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Friday, April 25, 2003
Earned Income Tax Credit continued
Here's the IRS report on EITC compliance. It's quite detailed, and reading it suggests to me that the Service thought this through pretty carefully.
Here's an IRS research paper describing the EITC "risk-based" targeting strategy.
Draft article about the blog
Here's a draft article about the blog that Jeff and I hope to publish somewhere. It's short and not terribly serious. Comments are most welcome.
The NYT usually does a wonderful job reporting on tax issues -- esp. David Cay Johnston, of course. They drop the ball today with a story today on the EITC that is unfair and ultimately counterproductive for EITC supporters. The story is written by Mary Williams Walsh. I'm not familiar with her work, as only recently have I begun to really pay attention to by-lines.
Background: The EITC (Earned Income Tax Credit) gives tax credits to the working poor. You get more credits if you are raising kids. The fraud/error rate for EITC is huge -- with about $9 billion of the $32 billion expended each year going into the wrong hands. Republicans really don't like this.
In her story, Walsh explains first that the new measures, designed to crack down on taxpayers who take the EITC when they shouldn't, requires that certain taxpayers who are likely to be in the "high error" category (i.e. more likely to commit fraud) will be required to submit proof in advance. Walsh explains,
The high-error category encompasses all claimants except married taxpayers filing joint returns and single mothers; it includes fathers with sole custody of children, grandparents, aunts, uncles, foster parents and others. They will have to provide papers proving that the relationship with the children claimed is as claimed, and that the children lived with them for at least six months of the year. (emphasis added)
When Walsh says the category encompasses "all claimants except married taxpayers filing joint returns and single mothers", she makes it sound like the IRS is trying to harass the working poor out of claiming their entitlement. This sounds like class warfare of the worst kind. But 80% of EITC claimants are married taxpayers filing joint returns or single mothers, so 80% of EITC claimants are not affected by the new measures.
Why does this make sense? The biggest EITC problem is taxpayers claiming that children reside with them when, in fact, they don't (under the EITC rules, anyway). What the IRS is doing is rationally targeting the population most likely to be cheating (intentionally or not) -- single fathers. Is this a reasonable policy enforcement choice: Maybe so. I quote from Sheryl Stratton's April 14 Tax Notes piece: "Data showed that children were 10 times more likely to live with a single mother, and 20 times more likely to live with married taxpayers filing jointly, according to [National Taxpayer Advocate Nina] Olson." So the IRS is implementing a presumption that if you are a single dad, you have to pre-certify that your child does, in fact, reside with you.
Well, how onerous is the pre-certification process? Walsh makes it sound awful:
Only a few types of evidence will be acceptable to the I.R.S., and some are documents that will be difficult or impossible for people to get within the six-month deadline. To prove their relationships to children, for example, they are expected to produce marriage certificates, in some cases for other people's marriages; for marriages that took place abroad; and in a few cases for marriages of great-grandparents and great-great-grandparents.
Walsh goes on to explain how difficult it is to get a marriage certificate from state bureaucracies. No doubt she's right. But there is an alternative, as Walsh (quietly) notes:
Filers who have no such documents will be allowed to produce instead a sworn affidavit from a school official, employer, member of the clergy or other person in a quasi-official capacity, specifically stating under penalty of perjury that he or she has "personal knowledge" that the taxpayer and child lived together during the dates cited. An affidavit from a landlord, who may live far away, would be accepted, but not one from a building superintendent who lives on the premises.
This doesn't actually sound so bad to me. It requires an affidavit from someone official sounding -- i.e., someone with reputational capital at stake who might not want to lie to the government. Sure, it's a pain, but so are lots of things related to tax preparation.
So before jumping to conclusions, let's think about the advantages and disadvantages of what the IRS is proposing.
The downside of the new measures is that paperwork will deter some percentage of single dads from claiming a tax credit to which they are entitled, and there is a risk (at least if the Times keeps it up) that enforcement efforts by the IRS will stigmatize a worthy social policy program.
But let's not forget the upsides: the fraud rate might go down significantly, and the new paperwork requirements seem to be carefully targeted to avoid unnecessary burdens on single moms and married couples filing jointly (who are much less likely to cheat). And if the fraud rate goes down, the EITC is much less likely to get cut back or repealed, and the program might even get expanded to capture a portion of the savings from the decrease in fraud.
To sum up: The Times makes it sound like the IRS is engaging in class warfare on the working poor. In fact, the IRS is requiring single dads to pre-certify (once) that their children live with them before claiming tax credits for the next several years. And in so doing, the IRS might cut the EITC fraud rate significantly, thereby preserving the social and political support for what everyone agrees is a very worthy social benefit program.
I have no doubt that the IRS should be spending more time on corporate tax shelters and less time on EITC fraud. But the proposed changes just don't sound that bad to me.
[Note: I'm not surprised that Jeff, on a quick skim of Walsh's story, read the story as the IRS "cracking down on the working poor." That's exactly how Walsh wrote the story, and no doubt her intended reaction. It wasn't until I read Stratton's Tax Notes piece an hour ago that I went back and read Walsh's story again more closely and realized just how misleading it is. Stratton's Tax Notes piece is wonderfully clear and balanced. I can't link to it, unfortunately, as it is a pay site.]
Earned Income Credit
According to this NYT story, the IRS is finally taking tax fraud seriously by cracking down on the working poor. The story discusses the Service's plan to raise the burden on the earned income tax credit.
I have been pretty quiet lately because I am preparing my corporate tax take-home exam. I will gladly accept any recommendations for problems.
Thursday, April 24, 2003
History of Dividend Exclusion
Taxprof Steve Bank discusses the history of the dividend exclusion in his recent paper on the history of the double tax and its relation to management's love of retained earnings. I esp. like the paper because it ties together the historical perspective with more recent work on "agency costs" as an explanation for the lack of political support for corporate integration.
Creation of the EDA concept
To answer Dick Riley's question from yesterday, the EDA concept was indeed present in the 1992 Treasury study on integration, and was limited to amounts on which the corporation had already paid tax. Thanks to Taxprofs Steve Bank and Gregg Polsky for the pointer. If I can figure out who at Treasury led the way on the dividend exclusion prototype, I'll report back ...
Does Size Matter?
NYT reports today on Bush's recent speech trumpeting tax cuts.
I don't know who is writing Bush's speeches on tax cuts, but the end result is an awfully simplistic analysis of economic stimulus. The Times quotes Bush:
"Some in Congress say the plan is too big," the president said. "Well, it seems like to me they might have some explaining to do. If they agree that tax relief creates jobs, they why are they for a little-bitty tax relief package? If they believe tax relief is important for job creation, they ought to join us and join this administration and join many in Congress and have a robust package that creates enough work for the American people."
Little-bitty tax relief? Ugh. Well, of course the size of the tax cut matters, but so does its form, and my sense is that many who oppose the Bush plan not just because it's too big but because it doesn't target those at the margin who are most likely to turn around and spend the tax savings. By reducing the debate to a simple bigger-is-better argument, the Bush administration is dumbing down the debate and, I think, underestimating the public's ability to understand how economic stimulus works.
Maybe I expect too much of the public. But I don't think the public really falls for lines like:
While it's true that seniors receive half of all taxable dividend income, most of those seniors are seniors like Dick Cheney ($490,999 in div income), not Aunt Minnie.
Reasonable people can disagree on the merits of taxing dividends, or whether cutting the tax on dividends will goose the stock market. But dumbing down the debate surely doesn't help.
Wednesday, April 23, 2003
Dividends and the EDA
Reader Dick Riley reminds me that there indeed used to be an exclusion for dividends (up to the first $400).
The exclusion was repealed by (I believe) the 1986 Act. As Riley points out, there might be some pretty good research out there from that debate, and I'll report back if I find anything good.
Riley also asks: Does anyone know who came up with the concept of the EDA (Excludable Dividend Amount) and limiting it to only that amount on which the corporation has paid tax? Presumably somebody smart over at Treasury, but perhaps it's an idea left over from the 1984 ALI integration study. If anyone knows the answer, let me know.
As Riley points out, the EDA concept is important because it reduces (at least at the margin) the pressure to shelter corporate income, since if income is taxed at the corporate level and becomes EDA, the EDA amount won't be taxed at the shareholder level. Whereas if income is untaxed at the corporate level, the EDA is zero and any distributions to shareholders are taxed as dividends (or not) under the normal rules.
(I note that corporations still have some incentive to shelter, as it's better to pay 0% at the corporate level and let shareholders recognize the gain at a 20% capital gains rate through sale or redemption than to pay 35% at the corporate level and 0% at the shareholder level. But I nitpick. Riley is certainly right that the EDA makes corporate tax shelters less appealing than before.)
Phasing in the Dividend Tax Cut
There's been talk this week about phasing in the dividend exclusion to reduce the cost of the cut and bring it within the demands of the budget resolution. The administration's game plan, I think, is to squeeze as much of the dividend cut into the budget as they can, and then bring new legislation later in the year for more popular measures like increasing child tax credits. As I understand it, the only need 50 Senate votes for the budget, but may need 60 votes for other legislation, so they'll push for the tougher stuff (like the dividend cut) in the budget.
But a 50% dividend tax cut with a promise to increase to 100% later might be the worst of all worlds. True, it would not decrease revenue as much as a 100% cut. But if part of the point is to encourage companies to increased dividends, then a phase-in would have the opposite effect -- companies would want to hold on to cash an extra year or two until the tax on dividends drops further. So companies would hoard cash rather than distribute it. Hardly a nice economic stimulus.
Also, changing the rate over time could make complex legislation even more complex.
A much better compromise: rather than allowing a certain percentage exclusion, leave the basic framework of the corporate tax alone and allow an exclusion up to a certain dollar amount. Allow shareholders to exclude up to $1000 in dividend income each year. Period. It doesn't solve the corporate integration ("double tax") problem entirely, but it's easy to implement and provides a better economic stimulus.
Cynics will say that this proposal stands no chance because, although it helps Aunt Minnie, with her small amount of dividend income from her GM stock that she's held since 1947, it doesn't help Dick Cheney nearly as much, with his $490,999 in yearly dividend income. In other words, my proposal doesn't help rich people nearly enough.
I suppose the other way to look at this is that the Bush plan is part of a broader agenda to move us away from an income tax and towards a consumption tax, where all investment income would not be taxed at all. And many smart people do think that moving towards a consumption tax is sensible (or at least inevitable). If one accepts that agenda as a given, my proposal to exclude a certain dollar amount of dividend income doesn't advance the ball very far, and the administration's phase in plan makes more sense.
UPDATE: Decnavda wonders if the agenda is really to move to a wage tax, not a consumption tax.
Tuesday, April 22, 2003
More on Taxes and Torts
At NYU this week Lawprof Christine Jolls will present a working paper, "Achieving Employment Equality for Disadvantaged Workers." Jolls doesn't want to post the paper yet, so I can't provide a link, but the paper explores the question of whether it might be more efficient to use the tax-and-subsidy system to protect disadvantaged workers rather than employment discrimination rules like the ADA (Americans with Disabilities Act).
Unlike the more traditional law and econ crowd (discussed by Weisbach in the paper I referenced yesterday), Jolls emphasizes that the expressive value / social meaning of the ADA can't be dismissed lightly, and thus that the tax-and-transfer system will likely be more efficient only in certain, narrow circumstances (which she then defines carefully). An interesting debate which is new to me.
Readers interested in Jolls' prior work on antidiscrimination law and accommodation mandates can find a paper here.
Monday, April 21, 2003
For those of you visiting from Larry Solum's Legal Theory blog, you might take a look at Taxprof David Weisbach's Coase Lecture at Chicago last year, Taxes and Torts in the Redistribution of Income. It offers a nice intro to the argument that the tax system, not legal rules (like pro plaintiff tort rules) should be used to redistribute income. And it's written in real, honest to goodness English. Well, most of it anyway (there are some graphs, as I recall).
Efficiency vs. Equity (In the Same Breath)
NYT article on recent academic research on the age-old equity v. efficiency debate.
Econprof Brad DeLong adds his input here.
Military Aircraft - Lease or Buy?
The military needs some new "tanker" planes. This New York Times article yesterday describes the latest proposal from Boeing: instead of selling the planes to the military, Boeing will sell the planes to an SPE (Special Purpose Entity), and the SPE will then lease the plane to the military for 6 years, at the end of which the military will have an option to buy the planes at a prenegotiated price.
My question: Who gets the tax deduction for the depreciation of the planes? The NYT article doesn't offer up enough detail. The answer, I suspect, is that Boeing or a third party puts some equity into the SPE to become the nominal owner of the planes for tax purposes, and thereby keeps the tax deduction, and thus Boeing is pushing this deal structure in part because of the tax advantage. (Another reason, according to Lawprof Steve Schwarcz, is that using the SPE allows Boeing to borrow to fund the project, but the SPE keeps the debt off of the balance sheet. This improves Boeing's debt-equity ratio and other financials. It's likely, then, that a third party would put some outside equity into the SPE, become the owner of the planes for tax purposes, and take the tax deduction. This would allow for the sale to the SPE to be a true sale for accounting purposes, which means that Boeing can book the revenue immediately even though the actual cash will come trickling in over 6 years.)
Why is this better for Boeing than a simple sale of the planes? Suppose Boeing were willing to do the deal as a sale for $100 million. If it sells the planes to the military, the military would be the owner of the planes, and take the depreciation deductions. But of course the military is tax-exempt, and can't use the deductions. So let's do a little financial engineering. Boeing would certainly be willing to do the same deal, structured instead as a lease, for $97 million plus $5 million worth of depreciation deductions. The military gets to report lower spending on its budget (97 vs. 100) and Boeing is at least as happy as before.
So why isn't this a win-win? Because the tax savings ultimately come out of our pocketbooks. The military budget will be lower by $3 million, but tax coffers are lower by $5 million, as Boeing will pay $5 million less in tax. On these facts, we taxpayers lose $2 million net. And that revenue will have to be made up somewhere else.
It seems obvious to me that when the government is structuring its contracts with private parties, it should not bargain away tax deductions to the party to whom it is most valuable. Airplane leasing deals have been around forever and are common, in part, because the airlines rarely need the tax deductions (since they rarely have taxable income). Because the airlines are effectively tax-exempt, it's more efficient to structure the deal so that a taxable entity, not the airline, gets the deduction. What's new here is that the military is playing the part of airline as tax-exempt entity. But it really shouldn't be doing this, as it should also be protecting the public fisc, and every dollar in tax deductions that it gives away has to be made up by taxpayers someplace else.
I suspect we will see more structured finance deals with US government contracts in the future. We need someone at Treasury or IRS to be keeping an eye out and making sure the public fisc is adequately protected. (The military itself has little incentive to do so, since presumably its first priority is keeping its budget in line with Congressional outlays.)
I'm curious to see how this develops.
Sunday, April 20, 2003
Treasury Secretary Snow suggests today in a WSJ article that Bush may compromise on the tax cut by delaying the income tax rate cut and settle for half the dividend exemption this year and phase in the rest of the exemption over a 10 year period.