Column: Limited Edition
Bill Lockyer, California State Treasurer, says that Winston T. Lee of Lafayette, Calif. owes his department $9,940,513.49 representing unfiled state income tax returns since 2002. One wonders, since both Bill and Winston agree that the returns were not filed, how Bill determined the delinquent income tax amount so precisely? At least you would think he could have rounded down on the 49 cents. (Google “California Delinquent Taxes.”)
“Not so,” Mr. Lee tells CNN on tax day. The assessment seemingly was set high enough in hopes of encouraging Mr. Lee to file his past-due returns and pay the correct tax with interest and penalties. “Won’t happen,” further retorts Mr. Lee. “I feel badly about the whole thing but I just can’t bring myself to figure out the complexities of the California income tax forms. I hope they will call me and we can agree on some number and I’ll just pay it.”
If Mr. Lee, a businessman with a few rental properties, is confused by the California returns, he is most fortunate not to be doing business in Michigan. The governor’s new Michigan Business Tax, with its mind-numbing complexities and inequities, sets the gold standard for costly tax attorneys and CPAs. Likely the governor’s State Treasurer has already realized – or soon will – the significant free give-a-ways, tax credits, and subsidies that will be needed to get any prospective new business to buy into the MBT mess, a tax adopted at 2 in the morning by a sleep-deprived (brain dead?) legislature surrounded by dozens of well-paid and wide awake lobbyists.
April 15th has come and gone for another year and with it the prolific number of blogs and editorial demands for tax change. Mr. Timothy F. Geithner, the new U.S. Secretary of Treasury, will likely offer up some changes (crafted by dozens of lobbyists imbedded in the Beltway) to a tax system already teetering on the brink of collapse from complexities and complications. The system can’t take too many more patches, particular from The Secretary, who recently nicked the Treasury for about $17,000 in unpaid Social Security taxes on his own personal return. More changes, more complexities, more unfairness is putting the tax system itself at risk. A small patch here or there now seems to be causing a leak somewhere else.
I have been in the tax compliance business, as a some-time teacher and full-time practitioner, since 1967. It is time for our industry, with all of its attorneys, CPAs, estate and tax planners, auditors, etc. to just go away. Shoo…go home. Our tax system doesn’t need a tweak, it needs a hatchet job.
The hatchet job would eliminate the income tax and adopt a national sales tax on consumption and financial transactions. All of the illegal drug and gambling money that is laundered through our banking system daily would be taxed upon deposit. If Bennie the Bookie decided to get out of the market entirely and go to cash on deposit in the back yard, at some point he will likely spend it. Those front row tickets at the Lakers games must be had. There would be no sales tax on necessities. The national sales tax on other items would be graduated, with luxury items being taxed at a higher rate at the time of purchase.
The system is already in place to accurately assess and collect the tax. If you are one of the 700 people at Merrill Lynch who had a bad year in 2008 (each only making more than $5 million), you would pay a financial sales tax when you stored your money in your CMOs, REMICS, and all of those other financial products that no one but you can understand. And, at this point we’re not so sure about your depth of understanding, either.
We, as a people, don’t like to focus on the income side, keep records, disclose salary and perks, keep track of what the person in the next cubical is making, paying or avoiding in taxes. But everyone likes to buy and consume or even invest. There would be no record keeping for Mr. Lee or any other consumer/investor. Bill and Winston, could become close friends, join the local coastal touring society and each drive out of the Mercedes dealership with a new roadster – but each would also be a little lighter in the pocketbook. This way, everyone participates by giving back for our national well-being at a time they are the happiest…at the moment of consumption.
The U.S. Treasury estimates that the amount of unpaid taxes is in the billions, enough to fund the Pentagon’s budget for six months. The department also anticipates that it will get worse this year as more people have to go into a self-employed/cash survival mode. It’s so unfair.
Consider the following: A middle-aged, self-employed single woman making $50,000 a year pays over $15,000 in taxes while barely able to make the monthly rent payment in a 700-square-foot studio in Brooklyn. Sam Slick, a real estate developer across the river in Manhattan, wants to sell his Park Avenue property for $100 million. Unfortunately, his tax attorney computes that the taxes on sale would approach $35 million, leaving only $65 million for Sam, hardly enough for a down payment on a new estate in the Hamptons. So Sam mortgages the property for $100 million at Bear Stearns, pockets all the money, pays no tax on the loan proceeds and upgrades to a beachside villa in St. Barth’s. Sam croaks the following spring, and before he can even push up some daisies, Sammy Jr. inherits the Park Avenue property. The income tax unpaid on the $100 million is forgiven in the estate tax process. The Treasury Department calls it an estate “step-up” adjustment. Further, Sammy Jr. falls in love with his father’s young widow (“Wiffels”), defaults on the $100 million non-recourse mortgage at Bear Stearns, takes the rest of the residual estate and hikes off to enjoy the beach with Wiff and the rest of the glitterati.
Sammy Jr. and Wiff may live happily ever after on St. Barth’s, free of U.S. income taxes because of the income exclusion rules for U.S. citizens residing in a foreign country. No, they don’t pay French income taxes either, because France does not tax the residents of St. Barth’s. However, the sales tax is very steep on a bottle of expensive wine. After a great day at the beach, it’s a tolerable expenditure for the common good.
Oh, by the way, your tax dollars paid off Sammy’s defaulted mortgage (now called a “toxic asset” by Mr. Geithner) which Bear Stearns sold to Goldman Sachs shortly before going out of business.
Say it ain’t so…but it is.
About the writer: Del Dunbar, a CPA and partner with Dunbar & Martel, has lived in Ann Arbor since the 1960s.
This “consumption tax” idea has been raised again and again as an alternative to the income tax. To paraphrase Winston Churchill, the income tax system may be the worst possible way to distribute the costs of government and civil society, except for all the others.
The first problem is that a consumption tax is basically a sales tax, which by its nature is regressive. Fortunately our income tax system still has many relief valves built in for lower-income people. The standard deduction has become quite generous in the last few years, there is an earned income tax credit, and one good aspect of the Bush tax cuts is that rates were also lowered for the lowest brackets. The income tax system needs to have its progressivity restored by immediately going back to the tax brackets of the Clinton years and by taxing capital gains as ordinary income.
The second problem is that Congress and other levels of government love to tinker with the tax code in order to encourage or discourage activities, or to reward certain people. After the tax simplification act of 1986 (in which many deductions previously available to lower-income people were eliminated), Congress immediately started piling on special exemptions. Yes, these should be re-examined and scaled back. But if we did go to a new system like a consumption tax, surely no one believes that this same political process would not be applied to find exceptions and apply exclusions again. Mr. Dunbar says that “There would be no sales tax on necessities. The national sales tax on other items would be graduated, with luxury items being taxed at a higher rate at the time of purchase.” There we have a huge window for special pleading right off the bat. (We used to have a luxury tax, but it was repealed because it hurt certain industries.)
If a consumption tax also applied to bank deposits and financial transactions at any level, ordinary people would be taxed merely for depositing their paychecks and any savings. Perhaps each credit charge transaction as well? It sounds as though the cost of daily life could become burdensome.
Yes, let’s enforce our tax laws, collect taxes due, and get rid of unfair exclusions. But the consumption tax is not the way to fix our system. (This comment is by no means an endorsement of the tax policies of our state legislature, which are incomprehensible.)
Interesting, but we all know it will never happen–the people who benefit from the current system will see to that. A national sales tax, in any event, would be no escape from government meddling in our personal lives as it offers endless opportunities for fiddling with rates and items/services subject to tax. You say necessities would be untaxed and luxuries would be taxed at a higher rate, but your necessity may be my luxury. I can see our representatives–as they do now with “sin” taxes–placing a greater tax on items not favored by the government (for our own good, of course) to change behavior. Then there is the issue of taxing financial transactions. What is a financial transaction? How about depositing your paycheck in your checking account? Is it taxed when your employer writes the check, again when you deposit it, again when you invest part of it in a CD, again when you receive interest on the CD, again when you renew the CD, and again when your checks start bouncing because of all the taxes deducted from your account? This could get expensive.
High enough rates for consumption tax would just merely cause a black market system in which one could buy luxuries at a discounted price by not paying the consumption tax. A black market in luxury items could be so widespread that the gov’t. would have difficulty collecting anticipated revenue.
Another problem with a consumption tax is that rich people would be paying ridiculously low tax rates. For example, the Coors family, that owned Coors beer, would just be taxed on what they consumed, not on the millions of dollars of dividends earned from stock ownership of their beer company. The consumption of items in which such a family would pay tax could never equal the income tax they would have had to pay on capital gains and dividend income.
The problem with federal gov’t. revenue comes from 2 sources. First was the Bush tax cuts that cut tax rates on capital gains and dividend income. This led Warren Buffett to question why he was paying a lower tax rate than his secretary who has far less of an income. The second problem were the vast wars that we are funding which includes health care costs for the wounded soldiers.
I have no firm position on this. However, I like the idea of people paying taxes directly. It gives a sense of ownership and inspires some level of interest in what’s being done with the money.
As system that collects taxes anonymously seems to be made to order for the proverbial “government bureaucrats”.
“The consumption of items in which such a family would pay tax could never equal the income tax they would have had to pay on capital gains and dividend income.”
Of course it could, David. If they spent all that income, they’d get taxed on it. The amount of taxes paid is a function of the quantity (purchased, in the case of a sales tax, or earned, in the case of an income tax) as well as the tax rate.
As for black markets, how does the black market for cigarettes in Michigan, for instance, now that the tax on them has been further increased, compare in dollars to the amount of income taxes that the wealthy avoid paying? If you don’t know the answer to that question (or for a similar example), I would suggest that your conclusion on the subject is speculation.
Vivienne, your argument against a consumption tax is that we’ve addressed the regressiveness of the income tax, but weakened that compensating factor over time? And that the income tax system is riddled with exemptions? Do you realize that you’re making Del’s point?
John, we already have sin taxes, so their impact is irrelevant to consideration of Del’s proposal, unless you believe they would somehow be different in that situation.
Del, why do you see a need for luxury taxes? They seem like an unnecessary complication.
Steve, I don’t agree with your summary of my argument though I clearly didn’t make it very well. I meant to say that a progressive income tax is still the best, most equitable system and that the current system contains some safeguards for lower- and middle-income people but that upper-income brackets need to restored to at least those of the Clinton years, when people of extremely high income were able to consume and invest just fine even with paying a slightly higher rate. During the Bush years, life was made safer for people who make money from money and we see what a great job they did with our economy.
The consumption tax would not be applied to food, medicine, and heath care services. The financial transactions tax would exempt retirement accounts (IRA’s, pensions, profit-sharing plans). I have no knowledge of the Coors family, but if their income is predominantly from dividends and capital gains (both taxed at 15%)they would likely contribute more through the financial transactions tax when they invested their family funds in private equity funds, hedge funds, and other sophisticated alternative investments. The Coors are not ones to bury their money in the backyard. The biggest tax loopholes continue to be real estate and life insurance products. It is not at all unusual for a successful real estate developer/owner to not pay any income taxes at all during his lifetime or at this death. He (or she) simply “cashes in” their equity,not by selling the property and creating taxable income, but by refinancing the property (loan proceeds are not taxed) .At death the unpaid income taxes over all those years on all those properties is forgiven because of the Treasury “step up ” adjustment. If you invest in life insurance policies, the interest and dividends that accumulate each year in the policy are not taxed. At death, the life insurance proceeds are tax-free and all of the accumulated income over the years escapes tax. The luxury goods tax would be collected, much like cigarette taxes at the point of manufacture, importation or distribution. The tax would already be paid before there was any black market opportunity. The underground market on cigarettes is caused by the differences between states in levying local or state sin taxes. I am all for taxing luxury items at a very steep rate. Somehow Jon Bon Jovi spending $60,000 for a night out on the town would probably not notice if the bill was $61,800. Before his death Aaron Spelling spent $150 million on his palatial and ecologically unfriendly magna-estate in Southern California. His wife received the property estate tax free and its basis was “stepped-up”. She now has the property up for sale and will pay no income taxes on its sale. (The Press wonders why he short-changed his daughter in his will. Transfers between father and children do not escape estate taxes. Its all about not paying your fair share….during your lifetime or at death). As for Warren Buffett, he should come to the aid of his country. No one is more respected or more qualified to change the system.
Vivienne, you might as well just say that you favor an income tax and leave it at that if you’re not going to evaluate alternatives equally (comment #1) or not compare and contrast alternatives at all (comment #6). Your comments are usually more thoughtful than these. This is the first time that the term “knee-jerk” has come to mind when reading something by you.
Here, I’ll get you started on your response: “It’s not the first time the term ‘jerk’ has come to mind when reading…”. ;-)
Steve, please go back to my previous comment. After the words, “I meant to say”, insert these: “in my view”. Is that better?
I don’t think spending time to contrast and compare alternatives is meaningful in this case, since the “alternative” is too ill-defined. (Del makes a number of specific suggestions, but there is no reason to suppose that those would be in a finally adopted system.) There are too many other pressing questions of the day and I need to get my leeks in. What I was trying to say in my original comment is that politics will intervene over time to alter any system, no matter how designed, to favor certain people’s interests, typically those with plenty of money. (Okay, you can call me cynical again now.)
I should also say that in my view, a system that has a moderately redistributionist tilt (i.e., progressive taxation) is more equitable. Some people will not agree with me. Many of those (who don’t see redistribution as fair) favor a consumption tax.
I don’t want to get mixed up in the discussion between the consumption tax vs. income tax issue that all of you have been conducting up to now. But I do want to pick up on one of Del’s points that appears to have gotten lost in the mix. Specifically, the myth that our current system represents a truly fair progressive tax system.
Here are a couple of real world examples:
A self employed individual had a 2008 Adjusted Gross Income of $46,000 and a Taxable Income of $27,500 on which he owed $3,700 in federal income taxes and $7,700 for Social Security and Medicare (remember that a self employed person pays both halves) for a total Federal Tax burden of $11,400. That’s an effective tax rate of 41% on the Taxable Income!!!
Another self employed individual had a 2008 Adjusted Gross Income of $422,000 and a Taxable Income of $368,000 and owed $96,000 in federal income taxes (representing the impact of the dreaded AMT) and $20,000 for Social Security and Medicare or a total Federal Tax of $116,000 for an effective tax rate of 35% of Taxable Income.
Does anyone think that a person with a taxable income of $27,000 should have a higher proportional tax burden than some someone making $368,000?
I think that these two very real world examples effectively demonstrate the impact that the so called employment taxes (Social Security and Medicare) have on lower income individuals vs. higher income ones.
The system as it currently exists seriously screws folks at the lower end of the spectrum. By the way, the $46,000 taxable income is a whole lot closer to the “average Joe” than is the other guy!
I think that this is really screwed up! Don’t you?
Screwed up? No.
Suppose that every day, ten men go out for beer and
the bill for all ten comes to $100. If they paid their bill
the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.
So, that’s what they decided to do.
The ten men drank in the bar every day and seemed
quite happy with the arrangement, until one day, the owner
threw them a curve. “Since you are all such good
customers,” he said, “I’m going to reduce the
cost of your daily beer by $20.” Drinks for the ten now
cost just $80. The group still wanted to pay their bill the
way we pay our taxes so the first four men were unaffected.
They would still drink for free. But what about the other
six men – the paying customers? How could they divide the
$20 windfall so that everyone would get his ‘fair
share?’ They realized that $20 divided by six is $3.33.
But if they subtracted that from everybody’s share, then
the fifth man and the sixth man would each end up being paid
to drink his beer. So, the bar owner suggested a plan to
reduce each man’s bill, and he worked out the amounts
each should pay.
And so:
The fifth man, like the first four, now paid nothing
(100% savings).
The sixth now paid $2 instead of $3 (33% savings).
The seventh now pay $5 instead of $7 (28% savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).
Note that the tenth man got the smallest percentage
reduction and now paid 61.25% of the total bill, where he
previously paid 59% of the bill. Each of the six was better
off than before. And the first four continued to drink for
free. But once outside the restaurant, the men began to
compare their savings.
“I only got a dollar out of the $20 declared the
sixth man. He pointed to the tenth man, “but he got
$10!” “Yeah, that’s right,” exclaimed
the fifth man. “I only saved a dollar, too. It’s
unfair that he got ten times more than I!”
“That’s true!!” shouted the seventh man.
“Why should he get $10 back when I got only two? The
wealthy get all the breaks!” “Wait a
minute,” yelled the first four men in unison. “We
didn’t get anything at all. The system exploits the
poor!”
The nine men surrounded the tenth and beat him up. The
next night the tenth man didn’t show up for drinks, so
the nine sat down and had beers without him. But when it
came time to pay the bill, they discovered something
important. They didn’t have enough money between all of
them for even half of the bill!
I’m just saying.
Please don’t pee in the pool, Marvin. If we wanted the simplistic, misleading, sexist propaganda of Fox News, we’d be watching that instead of reading the Chronicle.
Steve – “Lighten up, Francis…”
Steve,
Sorry I struck a nerve when I interrupted the groupthink. Thanks for your open acceptance of alternative views of the issue.
Curiously, Michigan was ranked 20th – above California (47th) – in one business tax index (by a small lobbying group in Virginia): Link to SBE Council
But even with online wizards such as these: Link to Michigan Business Tax estimator
The policy is still mind-numbingly byzantine.
Please read about the Fair Tax (www.fairtax.org) – it is a consumption tax that has answered many of the objections familiar to standard consumption taxes. It is not regressive (prebate), easier to collect (the state sales tax is rarely avoided) and while a lot of people like to claim that it would create a large black market, most economists do not agree with that. I had a lot of questions about the Fair Tax also when I first heard about it, now I believe it would be the most fair way for the government to collect their revenue that they need. Read about it, pros and cons, and make up your own mind, but don’t be blinded by half-truths being put out against it.
As far as the government “tinkering” with it after it is in, while, if we the people allow that, shame on us and we get what we deserve. Easier said than done, but any official that tries to tinker with the tax code after it is passed should face the consequences of those actions (i.e. no longer being in public office.)
The Fair Tax would be a huge boost to the state economy, as well as making for an extremely attractive environment for business, leading to more jobs, and more prosperity.
Marvin (and others), please excuse my crankiness. I was confused and didn’t sufficiently do The Work (www.thework.com) before responding to your post. I’ll try again.
I don’t think your story captures the complexity or the reality of the tax system–for sales or income–nor the reality of who pays and how much.
Yeah, that felt better. Thanks for the feedback. You too, Scott.
Bob Martel’s points are excellent. I agree, our current system is not adequately progressive. I’ve complained for years that the payroll tax (FICA, Social Security) is regressive. It should apply to all income without limit or at least to a higher limit. (Medicare, I believe, is without limit.) However, there is some relief in that SS benefits do go to lower income people with better proportionality. There are two bends in the formula so that as the contributing income rises, the amount of benefit decreases somewhat. Also, the Earned Income credit compensates somewhat for payroll tax at the lowest income levels.
Steve, this subject makes us all cranky. QED.
Sure, my example above is pretty simplistic but it is intended to do two things: 1) It encourages people not to focus on the minutia of the tax code (Viv) and instead focus on how taxation influences people in sometimes unintended ways and 2) Every once in a while it is nice avert you gaze from your navel and consider that 50% of Americans have a different view on a subject than the insulated environment within the walls of Ann Arbor.
Again, I appologize if I offended anyone by having an opinion contrary to the majority here. Rather than be nasty, I chose a way to express my opinion with a simple story. I respectfully disagree 100% with what Mr. Martel and Ms. Armentrout (as well as Mr. Bean) have said here but I also understand that no matter what I say, I will not change their views on the subject.
I’m more open-minded than you seem to imagine, Marvin. Take a chance that we’re not navel-gazers and state your opinion on the subject. You might also consider whether you are open to changing your own views.
Interesting that you can disagree 100% with all three of us given that Vivienne and I (at least) aren’t all that much in agreement. Groupthink? Doesn’t look like it to me.
Like Vivienne, I think Bob’s examples provided some interesting perspective. Why she doesn’t see it as further supporting something more in line with Del’s proposal is still unclear to me.
Steve, I know that minds are not easily changed. I speak from experience.
I have great faith that the readership and those who comment on Chronicle articles are more likely to comment in order to educate, and that we actually read the comments and are interested in a broad base of opinion. We like to learn. I have changed my mind about some issues based on what I’ve learned here. I’m certain I am not alone. One example that springs to mind is a city income tax. I totally reversed my opinion (changed my mind)based on discussions here.
I have seen Steve change his mind, also admit when he is wrong. It is just one of his admirable qualities.
Here is a great quote from today’s New York Times. It was describing the difficulty economists have in forecasting the economy: “looking at the same set of data, and coming to radically different conclusions based on their politics, their temperament, and their idiosyncratic reading of history.” I’d say that applies to opinions about taxes, too.