Tax VOX
President Obama gestures during a speech at a food security expo on Friday, June 28, 2013, in Dakar, Senegal. Mr. Obama and other Democrats have pushed for private equity returns to be taxed at regular income rates for years, but a new paper argues that private equity managers should already tax their returns at traditional income tax rates. (Evan Vucci/AP)
Do private equity firms owe regular income tax?
For a decade, Congress has been debating how to tax managers of private equity firms. The argument is pretty familiar to tax wonks: Should these partners treat this compensation (commonly called carried interest) as capital gains, as they do today? Or should they be taxed at the higher ordinary income rate as President Obama and others have urged?
But what if the predicate of the debate is wrong? What if the returns to private equity firms themselves, as well as their managers, are already ordinary income under current law? What if the IRS has been getting it wrong all these years to the great benefit of private equity funds and similar investment firms?
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That’s the provocative argument my Tax Policy Center colleague Steve Rosenthal made in a paper earlier this year. Last month, Steve, who has had a long career as a tax lawyer, debated his theory with Andrew Needham, a partner at Cravath, Swain & Moore and a well-known expert in the tax treatment of these firms.
An edited version of their debate, before the American Bar Assn. national tax section, was reprinted by our friends at Tax Notes who have kindly made it publicly available. The legal arguments get pretty technical but they come down to this: ( Continue… )
Senate Finance Committee Chairman Sen. Max Baucus (D-Mont.), accompanied by the committee's ranking Republican Sen. Orrin Hatch (R-Utah) speaks in Washington, D.C. on May 21, 2013. Gleckman is skeptical the blank slate plan Baucus and Hatch have proposed will push forward tax reform. (Charles Dharapak/AP/File)
Will the Baucus-Hatch plan trigger tax reform? Probably not.
Senators Max Baucus (D-MT) and Orrin Hatch (R-UT), the chairman and senior Republican on the Senate Finance Committee, tried to jump-start the drive towards tax reform today with what they call a blank slate rewrite plan. Trouble is, it is not exactly a plan. And it isn’t quite a blank slate.
Their idea is to get senators to tell them by July 26 which tax preferences are worth keeping and which should be scrapped. So Baucus and Hatch adopted a zero-base budgeting approach.
In a letter to fellow senators, they said they plan to start their reform exercise by assuming that nearly all tax preferences are repealed. They’d then restore those that meet at least one of three tests: “(1) They help grow the economy, (2) make the tax code fairer, or (3) effectively promote other policy objectives.”
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Unfortunately, the first two are in the eye of the beholder and the third, well, I have no idea what the third means.
I do know their plan will be a massive summer windfall for lobbyists and trade groups that are already gearing up to find senators to defend their tax subsidies (cell service on the Vineyard is dicey but it will have to do). Within an hour of the release of the Baucus-Hatch letter, I was getting calls and emails defending various tax breaks. ( Continue… )
Nathan Frietas waves a rainbow flag at a celebration for the U. S. Supreme Court's ruling on Prop. 8 in the Castro District in San Francisco, Calif. on June 26, 2013. In a major victory for gay rights, the Supreme Court struck down a provision of a federal law denying federal benefits to married gay couples and cleared the way for the resumption of same-sex marriage in California. (Mathew Sumner/AP)
What will the Supreme Court decision on DOMA mean for the IRS?
I’m celebrating today’s Supreme Court ruling on the Defense of Marriage Act (DOMA) with my friends and relatives whose marriages are today, finally, accorded equal status to mine.
But I am a tax geek and couldn’t help but think about the consequences of a hundred thousand or so married couples who will now file joint returns rather than as singles or heads of household. My Tax Policy Center colleague Bob Williams has pointed out that while the tiny fraction of couples with wealth high enough to be affected by the estate will be unambiguously better off, the income tax is more of a mixed bag. Gay couples will now get to experience the joys and agonies of marriage bonuses and penalties.
But for about 75,000 married same-sex couples, the Supreme Court’s ruling could come with a very nice (though belated) wedding gift: Nearly $200 million in refunds.
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As Bob and others have pointed out, today’s ruling means that many newly recognized couples will now be able to file amended returns to claim the marriage bonuses they might have enjoyed for the past three years were it not for DOMA. .
We can’t know exactly how many couples will benefit and by how much because there is currently no way to identify legally married same sex couples on individual income tax returns. ( Continue… )
A flag hangs outside the New York Stock Exchange in New York, New York. Although many policymakers look at the US' public debt, they should also focus their attention on the government's federal assets, Gleckman says. (Eric Thayer/Reuters/File)
Uncle Sam's portfolio is (partly) offsetting the public debt
When policy folks talk about America’s federal borrowing, their go-to measures are the public debt, currently $12 trillion, and its ratio to gross domestic product, which is approaching 75 percent. Those figures represent the debt that Treasury has sold into public capital markets, pays interest on, and will one day roll over or repay.
These debt measures are important, but they paint an incomplete picture of America’s fiscal health. They don’t account for the current level of interest rates, for example, or for the trajectory of future revenues and spending. A third limitation, the focus of this post, is that the public debt doesn’t give Treasury any credit for the many financial assets it owns.
As we noted last week, Uncle Sam has been borrowing not only to finance deficits but also to make student loans, build up cash, and buy other financial assets. That portfolio now stands at $1.1 trillion, equivalent to almost one-tenth of the public debt.
Those assets have real value. They pay interest and dividends and could be sold if Treasury ever cared to. In fact, Treasury has sold many financial assets in recent years, including mortgage-backed securities and equity stakes in TARP-backed companies, even as it expanded its portfolio of student loans.
One way to take account of these holdings is to subtract their value from the outstanding debt. The rationale is straightforward. If Ann and Bob each owe $30,000 in student loans and have no other debts, they both have the same gross debt. But that doesn’t mean their financial situations are the same. If Ann has $10,000 in the bank and Bob has only $5,000, then Ann is in a stronger position. Her net debt is $20,000, while Bob’s is $25,000. ( Continue… )
A sign for the Social Security Administration in Los Angeles, Calif. hangs on a door. The Social Security Disability Insurance program must be reformed for the sake of maximizing its benefits to people with disabilities while ensuring its survival, Gleckman writes. (Matt Sayles/AP/File)
Benefits for people with disabilities are in big trouble
Social Security Disability Insurance has often been forgotten in the debate over the broader Social Security program. But Congress is beginning to pay attention, perhaps because the program is due to become insolvent by 2016. The program needs to be fixed. The question is, as always, how.
There are some interesting solutions—many aimed at keeping people working or helping to get them back in the workforce after a bout of disability. These reforms won’t work for everyone—many SSDI recipients are permanently disabled. But they may work for some.
SSDI is critically important to people with disabilities. It benefits nearly nine million workers and more than two million of their dependents. And for many, it is a key part of the safety net that supports them when illness or injury makes it impossible to work.
Yet, the program has big problems. In 2009, it paid disabled workers $121 billion, triple what it paid in 1989.
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It takes in less money than it pays out in benefits and will be insolvent, at least technically, in just three years.
It faces severe administrative problems, including long delays in processing applications, and a deeply troubled appeals process. In the words of the Social Security Advisory Board, the benefit process “may award benefits to individuals who do not meet SSA disability criteria and deny benefits to individuals who do met the criteria.” ( Continue… )
New York Gov. Andrew Cuomo speaks in Albany, NY, earlier this month. The governor hopes his policy of lending tax breaks to businesses in struggling locales will revitalize the state's economy, but Rueben argues that it's a poor use of a temporary windfall of money. (Mike Groll/AP/File)
What not to do with tax money
After years of grim revenue news, state tax collections are surging. As they do, governors and state legislators are making decisions about how to manage the unfamiliar windfall. Some governors, including California’s Jerry Brown, are husbanding resources, trying to hold down spending and paying down one-time debts. Others, such as New York’s Andrew Cuomo, are falling victim to the siren song of targeted tax cuts.
Cuomo is not cutting tax rates across the board, like some Republican governors. Instead, he’s doubling down on a strategy of growing the state’s economy through targeted tax breaks even though there is little evidence that previous economic development subsidies paid off.
START-UP New York (SUNY Tax-free Areas to Revitalize and Transform UPstate New York), under consideration by the legislature today, would give businesses and their new employees ten years of tax breaks if firms open in specific areas designated on or near public college campuses. Employers would be exempt from corporate and property taxes (for the new business) and receive refunds for sales taxes. New workers at these firms would be exempt from personal income taxes on wages earned at the firm for five years and exempt from income taxes on income below $200,000 for another five.
Cuomo insists the subsidies would attract businesses from other states or lead to new businesses sprouting up. But researchers have found that targeted tax cuts rarely do that. While taxes matter, businesses make location decisions for many reasons, including infrastructure and labor force qualifications. Cuomo argues that while New York colleges and universities receive the second highest amount of research dollars (after California) they get much less private investment. And there is much less interest on the part of venture capitalists (as compared to California and Massachusetts). Of course, some might argue that the investment in these other states is more about the type of research underway at the schools rather than incentives from state government. ( Continue… )
Evamay Lawson, IKEA Sustainability Manager, joins John Hodge and Tony Navarino of the Stephen Siller Tunnel to Towers Foundation to announce this month in Staten Island, NY, that IKEA will be donating home furnishings to help Hurricane Sandy victims. Foundations can only maximize their ability to help those in need if taxes on charitable organizations are reformed, Steuerle argues. (Diane Bondareff/Invision/AP/File)
Some taxes on foundations punish giving. Here's a solution.
Charitable organizations form a vital part of America’s safety net. Ideally, foundations would be able to make greater payouts in hard economic times when needs are greatest. Unfortunately, the design of today’s excise tax on foundations undermines and in fact discourages such efficiency.
Under current law, private foundations are required to pay an excise tax on their net investment income. The tax rate is 2 percent, but it can be reduced to 1 percent if the foundation satisfies a minimum distribution requirement. The dual-rate structure and distribution requirements obviously introduce complexity. The stated purpose of the tax in legislative history—to finance IRS activities in monitoring the charitable sector—has never been fulfilled.
In the recent recession, the impact of the excise tax was especially pernicious, as it penalized those that maintained their level of grantmaking.
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How? As Martin Sullivan and I first described in 1995, the excise tax penalizes spikes in giving; under the current formula, a temporarily higher payout results in a higher excise tax when payouts fall back to previous levels. A foundation that reduced its grantmaking during the last recession would not be subject to an increased excise tax because the amount the foundation paid out would be measured as a share of current net worth. ( Continue… )
A television screen displays a logo for the Dow Jones Industrial average surpassing 15,000 during trading day on the floor at the New York Stock Exchange last month. As the federal government has spent more and more money trying to pull the country out of budget deficits, it has also created an increasingly sizable investment portfolio. (Brendan McDermit/Reuters/File)
Uncle Sam's growing investment portfolio
The federal government has been borrowing rapidly to finance recent budget deficits. But that’s not the only reason it’s gone deeper into debt. Uncle Sam also borrows to issue loans, build up cash, and make other financial investments.
Those financial activities have accounted for an important part of government borrowing in recent years. Since October 2007, the public debt has increased by $6.9 trillion. Most went to finance deficits, but about $650 billion went to expand the government’s investment portfolio, including a big jump in student loans. Before the financial crisis, Uncle Sam held less than $500 billion in cash, bonds, mortgages, and other financial instruments. Today, that portfolio has more than doubled, exceeding $1.1 trillion.
Financial crisis firefighting drove much of the increase from 2008 through mid-2010. Treasury raised extra cash to deposit at the Federal Reserve; this Supplemental Financing Program (SFP) helped the Fed finance its lending efforts in the days before quantitative easing. Treasury placed Fannie Mae and Freddie Mac, the two mortgage giants, into conservatorship, receiving preferred stock in return; shortly thereafter, Treasury began to purchase debt and mortgage-backed securities (MBS) issued by Fannie, Freddie, and other government-sponsored enterprises (GSEs). And through the Troubled Asset Relief Program (TARP), Treasury made investments in banks, insurance companies, and automakers and helped support various lending programs.
Together with a few smaller programs, these financial crisis responses peaked at more than $600 billion. Since then, they have declined as Treasury sold off all its agency debt and MBS and most of its TARP investments and as quantitative easing, in which the Fed simply creates new bank reserves, eliminated the need for cash raised through the SFP. ( Continue… )
House Ways and Means Committee Chairman Rep. Dave Camp speaks on Capitol Hill in Washington last month. Wenesday, Camp gave an important update on tax reform to a group of Washington tax wonks. Yet his talk got almost no attention, Gleckman says. (Charles Dharapak/AP/File)
Tax reform hits a political wall
If Congress is going to reform the tax code, it will take an enormous amount of hard work and a lot of luck. The stars, as they say, will have to align. Unfortunately, those galactic bodies seem to be getting more and more disarranged.
Reform just can’t catch a break. The deficit is shrinking, taking away one possible driver of a rewrite. The Congressional Budget Office now projects the nation won’t bump up against its debt limit until October or even November, taking even more steam out of any Grand Bargain—or even a not-so-grand deal. And pols seem unable to disentangle themselves from distracting sideshows such as the IRS tea party flap.
Some have argued that these events make reform easier, not harder. The IRS scandal, they say, will encourage bipartisan compromise. Without immediate deficit pressures, Democrats would be more willing to accept a deal that raises the same amount of money as the current code and not insist on a reform that raises revenue.
I don’t think so. ( Continue… )
An American flag flies in front of the Supreme Court in Washington, D.C., in 2012. The Supreme Court is considering whether to grant same-sex married couples the right to file joint federal tax returns, but Gleckman wonders if the court is missing the point. (Alex Brandon/AP/File)
Is marriage — and joint tax filing — outdated?
Any day now, the Supreme Court will rule on whether same-sex married couples have the right to file joint federal tax returns. But Yale tax law professor Anne Alstott has me wondering whether the entire debate over the tax consequences of the Defense of Marriage Act is missing the point. In an upcoming paper for Yale’s Tax Law Review, she argues that it makes little sense to tie the Revenue Code so closely to formal marriage when so many people are in very different family relationships than they were even 40 years ago.
As Alstott notes, nearly half of American adults are now unmarried, 40 percent of children are born to unmarried parents, and labor force participation among married women is now very close to that of married men (thanks to the always-helpful Paul Caron at TaxProf blog for tipping me off to her paper). Ozzie and Harriet have been in reruns for half-a-century. So why even bother with the concept of joint tax filing?
Alstott borrows from Johns Hopkins University sociologist Andrew Cherlin, who calls the trend away from formal marriage “new individualism.” This, she says, “has rendered obsolete legal doctrines and policy analyses that treat formal marriage as a proxy for family life….Joint filing is no longer well-tailored to serve important social objectives.”
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And, she adds, this argument applies whether one is a liberal who embraces the new individualism or a conservative who is offended by it.
Reframing the tax treatment of families in this way will help solve some problems and create some new ones. And Alstott isn’t so much arguing for a specific alternative to joint filing as urging tax wonks to consider the law in the context of social change. ( Continue… )
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