Mark Zuckerberg and his wife, Priscilla Chan, recently pledged to donate 99 percent of their Facebook shares to charitable purposes over their lifetimes. They are doing it through the Chan Zuckerberg Initiative, which uses a limited liability corporate structure.
Why not give to an IRS-approved charity, or a foundation created by Zuckerberg and Chan, instead? Two reasons leap to my mind, both shaped by nonprofit law. The first, which I fail to see in most commentary to date, is that generous lifetime giving by the wealthy can’t get much of a charitable deduction no matter how structured. Second, the Zuckerberg-Chan pledge falls into a class of efforts sometimes labeled “fourth sector” initiatives, which give much greater flexibility for how the money is used, including combining charitable and business purposes and lobbying for a favored cause—essentially what private individuals can but pure charities cannot do.
Economic Income, Realized Income, and the Charitable Deduction
In studies examining the behavior of those with significant wealth, other researchers and I show how little income they tend to realize, often 3 percent or less of the value of that wealth. That doesn’t mean the investors have earned such low rates of return. In fact, many like Mark Zuckerberg became millionaires or billionaires because they got very high returns. Most of their money, however, tends to be in stock or a closely-held business and, especially for those with only a few million dollars in total wealth, residences and vacation homes. As long as the wealthy don’t sell those assets, they won’t “realize” for tax or other accounting purposes the true economic returns or gains they achieve. And those gains can be substantially more than 3 percent: from 1926 to 2014, including during the Great Depression and Great Recession, stocks produced an average annual return of about 10 percent before inflation.
Related research examining the charitable activities of such wealthy individuals shows that most delay a huge portion of their giving until death. That is, they give from the wealth of their estates, not the income of their lifetimes. Why? Because tax law provides very little incentive to give huge donations to charity during a lifetime. Let’s suppose that Mark Zuckerberg and Priscilla Chan normally realize as income 2 percent of their estimated $45 billion wealth, or $900 million, this year. The charitable deduction is limited to 50 percent of yearly income, which in Zuckerberg and Chan’s case is $450 million; it’s only 30 percent ($270 million) if they want to give to foundation. Thus, if Zuckerberg and Chan give away more than 1 percent of their wealth each year, they run out of allowable charitable deductions. If in an average year they earn 10 percent on their wealth and give away only 1 percent, they are still accumulating much faster than they are giving it away, unless they consume billions annually.
Running out of charitable deductions doesn’t mean that the wealthy gain nothing from giving away money directly to charities earlier in life. Once assets are transferred to a charity, the donors don’t have to pay taxes on the income earned from those assets. But donors such as Zuckerberg and Chan would achieve only modest tax savings from early gifts to charity as long as their taxable income from the alternative remains a small percentage of their wealth. What also might be in play here, and I don’t fully know, is that the charitable side of the Chan Zuckerberg initiative will yield enough losses, transfers, and sales to needy individuals at below-market cost to offset any taxable income otherwise earned on the business side, so it can effectively avoid income tax just as well as an outright charity.
For Benefit Corporations and the Fourth Sector
So limits on the advantages of a charitable deduction provide a significant impetus for wealthy individuals to pledge money for charitable purposes without necessarily giving it to a charity. Donors may also think the flexibility they gain is substantial relative to any potentially modest tax costs. Giving to charity later is always an option, thus avoiding estate tax; meanwhile, other options haven’t been foreclosed.
Among the additional options at play is combining nonprofit and business activity. Among the many efforts of this type that get complicated in a pure charity setting are raising private equity; sharing real estate investment returns with low-income residents; running a business centered around training its workers and building up their equity rather than making profits for investors; investing in new drug research and pledging that the public, not investors, will garner any potential monopoly returns from some successful patent; or investing in green energy by granting some risk protection to private capital partners; and garnering research and development tax credits.
Some states have tried to create special rules applicable to certain “for-benefit corporations” that allow shareholders and charities to share returns. But, for the most part, the walls surrounding charitable money can’t be torn down. Federal and state tax and other nonprofit laws protect money that now essentially belongs to the public (with the charity as fiduciary), not to the donors.
If donors aren’t worried about getting a charitable deduction up front anyway, as is likely the case for Zuckerberg and Chan, the easiest route is to create a potentially profit-making limited-liability business. Meanwhile, donors can engage in all sorts of ventures without having their lawyers shouting “Stop” to each new creative idea because it might violate some charitable law. At the same time, Zuckerberg and Chan need a new entity since they can’t pursue their charitable pursuits directly through Facebook without soon running into problems meeting that corporation’s obligations to other shareholders.
If Zuckerberg and Chan decide that they want to lobby government, they also can avoid any limitation imposed on foundations or other charities.
These types of private initiatives, sometimes labeled as a Fourth Sector, push society in new, exciting, and yet-to-be-determined directions. As I’ve discovered when I raise money for charity, people will often consider giving away much more when asked to think about giving out of their wealth, not just their realized income. Fundraisers, take note: I don’t think we’ve even begun to tap this way of encouraging giving. Also, people often see new possibilities for enhancing charitable purposes when not confining themselves within the walls surrounding a typical charity, with entrepreneurs and venture capitalists often especially excited by the new adventure. Zuckerberg and Chan are merely two of the richer faces giving new attention to these broader movements.
When I was a kid, I asked Santa to bring me a bike or a baseball glove. As an adult, I mainly wished for good health and good cheer for myself and my loved ones. This year, I have a particular request that I hope the man in the red suit can grant: I want to be a drug company.
I want the government to give me a monopoly over what I produce. I want to be able to set almost any price for my products.
I want the government to pay for whatever tens of millions of government-subsidized customers buy from me. I also want the government to pay those who sell my product or spend their time advising and prescribing my product for others.
I want to be paid for years and decades for producing the same thing to meet some chronic need, even if it would be better to produce things that heal or cure. I want to be paid for things that sometimes turn out to be worthless, and to avoid the possibility of my customers haggling over prices or suing me because they don’t pay for those things directly.
I want Congress to give me the power to appropriate money to myself and give up some of the power reserved in the Constitution for itself.
But I’m not done.
I want the government to let me avoid paying tax on the income I earn from the money it pays me. I want to be able to live in the United States and claim citizenship for tax purposes abroad in some low–tax rate country. I want to defer taxes on my income, then have the government forgive that tax debt. And I want congressional representatives who for years—even decades—have been more interested in fighting among themselves than in doing anything about this type of arrangement.
Why not? A recent news flurry surrounds Pfizer’s announcement that it will now become a foreign company so it can avoid US corporate tax and grab money set aside abroad for US tax liabilities. But that’s only the tail on a long list of favors granted it and other drug companies.
I write a lot. Imagine if I put my work under copyright, then lobbied to have a law passed that creates millions of subsidized customers who can have my work for free because I’m billing the government. Of course, I should be allowed to set almost any price for what the government pays on behalf of those customers. And the government could promise to book and magazine sellers that their profits would rise automatically with sales of my writings. Meanwhile, I’ve been around long enough that I’ve got a good share of my income deferred from tax until I draw down my 401(k) accounts, so I should be allowed to rent a shack somewhere abroad, claim a foreign residence, and avoid ever paying tax on that income, even while I live in the States.
Now, don’t blame me if I respond naturally to all those incentives. Or lobby Congress to maintain them. And don’t blame me if I end up producing things less worthwhile than what I could produce. Hey, it’s a free country.
How about you? Maybe together we can invent a company for workers and could be granted power to charge anything we want for providing that work to a large set of government-subsidized customers. We shouldn’t have to pay tax, given all we are doing for the economy. We could get some deep-thinking consulting firms to prove that this would probably solve any future unemployment problem.
What do you say, Santa? For goodness sake, you know I’ve been good, and I’m not pouting. With this wish, I’m just asking for what your competitor, Congress, gave the drug company next door.
On October 22 Paul Ryan announced he “will gladly serve” as Speaker of the House if he can unify the Republicans around his vision for the party and the Speaker’s role within it. He faces an uphill battle: Mo Brooks of the House Freedom Caucus has already voiced his concern at Ryan’s reluctance “to do the speaker job as it’s been done in the past.”
But what if the job, not the person filling it, has become the problem? What if the expectations now placed on any Speaker of the House are so unreasonable that no one can meet them? What if the procedures of both the House and the Senate simply cannot meet modern legislative needs? Then we had best not place our hopes on the right person meeting wrong expectations.
Instead, to succeed, the next Speaker of the House must radically redefine that role and how the House conducts business. Ryan himself has stated that “we need to update our House rules…and ensure that we don’t experience constant leadership challenges and crisis.”
At least since the time of Newt Gingrich, an extraordinary amount of the House’s power has been concentrated in the Speaker’s office (although I sense that John Boehner struggled to simultaneously maintain that power and disperse it). Consider some consequences of this convergence:
- Acrimony. The antipathy that accompanies all concentrations of power has spread not just between political parties, but within them as well. One of Republican Congressman Mark Meadows’ chief complaints about John Boehner was that the Speaker had attempted “to consolidate power and centralize decisionmaking.”
- Attention to party rather than nation. In recent years, the House has attempted to confine enactments to items that receive broad consensus among members of the majority party. But the US Congress cannot operate like the British House of Commons, where party leaders become prime ministers. Our Constitution separates the country’s executive and legislative functions, slowing down reforms both good and bad. Although we can’t imitate most British parliamentary procedures, I do think the British tradition of the Speaker resigning his or her party position to serve all House members is worth looking into.
- Inefficient policymaking. Congressional committees are much weaker than they were 20 years ago. At one time the Ways and Means Committee was the most powerful in the House, and its chair was often as powerful as the Speaker. Working closely with the Senate Finance Committee, Ways and Means often took on the unpopular task of identifying how to increase taxes or cut the entitlement spending under its jurisdiction so the nation’s balance sheets maintained some semblance of order. However, once much of the committee’s power was relegated to a Speaker whose job revolved around keeping members of his party happy, necessary economic choices and the compromises that need to be ironed out in a small group— often including members of the other party—couldn’t be developed or sustained. In turn, the complicated, technical, details of policymaking—whether over a tax cut or a health care expansion—often got messed up when put under the purview of people with limited expertise on the particular laws being reformed.
In sum, a Speaker can’t serve either nation or party well when so much power is concentrated in one office, the acrimony surrounding such concentration rises so high, too many party obligations weaken the Speaker’s ability to focus on legislative obligations, and the assumption that the primary role of the Speaker is to promote partisan politics weakens the ability of the House to make tough choices and creatively draft detailed legislation.
Of course, the Speaker cannot reform his own role in isolation from other roles and rules within the House. As already noted, more legislative power can be returned to committees, and party politics can be relegated to party whips or other officers with no obligations to the House as a whole. Here I agree with many Freedom Caucus members, who claim they want to empower committees, but I disagree that this means that a small group within a majority party should be more likely to get its way. The job of the committee chair, just like the job of the Speaker, is to create legislation that will form enough consensus to pass the House, the Senate, and the presidential veto pen.
The House, led by the Speaker, must also start to tackle other obstacles to legislation. Here are three to start. First, political staffs should be reduced in size and nonpartisan staffs increased. The House budget and tax-writing committees can look to the Congressional Budget Office or Joint Committee on Taxation for objective analyses of legislative proposals; other committees lack independent reality-checkers. Second, the congressional budget process is long overdue for overhaul. As a former head of the Budget Committee, Paul Ryan should be all over this one. Third, the wasteful replication of hearings on the same subject matter across House committee jurisdictions should be curtailed.
There’s no guarantee that any particular reform will suddenly make the House more productive. But continuing under current expectations and processes almost assuredly insures that both the House and the Speaker will fail to meet their fundamental constitutional responsibilities to legislate for the nation.
Disgruntled minorities will always seek whatever power the existing structure grants them. The next Speaker can only meet his huge challenges by boldly changing the rules of the game he is called to officiate.
Setting disability policy is tough. Very tough. It’s tough empirically to measure and distinguish among degrees of disability or need. It’s tough legally and administratively to draw boundaries without excluding some sympathetic person or giving an inappropriate level of benefits to someone whose needs can’t fully be assessed. It’s tough economically to transfer resources to people with disabilities without setting up perverse incentives that separate them from the workplace and their fellow workers. It’s tough socially because the needs are so great.
Disability policy has gotten increased attention recently because the Social Security Disability Insurance (SSDI) trust fund is unable to pay our current benefits through 2016. But reform should involve more than money. By defining eligibility for benefits partly by the inability to work, SSDI and other federal disability policies effectively discourage recipients from trying to support themselves. If they work, they lose their benefits. This needs to be fixed. But how?
In a recent conference sponsored by the McCrery-Pomeroy SSDI Solutions Initiative (disclosure: I helped organize the initiative and still serve as advisor), no one advocated reducing benefits to bring SSDI back into balance. Nor did anyone suggest merely raising taxes.
Most speakers talked about the need to modernize US disability policy—in particular, to offer opportunities for people who want to work, can work at some level, or can keep working if they receive help when they first develop a health problem or impairment. Speakers recognized that work is therapeutic and that disability policy should account for the factors that can affect someone’s disability differentially across his or her lifetime, such as the episodic nature of many mental illnesses and the kinds of rehabilitation that can prove helpful to different people at different times.
Disability policy is exactly the same as other policy in one respect: it contains a fairly precise, even if implicit, calculus of what and whom will and won’t be funded. So, any reform to the policy must address the balance sheet.
The President and Congress seem ready to punt on dealing with SSDI, effectively covering shortfalls by transferring money from Social Security Old Age Insurance (OAI). Despite the pretense, such a move is not costless. Today’s taxpayers and beneficiaries won’t need to pay for the growing costs of SSDI, but future taxpayers and beneficiaries—of SSDI or other federal programs—will inherit even higher SSDI or OAI deficits, along with their compounding interest costs. Meanwhile, today’s catalyst for reform is neutralized.
As I listened to the McCrery-Pomeroy conference speakers propose adding work incentives and supports to SSDI (a suggestion I lean favorably toward, despite many design issues), it struck me that the proponents were implicitly suggesting that there is a better way to spend the next SSDI dollars than simply expanding the current program. If those proponents genuinely believe that work incentives and supports are the right way to direct additional dollars, then they also imply that we ought to look at how Congress already has scheduled additional dollars to be spent.
Some advocates may try to claim that we shouldn’t make such marginal budget comparisons. When I co-wrote a book on programs for children with disabilities, my fellow authors and I were criticized in one review for noting simply that the principle of progressivity requires figuring out who needs support the most. Such a critique ignores that we have to make choices, so we may as well do them as best we can. No one, proponent or opponent of current or any reformed law, can get around the simple fact that dollars spent one way cannot be spent another.
Let me put this in terms of the politics. Politicians never want to identify losers because then we voters crucify them. They want to operate on the give-away side of the budget: spending increases and tax cuts. So how can we give politicians some protection to reform disability policy if you and I know that putting relatively more money into work supports changes the nature of SSDI and prevents some other use of the money?
Here’s one way: emphasize the long-term dynamic that reform in a growing economy makes possible. Counting everything from health care to education to disability policy, our social welfare budget now spends about $35,000 annually per household. As the economy grows over time, the number is going to increase—perhaps to $70,000 if the economy doubles in another few decades. We don’t need to cut back on disability programs absolutely in order to allocate a share of those new marginal dollars to different approaches. We simply need to focus the growth of those future budgets.
SSDI and OASI grow automatically over time because benefits are indexed for real growth in the economy over and above inflation. No legislator determines that today’s additional expenditures should be directed one way or another; it’s in a formula set decades ago. Why not consider reducing that automatic growth to finance more subsidies and supports for people who want to keep working? What about capping growth—at least for those getting maximum benefits? What about re-allocating some of the federal health budget, where so many of the dollars are captured by providers rather than consumers, to help pay for work supports?
Or what about cutting back on those features of SSDI that add to the anti-work incentives? For example, what about paring the ability to increase your benefits by about 30 percent if you retire at age 62 on disability insurance instead of old age insurance, at least for people at higher incomes? Or at least not increasing that disability insurance bump, as now happens automatically when the full retirement age increases?
We can shift toward a more modern disability insurance system, but only when we face up honestly to the trade-offs implicit or explicit in every system. We will never move disability policy away from its antiwork emphasis if we’re not willing simultaneously to address the way we put additional resources into the current prevailing system. And, as best I see it, that is just what a scared Congress and president are about to do.
In testimony yesterday before a joint hearing of two House subcommittees, I urged Congress to modernize the nation’s social welfare programs to focus on early childhood, quality teachers, more effective work subsidies, and improved neighborhoods. One way lawmakers can shift their gaze is by considering the effects of combined marginal tax rates that often rise steeply as people increase their income and lose their eligibility for benefits.
While some talk about how we live in an age of austerity, we are in fact in a period of extraordinary opportunity. On a per-household basis, our income is higher than before the Great Recession and 60 percent higher than when Ronald Reagan was elected President in 1980.
A forward-looking social welfare budget should not be defined by the needs of a society from decades past. Two examples of how our priorities have shifted: Republicans and Democrats didn’t always agree on the merits of Aid to Families with Dependent Children (AFDC) or the Earned Income Tax Credit, yet they agreed on the need to shift from welfare to wage subsidies. Ditto for moving from public housing toward housing vouchers.
I sense that both the American public and its elected representatives are united in wanting to create a 21st century social welfare budget. That budget, I believe, should and will place greater focus on opportunity, mobility, work, and investment in human, real, and financial capital.
However, for the most part, our focus has been elsewhere. As I show in my recent book Dead Men Ruling, we live at a time when our elected officials are trapped by the promises of their predecessors. New agendas mean reneging on past promises. Even modest economic growth provides new opportunities, but the nation operates on a budget constrained by choices made by dead and retired elected officials who continue to rule.
For instance, the Congressional Budget Office and others project government will increase spending and tax subsidies by more than $1 trillion annually by 2025, yet they already absorb more than all future additional revenues—the traditional source of flexibility in budget making.
I am concerned about the potential negative effects of these programs on work, wealth accumulation, and marriage of combined marginal tax rate imposed mainly on lower-income households. To see how multiple programs combine to reduce the reward to work and marriage, look at this graph.
For households with children, combined marginal tax rates from direct taxes and the phasing out of benefits from universally available programs like EITC, SNAP, and government-subsidized health insurance average about 60 percent as they move from about $15,000 to $55,000 of income. This is what happens when a head of household moves toward full-time work, takes a second job, or marries another worker.
Beneficiaries of additional housing and welfare support face marginal rates that average closer to 75 percent. Add out of pocket costs for transportation, consumption taxes, and child care, and the gains from work fall even more. Sometimes there are no gains at all.
While there is widespread disagreement on the size of these disincentive effects on work and marriage, there is little doubt that they exist. One solution: Focus future resources on increasing opportunity for young households. Make combined tax rates more explicit and make work a stronger requirement for receiving some benefits.
This post originally appeared on TaxVox.
Remember when people complained that hedge fund managers and private equity firm owners paid a lower tax rate than many workers? Or when Warren Buffett said he shouldn’t pay a lower rate than his secretary? In those cases, investors were benefiting from low capital gains rates, but at least they paid some tax.
Now, thanks to Roth accounts, a special form of retirement savings, investors and even their children pay close to zero tax on huge sums of income. While this scheme can create significant future government budget shortfalls, my attention here is on how our tax code favors those who understand how to play this Roth-account game.
You got a hint of what might be possible when Governor Romney disclosed that he had over $100 million in his individual retirement account. However, this money was in a traditional IRA, taxable upon distribution, not a Roth IRA, where once a modest tax is paid up front, then all future income from the account escapes tax. Thus, Romney missed out on some of the tax benefits available to Roth holders.
The Taxpayer Relief Act of 1997 first made such accounts possible. At about that time, I warned in Tax Notes Magazine about how some investors could use Roths to avoid almost all tax on significant amounts of income. But I didn’t have a smoking gun, since I was anticipating future accruals on this then-new option. Tax professionals who put high-return hedge fund or private equity return assets into a Roth for wealthy clients have no incentive to disclose the details of these deals.
But a recent article by Richard Rubin and Margaret Collins for Bloomberg describes a redesigned retirement plan of Renaissance Technologies that allows employees to put retirement monies into Medallion, a hedge fund that historically has produced extraordinary high returns. My colleague, Steven Rosenthal, examines the tax implications and questions the future role of the Labor and Treasury Departments in these developments.
But you don’t need to work for a private equity firm or hedge fund to benefit. Let’s start with the tax sheltering opportunity available to almost anyone willing to invest far into the future and who earns no more than the normal long-term rate of return on stocks.
Suppose a 25 year-old taxpayer puts $10,000 in Roth accounts, perhaps helped out by parents. Once he pays a small upfront tax on the contributions, the tax on these accounts is now totally prepaid. He will never owe another dime. If stocks provide a traditional historic return of, say, 9 percent per year, the portfolio would grow to $483,000 by age 70, the age at which people must withdraw from traditional retirement accounts but not Roths. Make a few such deposits, and soon millions of dollars of income can escape tax.
But 9 percent represents an average return, chicken feed compared to the successful private equity investor, inventor, entrepreneur, or small business person. If they are insiders or somehow know, they might well know that they are likely to generate 15 percent per year over time. Others might also generate this higher return because of invention, luck, or simply leveraging up their returns. If the investment returns 15 percent annually, a $10,000 deposit held for 45 years grows to $5.4 million by age 70.
Perhaps you think the example of a 25-year old depositing money until age 70 is exaggerated. But it understates the more extreme cases. A Roth IRA can be held much longer than 45 years, e.g., a 35 year old living to 90 can leave the money to his kids who must withdraw the money only gradually after the parent’s death, so in this case complete tax exemption would last 55 years, and partial exemption would extend outward toward a century.
Think what this does for the fairness of a tax system. People who turn out to make millions of dollars of income on their investments will often pay no more tax (up front or down the road) than people who make little or nothing on their saving. To be clear, I’m saying dollars of tax, not rate of tax, would often be the same. The unsuccessful will be taxed the same as the successful, violating the whole notion of proportionality, much less progressivity, in taxation. I can think of almost no other tax provision, whether in an income or consumption tax, that goes so far in violating the notion that those who either make more money or consume more can afford to pay more tax.
This post originally appeared on TaxVox.
There are many ways to restructure the tax code. Elected officials often fail to detect opportunity when they adhere in a path-dependent way to one past model of success, such the 1986 tax reform. An alternative approach where even the acclaimed 1986 effort made at best modest progress would focus on making tax code simpler for taxpayers and improving compliance without adding to IRS costs. This reframing of reform stands a chance of stepping around the partisan wrangling that deters progress on so many other policy fronts.
In recent weeks, IRS Commissioner John Koskinen has been lamenting the Service’s inability to perform its functions well, mostly recently at today’s Tax Policy Center event on the impact of IRS budget cuts. It not only continues to lose staff, but less experienced staff quickly must replace a large fraction of senior employees who are leaving.
At the same time, congressional Republicans have been finding fault with much of what the IRS does, from its inability to regulate the activities of social welfare 501(c)(4) organizations to its implementation of the Affordable Care Act. Democrats say the solution is a bigger IRS budget. Republicans say it is a smaller one. But there is an alternative choice.
Focus tax reform on an objective almost never before given priority: developing a system that is less costly for taxpayers to comply with, mostly through simplification of existing laws. Simultaneously modify laws where IRS enforcement is difficult or impossible or too costly ever to do well. Such an effort would not necessarily require base broadening, though that often would be consistent. For instance, rather than engaging in a non-productive debate over whether to eliminate or expand refundable tax credits for low-income households, Congress could simply replace the existing credits with versions that are easier for taxpayers to understand and for the IRS to administer.
Put everything on the table, ranging from business deductions to multiple capital gains tax rates to complexity of retirement plan options to refundable credits that go mainly to the poor. Include many of the small items like mileage deductions that can be vastly simplified.
The first step in such an effort would be for the IRS to better understand known error rates for each preference and “program” based partly upon the audit data it keeps. Believe it or not, the agency has never done any good comprehensive study on this, though on occasion it has tried to measure the extent of noncompliance in rough terms.
And the IRS has never conducted this type of research to inform policy, as opposed to allocating internal audit functions. IRS should study taxpayer time costs, error rates, causes of error, costs of auditing, and administrative aspects of every program put into the tax code. For instance, although relatively easy to do, it has never really distinguished in its studies what it can’t know or can’t enforce well from the error rates that it can find under some audit technique.
The second step would be for the IRS and its colleagues at the Treasury’s Office of Tax Policy to be prepared, at least in a tax reform setting, to acknowledge what provisions it cannot monitor at a reasonable cost. For instance, it can estimate compliance with wages reported to the IRS on W-2 forms, but it seems fairly certain that it has little idea of how much charitable contributions of clothing are overvalued. Even if it did, it has no way to efficiently allocate resources to monitor such deductions.
I recognize that a balancing act is required, since IRS doesn’t want to encourage even more noncompliance. But an agency can’t engage in continuous improvement if it doesn’t study and acknowledge its problems in the first place. Indeed, some of IRS’s recent public conflicts, such as over the tax-exempt status of Tea Party and other social welfare organizations, stemmed from what every tax policy analyst has always known: that limited resources devoted to vague or hard-to-enforce law eventually can lead to disaster.
With attention to individual simplification, along with the improved compliance that comes from removal of laws that can’t be enforced, both parties could claim a victory. A simpler and more efficient tax system conforms to both progressive and conservative principles.
Unlike more money for audit, moreover, making the system more administrable and simpler modestly increases national well-being.
In a fairly comprehensive study I undertook for the American Bar Association and the American Institute of Certified Accountants many years ago, I found that expanding IRS audit resources was likely to raise more than was spent, ranging from $2 to $7, depending upon type of return, for every dollar spent. I doubt the conclusion has changed greatly since then. But while more auditors would help redistribute the tax burden in favor of compliant taxpayers, there’s no gain and a likely loss in output by taking workers away from more productive activities.
Administrative reform and simplification, on the other hand, can reduce noncompliance while increasing the time that taxpayers can devote to more productive pursuits. Of course, to achieve this goal, leaders of both parties have to cooperate to make changes that benefit the public, even when it gives them no partisan advantage.
This column originally appeared on TaxVox.
What happens when the claim to some financial right from the government creates some financial “wrong” somewhere else?
That is, when the government’s balance sheets don’t balance, and there aren’t enough assets to pay for claims on them, someone must get short-changed. If that “someone” must accept unequal treatment under the law, has the right been matched by a “wrong?” These issues have now arisen for underfunded state pension plans, but they continue to apply in other arenas, such as the unequal assessment of property taxes in states like California. In these and other cases, the young often end up paying the piper.
Protecting rights has long been crucial to maintaining a democratic order. The United States has a long history of protecting citizens’ rights, embedded from the beginning of the nation in the Bill of Rights and, since then, in many legal and constitutional clauses. These aim largely to establish liberty and require equal treatment under the law. When it comes more narrowly to most disputes over private property and assets, there are no “unfunded” government promises; contestants simply dispute over who gets the private funds. The court effectively fills out the balance sheet when it resolves those private disputes. A higher inheritance to one party out of a known amount of estate assets, for example, means a lower amount for another. There’s no third party or unidentified taxpayer who must to contribute or add to the estate so all potential inheritors can walk away happy.
When it comes to financial “rights” established by law, the issue becomes more complicated. The latest cases getting much attention revolve around the rights of state and local public employees to the benefits promised by their pension plans, even when those plans do not have the assets to cover the claims. Some courts have determined that the promised benefits are inviolable under state constitutions, regardless of available assets; other courts have recently interpreted state laws differently, led by the bankruptcy and financial distress of state pension plans.
As another example, some states give longer-term homeowners rights to lower taxation rates than newer homeowners. Proposition 13 of the California Constitution requires that property taxes cannot be increased by more than a certain rate, effectively granting existing homeowners lower tax rates than new homeowners receiving the same services for their tax dollars.
So where does the money come from? Saying that it can be the future taxpayer still dodges the issue of whether the allocation of benefits and costs meets a standard of equal justice.
Thus, when people lay claim to nonexistent government assets, “rights” can’t be totally separated from the “accounting” system under which they are assessed. I’m not a lawyer, but I believe courts and legislators do not do their job completely if they don’t admit to and address the following questions in any disputes on such matters:
- How can we judge anyone’s right to some financial compensation, pension benefit, or lower tax rate without at least knowing where and how the balance sheet is or might be filled out?
- How does the claim to a right by one set of citizens affect the rights of other citizens?
Even when courts determine that any resulting injustice is constitutional or the prerogative of the legislature, they still should do their balance-sheet homework.
In some arenas, the courts have made clear that the lack of underlying funds limits the rights of people to some promised benefit. The United States Supreme Court has stated, for instance, that Social Security benefits can be changed regardless of past legislative promises. This system is largely pay-as-you-go: benefits for the elderly come almost entirely from the taxes of the nonelderly. Because promised cash benefits now increasingly exceed taxes scheduled to be collected, even the pay-as-you-go balance sheet has not been filled out: some past Congress promised that benefits would grow over time without figuring out who would pay for that growth. Legislators can rebalance those sheets constitutionally without violating the rights of a current or future beneficiary. Whether they do so fairly is another matter.
When the courts have leaned toward treating as unalterable the rights of some citizens to unfunded promises made in the past, however, they have directly or indirectly required some unequal treatment under the law, with the young often paying the piper.
Our Urban Institute study of pension reforms in many states reveals that efforts to protect existing but not new state pensions almost always requires the young to receive significantly lower rates of total compensation than older workers doing the same work. Worse yet, we have determined that to cover unfunded liabilities from the past, some states are adopting pension plans that grant NEGATIVE employer pension or retirement plan benefits to new workers, essentially by requiring them to contribute more to the plan than most can expect to get back in future benefits.
In the case of California’s limited property tax increases, new, younger homeowners are required to pay much higher taxes than wealthier, older, and longer-term homeowners.
In these cases, it seems fairly clear that the “rights” of existing state workers or homeowners leads to an assessment of “wrongs”—unequal taxation of unequal pay for equal work—on others, mainly the young, to fill out the balance sheets.
As I say, I’m not a lawyer, but I do know that 2 + 2 does not equal 3. When the courts say that you are entitled to $2 and I’m entitled to $2, they can eventually defy the laws of mathematics if only $3 is available. It’s not that the declining availability of pension benefits to many workers and rapidly rising taxes are problems to be ignored. It’s just that assessing wrongs or liabilities on unrelated parties to a dispute is unlikely to represent equal justice under the law or an efficient way to resolve public finance issues.