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The New Black Gold–will tax boondoggles never cease?

The tax code seems to foster one boondoggle after another. The ones getting my attention this week are the alternative fuel tax credits enacted in the 2005 highway bill. This was intended as a credit to encourage the development of alternative fuels for vehicles to cut our reliance on global warming-causing fossil fuels. See Natural Gas Vehicles for America, “Regulatory Summary: Alternative Fuel Credit-IRS Notice 2006-92″ (Sept. 30, 2006) (discussing the alternative fuel credit of 50 cents a gallon under section 11113 of the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users). But it was modified in 2007 , and as a result the paper mills discovered a credit for a process the industry had been using since the 1930s –it just had to add (in some cases) enough diesel fuel to qualify.

The paper industry essentially cooks wood pulp to turn it into paper, and a byproduct of that process is a dark sludge called “black liquor”. The companies use the black liquor as a fuel to generate steam for electricity. And by adding just a small amount of real diesel fuel to the mix, they qualify for the alternative fuel mixture tax credit. And, not surprisingly, they love the “extra cash flow and income.” See Sharon, Paper Industry: Don’t Kill Fuel Credit, NPR (June 6, 2009) (reporting a $10 million savings from the credit in the past year for one company).

Sen. Bingaman suggested that the paper industries discovery of this black gold hasn’t got much to do with the development of alternative fuels.

The alternative fuel mixture credit was originally intended to encourage
the development and use of alternative fuels as a way to decrease global warming
pollution. But by adding fossil fuel to their black liquor mix, Bingaman
says, paper companies are rewarded 50 cents a gallon for doing the
opposite. Id.

Bingaman wasn’t the only critic. Canada joined with other countries to demand that the US end the paper industry subsidy, threatening a trade action because of the way the credit had distorted global pulp markets. Schott’s Vocab: Black Liquor, NY Times, June 11, 2009.

Some companies had in fact used diesel all along in their effort to burn their own byproduct to produce energy, while others had changed the fuel blend to benefit from the tax credit. Companies claimed that they are doing exactly what the law intended. The Natural Resources Defense Council disagreed, calling it a “travesty” because it has meant reduced reliance on biomass fuels and increased consumption of fossil fuels “in order to rip off the American taxpayer.” Lawmakers May Limt Paper Mills’ Windfall, NY Times (Apr. 17, 2009).

This particular credit is supposed to sunset at the end of 2009, but companies wanted it continued. Let’s face it, few corporations that have found a piece of corporate welfare in the Code are interested at all in seeing that “entitlement” turned off. The amounts are significant–for International Paper, $71.6 million for just one month from mid-November to mid-December last year. See Papermakers Dig Deep in Highway Bill to Hit Gold, Washington Post, Mar. 28, 2009. Not surprisingly, representatives of pulp mill states seem to think the credit is great–Republican Olympia Snowe called it a “critical lifeline to thousands of paper mills”. Snowe, What the Black Liquor Tax Credit Means for Maine, Apr. 25, 2009.

The Obama administration wanted to stop the billions flowing under this provision to the paper industry, we were told in May. See Obama Seeks to Halt Alternative Fuel Tax Credit for Paper Industry, Washington Post, May 9, 2006. At $6 billion a year, eliminating the credit–even retroactively for 2009 (it expires in December, unless extended)– for the paper industry could generate some revenue and at least some in Congress were considering just that. See Black Liquor Tax Credits: A Closing Loophole for the Pulp & Paper Industries, Accuval, Sept. 2009. Of course, the companies lobbied for maintaining it through 2009 and in fact for extending it for at least three years. See Appleton Papers et al, Comments to the Senate Finance Committee on the Alternative Fuel Mixture Tax Credit (July 9, 2009).

Now, it turns out that there is another biofuel tax credit that already extends through 2013, passed as part of the 2008 Farm Bill. See Voegele, IRS: Cellulosic biofuels are eligible for tax credit, BioMass Magazine (Dec. 29, 2008) (describing Notice 2008-110, which describes the tax credits under sections 40A, 6426, and 6427(e) for biodiesel and cellulosic biofuels, enacted in the 2008 Farm Bill for the years 2010-2013). See Committee on Finance, Finance Committee Leaders Detail Elements of Farm Bill Tax Package, page 3, Apr. 14, 2008.

Black Liquor is certainly cellulosic, so the mills may have something even better to replace the expiring black liquor alternative fuels tax credit–instead of 50 cents a gallon, they may qualify for the cellulosic biofuel credit amounting to $1.01 a gallon! Let’s see. That’d apparently mean a subsidy double the current one invested in “incentivizing” paper mills into doing what they’ve already been doing since 1930–converting wood waste into a source of energy to power the mills. See Donville, U.S. Paper Makers’ Black-Liquor Tax Break May Reach $25 Billion, Bloomburg.com (Oct. 15, 2009) (quoting Mark Connelly that we should “Think of this as a potential black-liquor II” and Marty Sullivan as forecasting “$25 billion in tax reductions for pulp producers claiming the cellulosic biofuel tax credit over the next three years”).

This credit for the paper industry is of slightly smaller magnitude than the bailout we gave the auto industry. In both cases, the argument is that these industries employ many who would otherwise lose their jobs, and who but the government will be willing to help them through these extraordinarily tough times. Yet both industries produce a product that we ought to learn to do without–the gas guzzlers that Detroit was producing pollute the air, require the destruction of vast land for roads, and use enormous amounts of energy in the process, while pulp mills chew up world forests at a frightening rate producing tons of waste that must be absorbed.

I wish it were as easy to get Congress to increase the taxes owed by the superrich as it is to get them to add boondoggles for one industry or another in the form of a tax break in the tax code. I want to see alternative energy succeed, but I’m not sure these tax credits are targeted sufficiently at the new technologies that we should be encouraging.

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Wyden’s Proposal for taxing oil and gas speculators

Ron Wyden, Democratic Senator from Oregon who serves on the Senate Finance Committee and the Energy Committee, is generally considered a liberal, though with a mixed bag of positions that hardly qualify on all grounds. He is against the estate tax and favors lowering rates of capital gains taxes, neither of which makes sense, from my perspective, in an economy already tilted to favor capital (and hence those in the upper distributions) and in need of revenue. His positions on the environment have been fairly consistently progressive. Back in 2004, for example, he worked on legislation to “get tougher” on responses to oil spills and get kinder in expediting loans to people impacted by those spills. See this press release. He has supported the US addressing CO2 emissions even if the big economies of China and India don’t (S. Con. Res. 70, May 15, 2008).

So what happens when you put tax policy (where I’m not terribly impressed with many of his positions) together with environmental policy (where he seems to have a fairly decent record)?

Today, Wyden introduced a bill (S. 1588) that deals with both of these issues. It would end a tax break currently enjoyed by speculators who trade in oil and gas. They’d have to pay tax at the ordinary income rates, rather than getting the preferential capital gains rates (o% for the first two income brackets, then 15%). This would be achieved by treating the gains as short-term capital gains (or losses) even if they would be treated as long-term under other provisions. Gains in trading by tax-exempt investors–e.g., Harvard’s endowment and similar funds– would be taxed as unrelated business income.

What’s the rationale? “To amend the Internal Revenue Code of 1986 to provide the same tax treatment for both commercial and non-commercial investors in oil and natural gas and related commodities, and for other purposes.” The first section has a short title that perhaps reveals more–it is the “Stop Tax-breaks for Oil Profiteering Act” (STOP Act). The bill also calls for a study of commodities exchanges and the effect of tax policy on the demand and price of commodities, and particularly of oil and gas.

I’m no expert in this area, but this sounds at first impression like a good idea. Wyden’s point is that those who use such fuels in their businesses have to purchase those commodities and treat any profits on related trading as ordinary. But speculators pay lower capital gains rates on trading profits, which may well mean that their trading distorts the market and raises prices.

Of course, I’ve long argued for eliminating the capital gains preference altogether, either through repeal of the provision in the regular tax or adding it as an adjustment in the alternative minimum tax. While I’d rather there be a wholesale change–to remove all the characterization games that taxpayers play and to help move the tax system towards a fairer one that does not give such inordinate preference to owners of capital over workers, these commodities trades may be an appropriate target, especially given their likely impact on pricing in an era when we can expect increasing oil and gas scarcity.

Any thoughts?

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Kornhauser’s Tax Literacy Project–about time

edited 072909 to correct link for giving online, by Linda Beale

One of my big gripes (in case you haven’t noticed) is the ease with which ordinary Americans can be fooled about tax issues by organizations, often ones with greedy purposes of furthering their own interests in lower taxes for themselves, that publish misleading or downright untruthful information and just keep repeating it. This has been a special problem with estate taxes, which hit only the very wealthiest amongst us and for a relatively small amount even for the large estates. It is also true of income taxes in general, the way flat taxes would work, the rationales for the corporate tax and many other key tax policies. Lobbyists frame the issues with inflammatory language, and most are too unknowing about the way tax really works to recognize the ruse for what it is.

Here are two of my pet peeves. (Many tax practitioners–and lots of tax academics–disagree with me on these.) Some of the worst phrases that have furthered the cause of cutting taxes for the wealthy so that the majority of Americans can either pay higher taxes themselves or do without the kinds of things that governments, not private enterprises, do best are “death taxes” and “double taxation” .

Much of the estate that is taxed when a decendent passes it along to his heirs as an unearned windfall has never been taxed at all during the decedent’s lifetime, in the case of wealthy people with mostly financial assets. If there is not a good-sized bite out of the estate upon the transfer to beneficiaries, there’ll be very little contribution to taxes from an agglomeration of wealth that has benefited enormously from the US legal system. And the heirs won’t have any taxes to pay either–they’ll just keep holding or will have a stepped up basis when they sell. All that is is a system for perpetuating or creating oligarchy–letting the wealthy become a ruling class with all the money and all the power without contributing anything much to help pay for the system that made all the wealth possible in the first place.

Similarly, the phrase “double taxation” is used to make people think that taxing corporations is unfair. But the decision about whether we tax entities or not is a reasonable one for societies to make. We made it a long time ago–deciding that we should treat corporations as taxpayers and thst we should tax capitalist owners of corporations on the income they are paid out of their corporate ownership as well. It is one of the most progressive parts of the federal income tax when it works, and it makes a lot of sense from a democratic egalitarianism perspective. Corporations can horde money and have enormous power because of their ability to lobby for their own benefit. Look at the way Big Pharm and Big Insurance has gotten Max Baucus in their pocket–putting money in his, and getting out of that a watered down health bill that doesn’t do half of what we should be doing to move towards a single payer, single provider system like the most advanced countries already have. The presupposition behind the term “double tax” is that you are overtaxing and that you are taxing somebody that shouldn’t be taxed. Yet corporations get to deduct salaries and purchases paid for with their own stock, which doesn’t cost them a thing to issue. Corporations get basis in property transferred to them by shareholders in exchange for issues of corporate stock, even though that stock does not represent an after-tax investment by the corporation. So the taxable income of a typical corporation is generally much less than the corporation’s actual economic income, and in addition to these provisions that are basic to the way the corporate tax is set up there are lots of provisions for reducing corporate tax–too fast depreciation, deferral of income through matching rules coming from court opinions where judges have been unduly influenced by financial accounting (the seventh circuit, in particular), depletion allowances and myriad other tax expenditure items favoring corporations, etc. Since Reagan, there has been a huge push by the same economic thinkers that brought us our current Great Recession to undo the US classical corporate tax system. It’s really a push for giving more money back to the wealthy and cutting the size of government. (Of course, the push for lower corporate taxes, more uneconomic credits like the R&D credit, etc., and the push for zero taxation of corporate dividends have been coordinated and have the same effect of huge reductions in taxes on the wealthy.) But it’s all argued in the name of economic efficiency–a theory without basis in reality that is probably more to blame for the greed that dominates today’s society and the consolidation of huge megafirms–Big Pharm, Big Oil, Big Banks, Big multinationals in general–than anything else. And strangely, no one makes the same “horrid double tax” arguments about the maid being taxed on her salary paid out of already-taxed compensation income of her lawyer-employer…

Of course, even for those who don’t pay much attention to the various organizations that are peddling particular views of tax issues and haven’t been particularly swayed by the push for repeal of the”death tax” or repeal of “double taxation”, there is a huge gap in information that isn’t filled in by the media. Most schools, for example, don’t teach much of anything about the tax system in the basic civics course. Most students don’t take a finance course in college, much less a course that teaches the basics of tax law. In fact, most law schools don’t even require that their graduates have a basic course in federal income tax law before graduating. (That is a major problem, I think, since almost every legal issue has tax consequences, one way or another, that a competent attorney should be aware of.) As a result, we are frighteningly ignorant, as a society, about how tax works, why it works that way, and what other possibilities there are. And as a consequence of that ignorance, it is all too easy for citizens to be in the dark about the consequences of tax legislation under discussions, for lobbyists to influence members of Congress to vote in their favor on bills (the public won’t know the difference), and for members of Congress to fail to fully inform their constituents about the tax issues they are voting on (or even, in far too many cases, for the members of Congress to understand, as when a certain person from Colorado supported windfalls in the agricultural bill based on his apparent failure to understand the difference between gross income (revenues without business or other deductions) and adjusted gross income (revenues with business deductions taken into account)).

So I’m glad to see Marjorie Kornhauser’s project take off. Maybe others won’t agree with me on these pet peeves, but if we have better educated citizens who have more basic knowledge about taxes and how they work, it won’t be so easy to bamboozle them into voting against their interest to support tax cuts for the wealthy and service cuts for everybody else while the boondoggles for the big corporations just keep pouring out (like an agreement that the government can’t use its bargaining power to get cheaper drugs, or that Big Pharm can prevent generics being sold for 12 years and other crap that is getting put into the “health reform” bill that is becoming, like so much else these days, a corporate giveaway).

What’s her project? It’s called The Tax Literacy Project–“a non-partisan effort to informally educate the public about taxes through popular methods such as web-based games and other internet activities.

Want to help? Donations are being accepted. What follows is the appeal, direct from Kornhauser and the ASU Foundation.

Money from Taxes Helps Every Person Every Day!

But polls show most of us do not understand anything about our taxes.

Why should we bother learning about taxes? Because:

Tax ignorance costs each of us money. Many of us pay more tax than we actually owe.

Because tax ignorance makes it hard to discuss and enact sound tax policies, we are not able to raise money in the fairest and most efficient manner possible.

Why do we need taxes?

Taxes support democracy. They fund government services and goods such as court systems and national defense that protect your life, your property, and your constitutional rights.

Taxes support economic growth. Governments use taxes to encourage economic growth in numerous ways such as maintaining a stable currency, enacting and enforcing laws that protect both workers and employers (their lives and proeprty), and helping to build and maintain large and dependable energy, transportation and communication systems.

Taxes support your daily quality of life. They help you and your family buy a house, breathe clean air, have safe food and drugs, travel safely and efficiently on highways, trains and planes. Taxes help pay for your health care (in the form of tax benefits or direct care) and they pay to educate you and your family. Taxes help you at work (e.g., enforce contracts, provide a safe workplace) and help you at play (e.g., national parks).

Become a part of a solution to the problem of tax ignorance by contributing to the Tax Literacy Project.

What is the Tax Literacy Project?

It is a non-partisan effort to informally educate the public about taxes through popular methods such as web-based games and other internet activities.

Can you support the Tax Literacy Project regardless of your political outlook?

Yes, the Project’s only pupose is to help provide information about tax, not to support any particular type or amount of taxes. No matter what kind of government people want, that government will cost money. Americans must understand how that money can be fairly and efficiently raised.

How can you make a charitable contribution?

Make your donation payable to the Tax Literacy Fund at https://secure.asufoundation.org/giving/online-gift.asp?fid=418 (no appeal code necessary) or Make your check payable to the ASU Foundation and mail to the Sandra Day O’Connor College of Law, Arizona State University, PO Box 877906, Tempe, AZ 85287-7906. Please write Tax Literacy Fund (3000 4788) in the memo line of your check. Thank you in advance for your support.

For more information or to become involved–

Please contact the project director: Marjorie E. Kornhauser, Professor of Law, Sandra Day O’Connor College of Law, Arizona State University, Marjorie.kornhauser@asu.edu, 480.965.0396.

All funds will be deposited with the ASU Foundation, a separate non-profit organization that exists to support ASU. YOur payment may be considered a charitable contribution. Please consult your tax advisor regarding the deductibility of charitable contributions.

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by Linda Beale

This is one of those weeks when almost everything has a tax angle. Let’s survey.

Michael Jackson’s funeral

Should taxpayers have to foot the bill for the extra security surrounding celebrity memorial services? Does an estate get to deduct the costs of gala receptions connected with a memorial as part of the funeral?

International relations and UBS

The Swiss have announced that they may seize the 52,000 account records that UBS holds in Switzerland for what are likely many American tax cheats if the federal court in Florida orders the bank to turn them over in response to the government summons. I’ve already written about that on A Taxing Matter, here. This is a game of chicken, where either the US or UBS/Swizterland will blink. UBS has substantial assets in this country in connection with its banking license here. The US has jurisdiction over UBS for various reasons and UBS has already admitted to criminal violations and given up about 250 names. Looks like UBS clearly violated its qualified intermediary agreement with the US. If I were betting, I’d bet that the Swiss will be the ones to blink, if the US only has the backbone to stand firm.

Health Care Reform

Democrats are wrangling over how to pay for much needed health care reform. On the Senate side, they are apparently taking very seriously the proposal by Citizens for Tax Justice that the Medicare tax be extended to all types of unearned income, not just compensation. (This proposal, of course, has been around, and I’ve made it quite often myself. CTJ has a specific version, and provides state-by-state figures on what it would mean.) Obviously, since the top quintiles own most of the capital assets, this would be primarily a tax increase on them (resulting in a slight increase to the capital gains rate from 15% max for most types of gains to 16.45%).

Defense of Marriage Act

Back in the 1990s, Congress caved to the “values” lobby (i.e., the group that wants to impose its “values” on all the rest of us, and whines about having others’ values imposed on it if it thinks anybody wants to do anything differently from the way it thinks they ought to want to do it) and passed the so-called “defense of marriage act” (DOMA). DOMA says the terms “spouse” and “married” in federal law can only refer to legal ties between a man and a woman –i.e., “traditional” marriage. Of course, there are lots of references to spouses and marriage in the Internal Revenue Code–spouses can transfer property to one another without tax. Spouses can receive alimony when they divorce. Spouses can file joint returns. Spouses can exclude medical benefits from their spouse’s medical insurance. And etc. When DOMA was passed, no state permitted gay marriage. Now, several states do. And finally, one of them is challenging the law as unconstitutional (which, you won’t be surprised, in my view it clearly is) because it “interferes with the Commonwealth’s sovereign authority to define and regulate marriage” and “constitutes an overreaching and discriminatory federal law.” See complaint; AG files first suit challenging DOMA, Mass. Lawyers Weekly, July 13, 2009. Good for Massachusetts.

Developers and tax-exempt bonds

A retirement community in Central Florida may owe millions in back taxes. The Villages is made up of “community development districts” that have been used to pay for roads, sewers and water lines that are essential to the developers’ being able to sell their developments. The IRS examiner has concluded that $64 million of bonds issued in 2003 shouldn’t have been entitled to tax exemption because the board members were all affiliated in one way or another with the developer, and the developer (an ardent Republican, natch) had gotten about $60 million from the district for golf courses and small parks that cost the developer less than $8 million to build. A pretty solid return, in a period of not so solid returns for people conducting their business without the aid of the US government. Other bonds are also being investigated. See Fineout, Florida Communities Pay Attention to a Tax Case, NY Times, July 10, 2009.

Banks, TARP purchases of toxic waste, derivatives regulation (or not)?

Obviously, the entire economy is impacted by the credit crunch and the huge amounts of money the federal government has put on the line for banks, including its plans for “partnerships” with private equity to buy up toxic waste, with the government standing to get a pittance of the up side (if there is any) but to lose most of the downside (which there will likely be a good deal of). Meanwhile, proposals for regulation of derivatives are tepid at best. “Standard” derivatives would be sort of regulated, but “exotic” ones (the ones, by the way, that have been customized to use in tax shelter deals, or to fool accounting regulators) won’t be. You can create a customized derivative to do anything the standard one would do, so who would do a standard derivative if both options exist? (nobody) And why do banks need to be doing exotic derivatives in the first place? (they don’t). Derivatives have been just one other way to manipulate tax burdens and get the right bundle of features at the right point to claim the right application of a particular part of the Code. Swap away the taxes. But here we are, letting banks continue without restructuring, aiding them with more US dollars on the line, and doing it in a way that allows big aid recipients in the bailout (like GE) to get bigger on more bailout-related dollars from the government, while continuing to engage in the same behavior as before. What part of this makes sense?

More tax shelter enablers biting the dust

This week, another of the BDO Seidman “tax solutions group” (that ended up being a euphemism for tax fraud promotional group) pled guilty to various charges in connection with the son of boss type deals done with defunct law firm Jenkins & Gilchrist. You can read all about that on A Taxing Matter here and more about the shelters and other cases, here and here. Will these guilty pleas help put a stop to the overzealous “tax minimization” norm. For a little while, I suspect. And then the race will be off again in a new cycle of tax shelters.

And being in Michigan, I can’t leave out Ave Maria (hat tip to Paul Caron at Tax Prof)

Ave Maria Law School, a Catholic school founded and funded by Tom Monaghan (of Domino’s Pizza wealth), is being moved lock, stock, barrel and faculty to a new city and campus in Florida. A number of tenured faculty objected to the apparent high-handed way in which Mr. Monaghan was able to control the school’s decision making on the matter. They are no longer at the school and are contesting their termination. Monaghan claims that they are Catholic ministers and therefore the school is exempt from suit in civil court under the First Amendment religious protections. See Baldas, Ave Maria claims ‘ecclesiastical abstention’ over termination of three law professors, National Law Journal, July 9, 2009. As one commenter on the Tax Prof posting on this noted–so do the faculty take the ministerial housing allowance exclusion?

Enjoy, and have a great weekend…..

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SILOs –more action needed?

Tax advantaged “sale-leasebacks” with strapped-for-cash municipalities (SILOs, in the ever-present tax acronym set) came back to light when the Washington Metro train crashed a week ago. The cars were ones that were involved in the metro authority’s SILO deals with various banks, and the authority didn’t have any spare cash left to fund replacements. See this A Taxing Matter posting on the Metro SILOs, Jun 25, 2009.

I won’t rehash the entire discussion of SILOs covered there. Just note that the transit SILO deals were contrived to permit banks to “buy” the federal income tax depreciation deductions on municipal equipment. The municipalites couldn’t use the deductions, since municipalities are tax-exempt entities. The buying corporations were subject to US tax (usually, a bank) and they were looking for every way possible to avoid paying tax–they would essentially pay a fee to the municipalities, sharing part of their tax savings, for serving as an accommodation party in these deals. They “purchased” the municipalities’ property with nonrecourse debt, and then had “lease income” that was offset by both interest deductions and depreciation deductions, generating artificial losses from the accelerated depreciation. Most of the purchase price was set aside to defease the seller’s obligation under the lease, with the excess the fee for accommodating the tax shelter.

Jim Lehrer covered transit agency SILOs in the March NewsHour, depicting many of the transit agencies as motivated by their desperate need for capital–and encouraged by the federal Dept. of Transportation to use these means to get some. So there is a vicious double circle of irony here, that as states and localities cut taxes during the GOP years, under the flawed assumption that lower taxes means higher revenues, the states and municipalities also cut back on the funding needed by these important public service agencies, and an arm of the federal government encouraged these transit agencies to enter these deals, and at least 30 of them did, serving as accommodation parties in tax shelter deals with banks, so that banks would pay even less taxes than they already did.

Future SILOs were generally undone by new section 470, one of the few revenue raising provisions in the 2004 tax act. (The 2004 Act otherwise amounted to a pile of tax breaks for US corporations, such as the rate cut on repatriating offshore profits. It was misleadingly labeled the “American Jobs Creation Act” to signal the purported justification for all the corporate tax breaks. It didn’t lead to the creation of many jobs.) The new section disallowed to U.S. taxpayers a “tax-exempt loss”, defined as the excess of deductions other than interest and interest deductions allocable to tax exempt use property over the aggregate income from the property. Exceptions allowed certain “true” leases–essentially, ones in which the obligation of the seller-renter had not been defeased by the payment from the buyer and where the buyer had actually put some equity into the deal (the provision requires only 20% of genuine, at-risk equity). There are fewer tax benefits to true leases, so even with the exception, the provision deters leasing deals.

One hitch–the act only applied prospectively, and the transit deals (just one of the varieties of SILOs that were being done at the time of the 2004 change) got special treatment, in that any deals in the pipeline were allowed to be grandfathered in as long as they were done by 2006!

The IRS pursued the old deals with pre-2004 Act tools and won SILO (and LILO–the earlier “lease in, lease out” deals) cases against Fifth Third Bank, BB&T, PNC and other banks. See, e.g., IRS Wins AWG SILO Tax Shelter Case, TaxProf Blog (May 28, 2008) (dealing with the Ohio court’s decision in 2008-1 USTC 50,370, in favor of the IRS in a SILO case involving two US national banks’ “purchase”, with nonrecourse loans from German banks whose proceeds were used by the “seller” to defease the lease obligation, of a German waste facility used to acquire beneficial tax deductions); Ohio Judge Rejects Tax Claims on $423 Million Alleged Purchase of German Facility Made by Cleveland & Pittsburgh-Based Banks, DOJ (May 30, 2008); DOJ, Ohio Jury Finds Cincinnati-based Bank not Entitled to $5.6 Million Tax Refund (LILO transctions); BB&T Corp, 2008-1 USTC 50,306 (4th Cir.) (striking down tax treatment of financial service company’s lease of Swedish wood-pulp manufacturing equipment as a LILO shelter); DOJ, Statement of Assistant Attorney General Nathan J. Hochman on Today’s Decision in BB&T Corporation v. United States (Apr. 29, 2008).

After the court victories, the IRS offered a SILO settlement for these deals that permitted them to keep 20% of their claimed tax losses and waived the penalties, if they terminated the transactions. IRS Commissioner’s Remarks Regarding LILO/SILO Settlement Initiative (Aug. 6, 2008); Donmoyer, IRS Offers to Settle 45 leasing Tax-Shelter Disputes, Bloomberg.com (Aug. 6, 2008); Service Launces LILO, SILO Settlement Initiative, J. Acct. (Oct. 13, 2008). It later announced that “hundreds of taxpayers settled similar cases involving tens of billions of dollars.” DOJ, Justice Department Highlights FY 2008 Tax Enforcement Results (Apr. 13, 2009). On leaving office, Korb statedthat “taxpayers representing over 80 percent of the dollars involved have elected to take advantage of the settlement initiative.” See Korb Interview. (Dec. 19, 2008).

The settlement offer required taxpayers to terminate the transactions by Dec. 31, 2008, else they would be deemed terminated by that date, with taxpayers still able to claim the partial loss benefit through the actual termination date if they terminated the transaction by Dec. 31, 2010. That’s a fairly strong incentive for termination, but the municipalities may be on the hook for hefty termination payments under their contracts. Even worse, the AIG situation provided a perfect trigger for causing a technical default to apply. AIG guaranteed these deals, so when its credit rating went down, the transit agencies are in technical default and liable for hefty penalty payments. (see NewsHour video, above).

There are real problems here, including the idea of one agency of the government supporting its “clients” (transit agents of municipalities) entering into deals like this that result in corporate tax cheats robbing the government of important revenues. Another problem is the idea of the banks that were instrumental in causing the fiscal crisis–by risky, speculative behavior that disregarded the systemic risks–using AIG’s collapse because of that fiscal mess as an excuse to get municipalities that are especially cash-strapped because of the fiscal crisis (and finding their ability to borrow or get tax revenues severely restricted) to pay over large penalty amounts under their shelter contracts. It seems like an unfair windfall for tax cheating Big Banks at the cost of the people.

And of course, just extending the 2004 provision to make grandfathered SILO/LILO transactions illegitimate and their tax deductions disallowed doesn’t solve this problem, since these are windfalls that the tax cheaters would get under their “lease” contracts.

Rep. Menendez of NJ has proposed a potential solution–the “Close the SILO/LILO Loophole Act” S. 1341, introduced in late June. His bill, he says, would “help protect WMATA and other transit agencies who are being threatened by banks seeking to gain a windfall from the current economic climate while potentially putting transit agencies at risk.” See press release, As Lease-Back Deals Are Raaised as an Issue in Metro Crash, Menendez Says legislation Can help Unwind Deals, PolitickerNJ.com (Jun 26, 2009); Davis, Bill Would Tax Banks that Sue Agencies , Star Ledger (Jun 24, 2009); Letter from Menendez to Hoyer (Jun 26, 2009) (noting a need to “protect transit agencies from banks who are seeking to exploit a technicality that would result in agencies having to pay banks millions of dollars that could otherwise be used to shore up equipment and ensure safe operations, even though they have not missed a single payment to the bank”). The bill imposes an excise tax equal to 100% of any “ineligible amount” collected by “any person other than a SILO/LILO lessee” as a party to a SILO/LILO transaction. Ineligible amounts are proceeds from terminations, rescissions, or remedial actions in excess of those under defeasance arrangements. The bill also would deny deductions for attorney fees and other costs attributable to seeking to recover ineligible amounts.

It’s messy, but it does end up with the right results, it seems. I note, though, that there are no additional co-sponsors at this time. Doesn’t look like Congress is hopping on the bandwagon.

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Fairness as a concern of economics

by Linda Beale

There is an interesting book that I am just beginning, by George A. Akerlof & Robert J. Shiller. It’s called “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism”. The jacket says that the authors “challenge the economic wisdom that got us into this mess, and put forward a bold new vision that will transform economics and restore prosperity.” It is clearly a Keynesian approach–the jacket, again, says they make the case for “a more robust, behaviorally informed Kenyesianism”.

Sounds like a tall order, and I have not yet read or thought about enough of the book to know whether it is satisfied or not. But I do find the emphasis on fairness of considerable interest.

Fairness has long been a keystone of tax policy, and yet there are a number of tax scholars who consider efficiency the quintessential policy consideration and sometimes appear to relegate fairness to the corner for hobgoblins of small minds. So I wonder if this book, and its recognition of the overriding importance of fairness to economic analysis, is indicative of a fundamental change in the academic approach to economics and related fields that have tended to push fairness aside.

Here’s a quote from Albert Rees (Chicago PhD in labor economics) that starts off the second chapter on fairness.

The neoclassical theory of wage determination, which I taught for 30 years and have tried to explain in my textbook…has nothing to say about fairness. … Beginning in the mid-1970s, I began to find myself in a series of roles in which I have participated in setting or controlling wages or salaries. … In none of htese roles did I find the theory that I taught so long to be the slightest help. The factors involved in setting wages and salaries in the real world seemed to be very different from those specified in the neoclassical theory. The one factor that seemed to be of overwhelming importance in all these situations was fairness. (Akerlof & Shiller at 20, quoting Rees, The Economics of Trade Unions, Univ. of Chicago Press, 1973).

The authors go on to admit that Rees exaggerates, but then they provide a critical insight.

However many articles there have been on fairness, and however important economists may consider fairness, it has been continually pushed into a back channel in economic thinking. … But fairness may be just as important as the economic motivations that are given prime time. (Akerlof & Shiller at 20.)

So what economic theories of fairness do the authors suggest merit consideration? They highlight socilogy’s equity theory of exchanges, which consider far more than the monetary value of the counterparties’ positions, adding subjective evaluations about status, gratitude and similar factors. Another if the theory of social norms, that suggests that people are happiest when they live up to what they think they should be doing, including conducting themselves fairly with others (and being treated fairly by others).

And how should fairness be taken into account? Essentially, Alerkoff and Shiller argue that the old way of treating “real” economics as fundamental and fairness as an afterthought has to go. In stead, if fairness motivations are discounted, justification must be provided for doing so.

This approach, they say, explains much better than traditional economics the reality of unemployment and the fact that most firms pay their workers more than the market would require. It has to do with one’s sense of fairness–if workers sense they are being treated more than fairly (and their wage is the ulimate symbol of this treatment), they will fully buy into the goals of their employers.” If they are treated unfairly, they will tend to shirk. Id. at 105.

The difficulty of course, is in settling upon a definitive theory of fairness. In tax, we often talk about “ability to pay”, in a relative sense, as the critical definition, which is in turn the justification for a progressive rate schedule that taxes wealthy people at a rate considerably (or, after 40 years of rate lowering, somewhat) higher than it taxes middle income people. Libertarians, among others, have pushed back against the ability to pay concept of fairness, arguing for one version or another of a flat tax. It is one of the critical struggles, from my perspective, in the current class warfare whereby some groups are pushing for zero taxation on capital income (through a national sales tax or consumption-base rather than an income-based tax system). In other words, though there is a long-held consensus position about fairness in tax, there is currently considerable foment around the very concept of fairness. I’m glad to see fairness appropriately emphasized, but that is just the first step to developing a fairer tax system or a more complete economic theory.

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Taxes for States in Trouble?

by Linda Beale

[Excerpted from an earlier posting on ataxingmatter]

On ataxingmatter, I considered Michigan’s tough problems and proposed a solution that could offer a way to deal fairly with the many issues the State faces. Michigan, as everybody knows, is a depressed state these days. High unemployment, high foreclosure rates, and even the Red Wings can’t win it all. As two of the Big Three auto companies go into bankruptcy, Michigan is shedding jobs as fast as ice melts on a sidewalk on a hot summer day in Mississippi. Michigan, in other words, has real problems, and real needs that the state government should address.

My suggestion? It’s time to change Michigan’s income tax. Michigan has its share of very wealthy people–just look at the millionaires’ homes in the wealthy suburbs of Detroit, from the Grosse Pointes to those new ‘burbs to the Northeast. But the wealthy in Michigan pay the same flat income tax rate that the middle class pays–4.35%. A family of four starts paying that on wages above the personal exemption of $13,200 (after other deductions, if any). But a family of four with a salary of $500,000 pays the same rate.

Obviously, those few dollars mean a lot to the poor family and hardly anything to the wealthy one. That’s why the federal income tax has had a progressive rate structure since its inception. It’s also why almost all of the states that have a broad-based income tax, have a progressive tax rate structure, generally ranging between 3 and 8 or 9% of adjusted gross income (sometimes as modified under state rules). Only seven have a flat rate structure. See this chart from the Federation of Tax Administrators for a synopsis of state rate structures and exemptions. (Note–apparently, the tables to which I linked yesterday are not accessible at the link at this time. Wikipedia has some of the same information, at this link.)

Michigan should enact a progressive rate structure. How about a zero bracket for the first $25,000 in income, and then a progressive rate structure moving from the current 4.35% on the first $100,000 above that, to 5.35% on the next $200,000, to 6.35% on the next $400,000, to 7.35% on the next $2 million, to 8.35% on anything above $2,725,000. (Look at this study, which has information on city and state tax burdens, including income, property and sales taxes, and you’ll see that Detroit has very high tax burdens–because of the flight of its industrial base and the white flight to the suburbs; so most of the wealthy who work in Detroit don’t live in the city and don’t pay those higher taxes–they live in the surrounding suburbs that can’t be annexed to the city.).

Would people move out of Michigan because of the income tax change? Sure, some in the upper brackets would. (They’re already doing so, of course, because of the Great Recession, which has hit Michigan particularly hard.) But most other states already have a progressive income tax, often reaching 6% on fairly low incomes–so many of those states’ effective tax rates would be much higher than Michigan’s current flat rate and maybe higher than the proposed change. So those that move because of the tax would have to choose a state that had a lesser tax than Michigan’s new one–and states with lower rates may also have a troubled economy. But a reasonable tax of less than 7% on the first $725,000 would make a difference in the ability of Michigan to help create a sustainable economic environment through expenditures for human capital infrastructure (i.e., for K-12 through university funding) and physical public infrastructure. Not to mention that it would also be much fairer, by taxing people on their ability to pay.

Is this a “pie in the sky” proposal or one that has some chance of enactment in the current political climate. A big negative factor that operates at the federal and state level is the anti-tax rhetoric on the right. Tax increases have been an incessant target of the libertarian “think tanks” that oppose most government programs for vulnerable populations and most tax increases, as a matter of faith. Tthese groups have blanketed the internet with PR pieces proselytizing for their faith. See, for example, my various critiques of the the Cato Institute’s Dan Mitchell’s videos for the “Center for Freedom and Prosperity”: CFP’s Laffer Curve Video (Feb. 18, 2008) and The Laffer Curve II–proof? (Mar. 10, 2008) and More Class Warfare from the Cato Institute’s Dan Mitchell (June 17, 2009).

This anti-tax propaganda has made it politically difficult for any person in Congress to address tax increases in a deliberate, thoughtful way. Especially in the Senate, the anti-tax groups’ rhetoric–about corporate taxes, capital gains taxation, and rate structures, in particular–has made it hard to have an open and in-depth discussion of alternatives. As a consequence, the tax agenda in Congress continues to be dominated, to a considerable extent, by objectives that favor those in the top distributional quintile. Take the alternative minimum tax (AMT) as one example. Congress continues to pass annual “patches” to the AMT to prevent the clawback that would otherwise result from the interaction between the lower rates of the regular tax as amended under Bush and the AMT, which was left without corresponding changes. But these “patches” are not limited to much smaller amount needed to keep whole the below-$100,000 crowd. They instead cost many tens of billions annually to keep taxes lower for those most affected in the $200,000 to $500,0000 range. (The AMT generally doesn’t result in additional tax liability for the “super-rich”, since they are ordinarily in the highest tax brackets so their AMT calculation is still less than their regular tax liability.) Yet the patch is urged by the anti-tax rhetoric and touted as preventing tax increases for the middle class. Those same influences are at play in the several states, making it just as difficult to enact progressive tax changes at the state and local levels.

But state legislatures are, for all that, somewhat more exposed to and perhaps even more aware of their local constituencies. The populist distaste for the amount of government money going to financial institutions (and bankers) in the bailout–and the high bonuses for bankers in banks on the public dole–has made an impression. States often have more stringent requirements about running deficits, which has the potential for forcing more decisive action, for good (setting taxes at the right amount to fund needed programs) or for worse (refusing to increase taxe, to ‘starve the beast’, and axing government programs of high importance). The problems are growing more visible, as California’s hobbling by Proposition 13 and its inability to enact needed tax increases has put it in a state of crisis that is shutting the doors to essential state services. See Krugman, State of Paralysis, NY Times (May 24, 2009).

There is some movement in some states. As a commenter noted on the original ataxingmatter post, Wisconsin’s governor proposed an added 1% on joint filers’ income in excess of $300,000 ($225,000 for individual filers), bringing Wisconsin’s top rate to 7.75%. (The budget also proposed dropping the exemption for capital gains, taxed at the same rate as ordinary income, from 60% to 40%.) See Wisconsin Tax Summary 2009-2011, Wisc. Estate Planning and Tax law Blog (Mar. 13, 2009). Meanwhile, Pennsylvania, which increased its personal income tax rate from 2.8% to 3.07% in 2003 in the first change since 1991, is considering at least a temporary income tax increase to 3.57% to avoid cutting state employees and Medicaid reimbursements to hospitals. See, e.g., Hamill, Proposal to Raise Income tax in Pennsylvania, NY Times (June 16, 2009) (noting proposal for a 16% increase for 3 years); Bumsted, Tax increase needed to erase state’s $3.2 billion deficit: Evans, Pittsburgh Tribune-Review, June 5, 2009.

Addendum: California’s Democratic leaders announced today that they intend to send a partial budget fix amounting to $23.2 billion to the governor that will include massive cuts to public education and health and human services, along with $2 billion in new taxes–$1.50 per pack on cigarettes ($1 billion annual revenue projected) and 9.9% tax on each barrel of law ($900 million projected). According to BNA Daily Tax RealTime (June 17, 6:54 pm), Senate President Pro Tempore Steinberg said that “Our biggest argument [with the Republicans] is over the $2 billion in taxes.”

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Health Reform: does limiting the exclusion for employer-provided insurance make sense?

by Linda Beale

[also posted on ataxingmatter]

Both President Obama and Senator Max Baucus, key players in the health reform debate, have now indicated that one source of funding for health care reform on the table is a possible limitation in the exclusion from income of employer-provided insurance. See, e.g., Connolly, President Pivots on Taxing Benefits: Obama is Willing to Consider Move to Gain Health Reform, Washington Post, June 3, 2009.

The immediate reaction (seen in the comments section on the cited article) is rejection of this alternative. After all, many of us rely heavily on the fact that we have health insurance through work, and those of us in the lower income brackets probably would not be able to afford health insurance (at least, under the current privatized system) without that benefit.

But is the populist response the right one? We should not lose sight of the fact that the employer-provided insurance exclusion is the biggest tax expenditure in the Code that, like most tax expenditures, also tends to benefit most the highest income individuals. The Center on Budget and Policy Priorities has put out a new report titled Limiting the Tax Exclusion for Employer-Sponsored Insurance Can Help Pay for Health Reform that addresses this question directly. The Center notes that the tax expenditure is “poorly targeted” and benefits most the high income group who “least needs help paying for health insurance.” Lower-income taxpayers get less from the benefit because they may not have jobs, even if they have jobs they may choose to forego participation because of the cost of their share of the premium, and even if they participate, they get less of a benefit (in absolute dollar terms) because their tax rate is lower.

Here’s the graph showing the benefit relative to the income group.

CBPP suggests that the exclusion can be reformed without eliminating the value of employer-provided health insurance. One of the concerns is that employers will no longer provide the benefit if it becomes taxable, but a “play or pay” requirement could discourage that option and mitigate its effects. CBPP suggests that concerns about a rigid cap that would apply in all cases can be mitigated by adjusting the cap when a firm is relative small (so that more goes to administrative costs) or has more older and sicker workers (so that more health care costs must be covered) and for other, similar issues. The paper provides three specific alternatives for structuring the limitation in order to promote the goal of universal health coverage.

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Watch What I Do…..

This is my first official posting on Angry Bear. Let me start with a “thanks and delighted to be here.” I look forward to a productive interchange and expansion of the work I have been doing through ataxingmatter, my blog on tax and economic issues. I will continue to maintain the tax blog, and post here about once a week (usually with simultaneous posting on ataxingmatter).

There has been quite a bit said about Obama’s proposals for international taxation. If you read ataxingmatter, you know that I think the proposals to tighten up the way the rules work to prevent abuses are important starts in the right direction. Not surprisingly, multinational corporations have suggested that any change to the international regime that increases their taxes will make them even less competitive internationally (implying that they already have too little money to compete well) and ultimately, even quickly, lead to the demise of U.S. jobs. See, e.g., Donmoyer, Ballmer Says Tax Would Move Microsoft Jobs Offshore, Bloomberg.com, June 3, 2009.

One would think from such talk that US multinationals are just hanging on by the sheerest strings, unable to reduce costs further, leaving very small profits (if any) for their shareholders, and barely managing to pay their managers enough to keep decent talent aboard. But is that what Ballmer really means? Isn’t it more likely that it is a question of Microsoft hoping to retain all that money for its managers and owners rather than see a penny of it go to government purposes (like education, basic research)? How do we get any idea about what differences taxes make to companies when what managers say can’t really be trusted to shed much light on actual plans for the future?

Well, there is some real data on this issue that comes from the 2004 tax legislation–the corporate pay-back bill that was sold to the public with the same old claim that tax cuts would create millions of new jobs. The 2001-2003 tax bills cut revenues, but primarily lowered tax liabilities for individual taxpayers. (As I recall, Bush himself saw about a $37,000 tax cut from the 2001 legislation and Cheney more than double that.) Corporate lobbyists had agreed to this plan–ram the individual tax cuts through first and then pass a big bill fulfilling the multinationals’ wish list. The Bush administration and Congress came through in blazing colors for the corporate lobbyists, passing a host of corporate-friendly provisions under the guise of “job creation tax incentives for manufacturers, small businesses, and farmers.” (That’s the heading for Title II of the so-called American Jobs Creation Act of 2004. Even the names of the various bills ultimately passed in 2004 represent a veritable smorgasbord of propaganda–the “Homeland Investment Act”, the “American Jobs Creation Act”, and, the same year, the “Working Families Tax Relief Act”. )

The Jobs Act provisions included a host of bad policy choices all in the name of freeing up investment cash so that corporations could invest more in the good ol’ USA: even more section 179 expensing; even more accelerated depreciation for leaseholds, restaurants, aircraft, and syndication property; S corporation expansion; AMT breaks; more cross-crediting of foreign tax credits; more tax expenditures for the Big Oil, Big Timber and Big Pharm. And there was one other tax expenditure that was heavily lobbied for on behalf of multinational enterprises–a (purportedly one-time) provision for very low taxed repatriation of foreign earnings, in new section 965 of the Code. The MNEs claimed that the break would permit them to create thousands of new US jobs by reinvesting tax savings in their US businesses–investments that just couldn’t be managed under the constraints on the current tax burdens on repatriated cash. Repatriation, on the other hand, was supposed to lead to an increase in capital spending in the range of 2-3% over two years (see NBER paper, below, noting J.P. Morgan Securities’ estimate) and firms stated both confidentially and publicly that they planned to use repatriated funds for business purposes like acquisitions, capital spending, R&D, debt repayments rather than to pay out profits to shareholders.

The express purpose of the repatriation tax cut was to increase investment and viability of U.S. operations. Hiring new employees, conducting R&D, increasing capital investment in the US were all good uses, and Treasury guidelines indicated that use to pay executive compensation, dividends or stock redemptions would disqualify the repatriations from the tax benefit.

Did the corporate giants deliver? An NBER working paper by Dhammika Dharmapala, Fritz Foley and Kristin Forbes concludes that they did not. Watch What I Do, Not What I Say: The Unintended Consequences of the Homeland Investment Act, NBER Working Paper No. 15023, June 2009. Here’s the conclusion, as stated in the abstract.

Repatriations did not lead to an increase in domestic investment, employment or R&D—even for the firms that lobbied for the tax holiday stating these intentions and for firms that appeared to be financially constrained. Instead, a $1 increase in repatriations was associated with an increase of almost $1 in payouts to shareholders. These results suggest that the domestic operations of U.S. multinationals were not financially constrained and that these firms were reasonably well-governed.

Furthermore, money is fungible. The paper concludes that firms “were able to reallocate funds internally to bypass the publicly stated goals of the Act.” Id. at 5. So of the $299 billion that companies brought back from foreign subsidiaries (about 5 times the normally repatriated amount), about 92 percent of it went to shareholders in share buybacks and increased dividends. And interestingly, the firms that brought back the most money under the repatriation scheme were the firms that tended to “shield[] foreign income from U.S. taxation by using tax haven affiliates or holding companies.” The study also found that “[f]irms that increased parent equity provisions around the time of the tax holiday … had significantly higher levels of repatriations. This pattern suggests that the domestic operations of U.S. MNEs were not capital constrained and were instead providing liquidity to affiliates. These firms seem to have taken advantage of the HIA by ’roundtripping,’ that is, by replacing retained earnings that would be subject to high repatriation taxes if there were no tax holiday with new paid-in capital.” In fact, the paper includes a comparison of MNE and nonmultinationals on financial constraint indicators, showing that the MNEs are less constrained than nonmultinationals under each of the three important indicators.

At least one result was that good guys–the MNEs that didn’t use as many tax shelters to shield their foreign income and who regularly repatriated it and paid taxes on it–didn’t get nearly as much benefit from this bill as the bad guys–the MNEs that shielded their foreign income as much as they could and held it abroad until they could get this repatriation measure passed through their intensive lobbying pressure. And the bad guys didn’t do much of anything in the way of job creation, the political calling card they used to get their special tax break passed.

Seems to me we ought to at least keep this Jobs Act history in mind in the discussion of President Obama’s efforts to tighten international taxation rules and the already begun whining by MNEs that they are having such a difficult time competing that any further taxation will force them to move out of the US completely.

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