The Hidden Taxes of Underfunded Government Services

Waiting in line to get a number to wait some more at DMV.

I am writing this while waiting at the DMV in Syracuse, NY. More than half of the service windows are closed, hinting that there was once a time when more people worked here and lines were shorter. I know the state has cut services to deal with a budget shortfall without raising taxes, but I view my time here as a particularly onerous tax. I know that I'll be working late tonight making up the time spent here and I'd be willing to pay a lot to avoid that. That's the hidden tax my political leaders imposed on me to avoid an explicit tax. Right now that looks like a bad deal.

There are other hidden taxes. Crumbling roads create hassles and wear and tear on vehicles. I once ruptured an oil pan when I hit a deep pothole, which cost hundreds of dollars to repair, plus towing costs, plus the time my wife wasted coming to fetch me and I spent waiting for her and, later, the tow truck. And for bicyclists like me, potholes can cause injury or death. I'd pay a lot to avoid those hidden taxes.

Underfunding education lowers our productivity, as does skimping on basic research and development. And cutbacks on law enforcement can entail huge financial and human costs.

By all means, we should make government more efficient and cut wasteful programs and services.  We absolutely have to figure out how to cut spending on entitlement programs like Medicare.  But we should be spending more money on some programs and services because they'd save taxpayers much more in hidden taxes than they cost in explicit taxes.

Put differently, we are the richest country in the history of the world.  Why do we aspire to third world public services?

[When my number was finally called, I asked the DMV person whether staff had been cut.  She was surprised by the question, but, after a moment's hesitation, said, "Well, when people retire they aren't replaced. So I guess that's a cut."]

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Gov. Romney: Just Release the Tax Returns

Mitt Romney is right that the Democrats’ attack on him for not releasing his tax returns is a diversion from real policy issues that should determine who the next president is, but he’s not going to win this battle and it’s painful to watch it play out in slow motion.

I don’t know why Gov. Romney released fewer tax returns than previous candidates. Possibly he believes that he’s entitled to something like the privacy of ordinary citizens, whose tax returns are completely confidential.  But that would be incredibly naive.  Candidates’ lives become an open book when they decide to run for president and anyone not willing to tolerate that shouldn’t run.

Possibly, he has something to hide. The White House is peddling that line. Washington Post blogger Greg Sargent talked to tax lawyers and economists who said it’s possible that he could have sheltered much of his income from tax using offshore tax havens or other techniques.  University of Virginia law professor George Yin said that you’d expect somebody with a lot of wealth to hire good advisors to minimize taxes, all presumably in compliance with the law. Would it shock and appall the American public to see how that’s done?

It’s remotely possible that Governor Romney avoided US income tax entirely in some years. The IRS periodically looks at the returns of high-income filers who pay no income tax. Some returns are nontaxable in the US, but have foreign income that is taxed abroad at rates at least as high as would apply in the US.  That’s unlikely to be Gov. Romney’s situation.

Among tax returns with no net tax liability anywhere, the most common tax shelter is tax-exempt bonds.  That was the prime factor explaining tax avoidance in 2009 according to the IRS. (See chart.)  But it’s hard to imagine that the former CEO of Bain Capital would be happy with returns of 3 or 4 percent, even if they were tax free, and extremely unlikely that all the various sources of income on the governor’s 2011 return would have been absent in prior years.  Although much has been made of Romney’s lightly taxed capital gains, he had $10 million of income from interest, dividends, and partnerships.

Source: Internal Revenue Service,."High-Income Tax Returns for 2009," SOI Bulletin, Spring 2012. (Public Domain)

Taxpayers can reduce tax liability through charitable contributions, but they can’t eliminate it.  If Romney avoided income tax altogether, my guess is that his partnership holdings generated large losses.  That was the most important factor on 5.7% of nontaxable returns in 2009.

There might be a hint on the governor’s 2010 return.  In that year, the Romneys reported a $280,000 partnership loss.  In 2011, the partnerships produced income of over $2 million.  Was this the end of a process where the partnerships were converted from tax shelters into income generators–possibly in anticipation of the scrutiny that would accompany the Romney tax returns when he became a candidate? Who knows?

Of course, there’s also the $10 million of capital gains on the Romneys’ 2011 return ($5 million in 2010). It is fairly easy to avoid paying tax on capital gains if you are wealthy.  Don’t sell assets with gains.  When you have to sell assets with gains, also sell some with losses so your net gain is close to zero. It’s possible that the capital gains that played so prominently on the Romneys’ released returns are largely absent in earlier years.

It’s also possible–even likely–that seeing the returns would not tell us that much.  If much of the income is parked in offshore entities, it might not be reported at all on US income tax returns until those entities pay a dividend.

But assuming that whatever the Romneys did was legal, it’s hard to imagine that his tax returns could be more damning than the speculation surrounding their suppression.  Mr. Romney is rich and he doesn’t pay much tax.  We already know that.

Is it possible that the earlier returns would reveal some real chicanery? That seems extremely unlikely. As Romney supporter Michael Gersonpointed out, “Romney — though he has his weaknesses as a candidate — does not fit the part of a sleazy businessman or a Nixonian liar.”

When your supporters are saying that you’re not a Nixonian liar (great bumper sticker), it is time to change the narrative.  Release the returns and let’s move on to the real debate.

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Obama is Again Backed into Corner on Tax Cuts

President Obama has proposed to extend the middle class "Bush era" tax cuts for another year.  My first reaction was "Wow, that's a big surprise." (That was sarcasm.) My second was that the euphemistic "Bush era" sounds like a time when humans were wandering around in loin cloths seeking shelter in caves and under shrubs.

As part of my ongoing series, "I told you so!", I'll point out that the current impasse was completely foreseeable when President Obama and Congressional Republicans agreed to a "temporary" two-year extension of the expiring Bush tax cuts in 2010.  The following is from "Will Dems fall for temporary tax cut gambit (again)?", which I published on December 8, 2010.

In the short term, there's a certain logic to giving in. Yes, passage of the middle class tax cuts and extended unemployment benefits won't happen without Republican support. Yes, the Democrats will be even less able to control the political agenda when the Republicans take control of the House in January [2011]. And, yes, letting all the tax cuts lapse would hurt the fragile economy.

But in the long term, the consequences of the "deal" could be devastating. Here's my nightmare scenario:

Think ahead two moves, to 2012, when this temporary deal expires. Many forecasters think the economy will still be fragile, so you can expect Republicans to argue that it is no time to raise taxes. 

And it's very possible if the economy remains weak and/or Obama doesn't find his mojo, that there will be a Republican president and a Republican senate. 

At that point, Republicans might well not agree to another temporary extension of the tax rates. Instead, they'll wait until they control government to introduce HR1 in the 2013 Congress -- a permanent extension of the Bush tax cuts that the new president will sign triumphantly.

That is exactly where we are today.  The president has proposed a one-year extension of the middle class tax cuts, which he defines as incomes under $250,000.  The Democrats in Congress apparently would like to ratchet up middle class to include everyone earning under $1 million.  The Republicans are insisting that all the Bush tax cuts be extended permanently.  And, by the way, we are several trillion dollars closer to insolvency than we were in 2010 and the economic recovery seems hardly more secure than it was then.

Since the economy is weak, the Republicans have a plausible argument against tax increases and a decent chance of regaining the White House so they won't compromise.

This plays nicely into the Democratic narrative that Republicans only care about rich people and the Republican narrative that Democrats want to raise taxes.  It's a very tiring and unenlightening debate.

Obama's original sin was never seriously proposing a tax reform plan.  Replacing the Bush Tax Cuts with Bush Tax Cuts Lite is just bad policy.  Over the long term, we simply can't afford even the middle class part of the Bush tax cuts, and the tax code is unfair, inefficient, and incomprehensible.  It badly needs an overhaul.

The president has talked a lot about tax reform--he asked Paul Volcker to put together a plan (which was more of a set of guidelines than actual legislation) and his debt reduction commission  proposed eliminating most tax breaks and cutting tax rates.  Volcker's plan went into the same impregnable file drawer as President Bush's tax reform panel report. President Obama said that the Bowles-Simpson proposal had "made important progress" on tax reform, but apparently not enough to prompt an actual presidential proposal.

The president has also proposed corporate tax reform, which isn't a bad idea, and the "Buffett Rule," which is, but nothing resembling comprehensive individual income tax reform, or even a coherent alternative to the Bush tax plan.

So we'll dance to the edge of the fiscal cliff and, more likely than not, we'll temporarily extend all the Bush tax cuts after the election.  Even if Mr. Romney wins, I wouldn't be surprised if the extension is only temporary.  Getting to play the Democrats for suckers every year or two must be a lot of fun--and a great source of campaign contributions--for the GOP.

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