeath conundrum. Throw in some Black Sabbath and we could have a flame war to remember!

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Revisiting the Ryan Roadmap: Tax Freedom for Billionaires

The Ryan Roadmap was introduced and then dropped into obscurity as Republicans simply ignored it and appararantly its author, the House Budget Committee Ranking Member Paul Ryan. Well that was then, today that is CHAIRMAN Paul Ryan and the official respondee to the SOTU plus the man who has unilateral control over budget levels this year. Not exactly ‘Paul Who?’ any more. So in the interest of public education let’s take a little trip on Paul’s highway.

A Roadmap for America’s Future: from and specifically its ‘Tax Reform’ page.

Provides individual income tax payers a choice of how to pay their taxes – through existing law, or through a highly simplified code that fits on a postcard with just two rates and virtually no special tax deductions, credits, or exclusions (except the health care tax credit).
Simplifies tax rates to 10 percent on income up to $100,000 for joint filers, and $50,000 for single filers; and 25 percent on taxable income above these amounts. Also includes a generous standard deduction and personal exemption (totaling $39,000 for a family of four).
Eliminates the alternative minimum tax [AMT].
Promotes saving by eliminating taxes on interest, capital gains, and dividends; also eliminates the death tax.
Replaces the corporate income tax – currently the second highest in the industrialized world – with a border-adjustable business consumption tax of 8.5 percent. This new rate is roughly half that of the rest of the industrialized world.

Billionaires don’t become such by paying themselves large salaries, it taking 100 years to earn your first billion even with a salary of $10 million a year, instead they gain that wealth by accumulating capital and taking gains on it in the form of actual capital gains as defined and interest and dividends. None of which are taxable under the roadmap. Nor are any future disbursements from their grandchildren’s Trust Funds. Tax Freedom FOREVER! Hurray!! If you chose your grandparents right. (Me? Not so much).

But gosh wouldn’t exempting all returns on capital from taxation blow a hole in the budget? I meant the Right spends endless time complaining that the lower 40% don’t pay taxes. Au contraire mon frere. Per CBO this is all free!! At least once they adopted the scoring rules provided them by Ryan’s staff.

CBO: Ryan Roadmap Letter

The proposal would make significant changes to the tax system. However, as specified by your staff, for this analysis total federal tax revenues are assumed to equal those under CBO’s alternative fiscal scenario (which is one interpretation of what it would mean to continue current fiscal policy) until they reach 19 percent of gross domestic product (GDP) in 2030, and to remain at that share of GDP thereafter.

See how easy that is!! Just tell CBO to not score the cost of your tax cuts and BINGO! Balanced budget!!! Well in year 50, but still.

This is the man official Washington is swooning over as being “serious”. Sorry folks Ryan and his Roadmap are frauds, more like the Tour Guide and Map to VoodooLand than anything.

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