Unintended Consequences: Estate Tax and the Life Insurance Maneuver

The new estate tax on $5 million and above is 40% on everything above . This is getting to be a bit high for “Taxes are the cost we pay for civilization.” per Supreme Court Justice Oliver Wendell Holmes. At what point does the about-to-decease decide they refuse to pay?

The Options
One anticipates serious efforts to avoid and evade. $5 million is not such a large number any more – easily reached by the elderly if you are sitting on a $500,000-plus McMansion, and some other asset besides a life annuity (pensions, social security, and insurance products).

Toss in a few years of inflation and this becomes truly an everyman issue (think AMT – alternate minimum tax). I for one fully expect that within ten years, at historic inflation rates in the US, millions of retirees will be looking at this number, including myself and my wife.

Having spent some time contemplating Nolo Press excellent plain English texts on such things, it becomes obvious that most legally (avoid) available procedures incur major complications and costs in legal overhead, inflexibility (refer to Nassim Nicholas Taleb on fragility), effectiveness, and potential unintended consequences. What to do?

Not on the Dole?
Not everyone falls into the medicaid/social security dole. A sizable minority of the population manage to populate nursing homes, which require cash, and lots of it. Let us presume that the natural costs of being alive, and the incredible costs of “elder care” and medical care, will leave you something more than the taxable limit when you expire.

Let us also assume you may not buy into Mr. Holmes argument entirely, or at least have better places to send your cash. Just possibily, one may wish to ensure that one’s widow or widower has enough to afford these exactions.

One might even have deserving children or other beneficiaries. Or, just dislike the Sherriff of Nottingham option.

The Big Loophole
Fortunately for the whole life insurance industry – talk about unintended consequences, or if skeptical, intended consequences? – life insurance bequests bypass both probate (what happens with wills) and estate taxes.

Whole life insurance has a horrible rate of return and certain counterparty risks. Typically it is sold, not bought (high upfront cost). Typically it is a savings device with term life insurance tacked on. Typically since one can remember, life insurance have allowed one to pass money after death to whomever one wishes taxfree.

Perverse Incentives?
Knowing that death taxes are 40 cents on every dollar, one can accept an absolutely horrid loss. Life insurance makes sense in this case. Perverse, but a sure loss of 40% is socially sanctioned by our government as enshrined in the tax code. Any loss less than 40% is a profit!

The goverment is counting on what is well known in game theory and behavioral economics circles – people are intrinsically risk averse and generally very good at denying unpleasant alternatives. There is a reaon why poeple “pass away” or “go to their maker” instead of plain old die. Denial yields a handsome profit to the Sherriff of Nottingham.

Godfathers?
This is a glaring loophole to anyone who looks at the issue. Our elected officials are not totally stupid and one presumes understand this. One presumes the insurance industry understands this as well. One presumes they invest (the new blatant euphemism) handsomely to ensure this continues.

Other Options
Or, you can hide your money outside the USA in some discreet haven. Or, you can plain flat lie about it all. Or, you can spend wildly before you go.

Or, you can convert your assets into a non-productive easily-hid form like gold. Leave a treasure map to the hole in the ground where you discretely buried those gold coins and gold prices can collapse from the present $1,500 an ounce to anything more than $1,000 and it will be a fine hoard. They are still digging up Viking hoards.

This Curmudgeon takes the view that it will be a cold day in hell (no pun?) before he hands over 40% to the Sheriff of Nottingham. What say you?

 

Taxes and the Fiscal Cliff(s)

Long ago everything you need to know about taxes to rasie revenue was summarized in one statement: “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.” – Jean-Baptiste Colbert served as Minister of Finances of France from 1665 to 1683 under the rule of King Louis XIV.

The Looming “Fiscal Cliff”
As we approach the January circus of histrionics over the dread Fiscal Cliff, it is good to contemplate this succinct statement. One will note that this statement includes nothing about equity, fairness, or such stuff of drama. At bottom the issue is how much money can the government raise, how much will it cost to raise the money, and at what point do geese fight back against plucking (re last, see the first two clauses in this sentence).

Indirectly, of course tax policy may favor different parties depending on how the taxes are structured. This needless to say is central to any discussion on taxation. Obviously, as taxes rise towards 100% confiscation, resistance may ensue. The sole interesting point is – at what point does the attempt to collect more tax result in collecting less tax.

Withholding from Paychecks
We early saw this initially implemented with the original social security levy in the 1930s. This worked so well that it was extended to income tax later. Collecting the money is so easy and cheap that the federal government has come to rely on it for three of four dollars collected.

Steady increase followed, broken only by too-brief tax reductions by President’s Kennedy and Bush. Backed by the awesome power of the IRS to peremptorily seize anything of value one owns, with minor exception, the government has prospered mightily. The goose may hiss, but may not escape.

Tax Avoidance and/or Evasion
One is legal; the other not – no matter. Avoidance is heavily used by those who obtain the bulk of their income from non-wage sources. Evasion (also called “working on the black”) is more characteristic of lower incomes.

As the tax collected from an individual rises, at some point things quickly graduate from hissing to biting back or escape. Both are perfectly reasonable defenses once one has concluded that the cost is comply is significantly greater than the profit to avoid and evade.

An Example  – 40% Wage Tax
Having retired, I  assured myself of both pension and Social Security annuities until I expire. I also receive income from financial investments (thrift plus fortuitous inheritance). Having always been thrifty (my progeny have used the term “cheap”) and of the habit of industry, I proceeded to obtain further employment.

To my shock, filing the next income tax made brutally clear that federal income, medicare, social security, and state income taxes combined took 40% of every dollar earned by employment. And of course there are costs to employment such as commuting, suits, lunches, and so forth.

Consultation with the spouse ensued. Concluding that we could get by nicely without the additional employment income, I quit. In this case, 40% tax was sufficient incentive to avoid tax by simply not working. Legal, too.

This “duh” moment made obvious that any future efforts to increase household income would require tax avoidance or evasion. Avoidance is of course safest. Nothing here to see, sir.

Widespread Evasion Evolves
US taxpayers (like Germans and Scandinavians) generally pay the tax man without undue hissing. There is evasion, but considering that the top income earners generally deploying avoidance in the US pay more than half of taxes collected, the issue so far is less than overwhelming.

Once the lesson of evasion is learned though, it is too late for the authorities to put the birds back in the cage. Once fear of the IRS is unlearned, the multitudes will have already graduated from hissing geese to hard-to-find geese. Pathetic efforts to corral the geese follow like leaves dropping in the fall – to wit the recent IRS rundown of the few unwary or inexperienced avoiders who hid their money in the Swiss bank named UBS.

One does note that Greeks, French, and Italians are all famously known to use both techniques to the extent that possibly 40% of the national economy goes untaxed. In my extended travels around the world, I learned that this is not an atypical response to government levies. Technique is legion and multi-headed. Congress, the President, and academic economists might wish to consider this in their theorizing and advocacy. This is as it were the absolute crux of the matter.

The Chase is On
In my capacity as treasurer of a very small local non-profit, I was recently tasked with researching acquiring 501.c.3 status. As treasurer, I also had to study the IRS form 990 process. These are most intentionally not user-friendly processes – nontrivial tasks. Truly the federal government is bending over scraping to pick up pennies on the street.

Having investment income, one notices that of late, the government has massively extended its “information gathering” (form 1099) of investment income from financial firms. As yet this has not evolved to the obvious next step of withholding at source as for wage income. That train is certainly coming down the track. Were they to have implemented both information-gathering and tax collecting simultaneously, the wild geese would have flown instanter. To the government.the revenue potential is too glaring.

Further musings on these and related issues may follow. Its interesting times indeed.

The Noose Closes?
The Curmudgeon suspects that ever increasing revenue enhancement effort by the government is soon to have its predictable result – fewer collections at higher cost. One does wonder, however, from where they will get the money they need once the international debt markets get antsy – already the source of most of the dollars trillion every year the federal government now needs to borrow.

Complexity breeds

US Firms Move Abroad: Tax Havens?

In the August 29 Wall Street Journal I chanced on an article with this headline. I was have long wondered how long it would take before someone authoritative pointed out the obvious (unless one is an academic economist with no real-world experience, or a fanatical political adherent.)

Anyone who reads corporate annual reports is well aware that many publicly listed companies regularly note they have large amounts of funds trapped offshore, unless they want to pay 35% income tax. One also notes that many re-insurance and insurance companies have quietly decamped to Bermuda with a more favorable legal environment and lower taxes, not to mention strictures on reserve levels and such.

The above does not even include taxes  at the state and local level which can easily raise this percentage to 38%.

35% encourages investment offshore
Needless to say, giving away 35% is not an  option popular among corporate chieftains. Besides, most companies earning income overseas can easily justify re-investing these funds overseas in factories, mines, oil fields, marketing and sales operations, design and development, and so forth. Why hand it to the feds?

Yesterday, I read the just-delivered annual report of a S&P 500 cmpany in which I hold stock, and which does nearly 50% of its business outise the USA. They have $410 million not repatriable without paying this 35% fee. They also noted that they had no current need of the cash for current business purposes within the US, and they had useful places to deploy it overseas. In the same report they noted three acquisitions outside the USA, roughly equivalent to the amounts cited. This is NOT an isolated example. It is a very well run, highly regarded corporation.

Drip, drip the Pace Accelerates
In effect, a US-domiciled company faces an immediate 35% cost disadvantage versus locating that same factory offshore and exporting into the US. If a large part of your business, especially a growing business, is offshore, why even consider the US. Those factories lined up on the Mexican border are not just looking for cheap labor.

The advantages of a non-US location are far greater than low-cost labor. This article cited recent examples AON, Eaton, Ensco International, Rowan and SaraLee spinoff D.E. Master Blenders. By the way, if you state your are moving offshore to reduce taxes, said action is against US law and you shall be chastised approrpriately. Don’t ask, don’t tell?

Advantages to be Foreign Owned
Then there is the glaring example of foreign-owned companies operating in the US who  pay very moderate US income taxes, if any. This has been documented many times. Legion are the legal ways to shift income to a more salubrious tax environment using inter-company transfer pricing and “purchase” by an offshore entity of diffferent services, royalties on patents and copyrights, ad nauseum.

Therefore a US company operating in the US faces a financial handicap versus its foreign-owned competitors by the amount of the federal income tax (less whatever pittance the foreigners chosse to pay to avoid criticism). No need to smuggle currency past the FINRA inspectors.

The Individual Offshore Option
Lately we have been treated to headlines how the IRS chased down thousands of tax evaders tucked quietly away – they thought – in Swiss banks. These were the failed tax evaders – certainly a relatively small portion of those who find this an interesting option. Rather like the drug dealers caught by DEA – the incompitent low-level fish.

The IRS is hiring 800 more agents which will be expensive and agonizingly unproductive (how much is the full-cost to employ a senior level lawyer or accountant possibly capable of tracking these bad boys down). This is tantamount to the IRS admitting publicly that the set of evaders is far larger.

The above paragraph might give a reader just a small inkling of how hard it is for the IRS to chase down and tax these iniquitous evaders of the exchequer.

Says the Curmudgeon of Staunton
Long ago and far far away in another universe (various foreign countries) the Curmudgeon gained considerable personal knowlege of how these things are done in other countries. The US is not a unique city on a hill shielded with a manifest destiny.

The issues raised here also relate to blogs Offshore and the IRS June 24 2011 and Tax the Rich? Millionaires gone Missing  blog August 25, 2011.

Raising taxes on those evil profiteers will have its due effect. Though not the morality play high-tax proponents seek.

Student Debt Hits the Middle-Aged

So reads a headline in the Wall Street Journal earlier this week. The WSJ often points out interesting things – especially in this case with its accompanying chart sourced from the Federal Reserve Bank of New York.

Student debt has risen from the beginning of 2005 from $363 billion to in 2012 an astounding $902 billion. Truly exciting numbers. More than is owed by John Q Public for auto and credit card debt. Unlike these two latter major ittems for middle-class cash flow, these may not be discharged by a personal bankruptcy.

The Contingent Liability – IRS Confiscation
Unpaid student debt is a disaster waiting to happen at some future date undetermined when the dilatory collection agency – the IRS – finally decides to seize your payment from your Social Security check, your tax refunds federal and state, your IRA, your inheritance, your pension, your wages or whatever cash income source you rely on.

College Cost Payback Issues
Also flagged in this article is the notation that many debtors over the age of 40 are still paying loans incurred for college many years ago. Consider that the vast bulk of borrowing for college is incurred before one reaches the age of 24-26.

One would think that one of the first things one does on graduation and finally obtaining that good paying job is to pay off that stdent debt, and get on with life and doing such things as borrowing to buy a house and getting married and having kids, and normal stuff like that. One might question validly the assurances of educators that of course college increases incomes for everyone and is Your Best Investment.

This chart shows that an increase during the seven lean years of the Great Recession, student debt increased from $124 billion to $307 billion, just when you would think they would have sensibly paid it off. Similarly, student debt jumped from $144 billion to $292 billion for those under 30 indicating that pay0ff is becoming less an immediate thing-you-must-do on getting that first good job. These numbers mean borrowers (the bulk of the middle-middle and upper-middle class) are either (1) unable to pay off these loans or (2) decided to defacto default in expectation that the IRS will NOT ever drop the hammer.

The same statistics also show that the default rate (loans over 90-days delinquent) for under-30s has risen from 3.7% (not worrisome) in 2005 to 6.2% in 2012 (a symptom of the post-grduate job search problems?). More alarming is that the rate for those in their thirties (a period of rising income normally?) has jumped during this nigh-Biblical seven lean years  from an already-high 7.2% to 9.1%. For a real-world bank balance sheet, these kinds of loss rates get CEOs fired, pilloried in the press,  or hauled in front of Congressional committees.

The payback problem also means a steady reduction in cash income available to spend on usual consumer items, much less the big elephant of home purchase. These kinds of debt problems presage some social difficulties down the road as this generation realizes how badly they screwed up taking on this level of debt repayment obligation, and start looking for someone to blame.

The Over-Forty Conundrum
Under a more “normal” scenario by the time one is in one’s forties, student debt and the first new car debt have been paid off and one can look forward to retirement savings, home mortgages, and funding your own kids. One’s peak earning years should have begun. Regrettably, these statistics raise some interesting issues about a “new normal”.

Education debts for those in their forties have trebled during these seven years from $53 billion to $154 billion. Likewise, the numbers for the fifties have jumped from $34 billion to $106 billion, a similar trebling.

At the same time, the forties default rate jumped from an already phenomenal 9.4% to 11.9%, symptomatic of extreme financial stress. Given the effectiveness of the IRS’s taxpayer intimidation machine, either these people know something the rest of us do not (IRS forbearace or incompetence?),

More likely they are plain flat broke right at the time when one is supposed to be living the American dream. This is truly socal dynamite. This number is far more scary than the already-scary recent default rates on home mortgage debt.

Retirees and Near-Retirees Default
The truly amazing part is those over age 60 – an increase from a measly $8 billion to an impressive $43 billion. What are these people thhinking, I  wonder, to carry that level of obligation into retirement? What kind of idiots are these, and what did they learn in college, and adulthood?

This only makes rational sense if you know you shall never have to pay it back. Maybe the IRS will never coming knocking at your door – sad tales of destitute widows make for politically perilous headlines. Of course it makes a sucker out of all those (AKA taxpayers) who did not gamble on the IRS forbearance.

The really interesting numbers are the default rates during our seven lean years. The fifties jumped from 6.3% default rate to 9.4% The sixties only jumped similarly from 6% to 9.5% defaulting, an astounding figure in itself.

The Implications for Finance
Since these collecting these debts is an issue for the federal government (not my and your bank) we investors can igonre the issue. Banks now only earn handling or administration fees on student debt, and may well find themselves out of that business soon. Uncle Sam has a problem, but then he has many other problems, and of course is the ultimate to-big-too-fail.

Says the Curmudgeon, there is an interesting issue though for those who lend to these potential (probable?) defaulters. Are you willing to be in a junior position in your lending to the IRS when the IRS seizes either these deadbeats’ income or assets? Think on it. Consider. Think what this means in credit evaluation.

The Curmudgeon taught his kids to pay of their student debt ASAP, even if it had a cheap interest rate, so that one could sleep well at night. He is an old-fashioned believer in Thrift, Education, and Hard Work (most unfashionable).

He does not like to gamble on the tender mercies of either lenders or the IRS.

Home Mortgages: Everyman’s Tax Shelter

Once again it is tax form season, and as a girl in spring, the heart turns to love – of tax shelters.

There are bird’s tweeting in the financial press about the bottoming of the housng market. Up front, I owe my home free-and-clear so am not in  this game. I lack expertise and interest in being a landlord. However, once I too had a home mortgage on a property which rented out generated a tidy cash-flow interest subsidy as an active- investment loss, a credit off of gross income. Said cash flow subsidy helped a lot in my calculation of affordability.

We moved back into said rental so were able to take legal advantage of the rules that allow tax free capital gains on the sale of a primary residence. Sweet – one  of the few ways in America to make money legally without giving Uncle Sugar a large proportion of the gains.

Does the IRS Track Home Sale Profits?
This may be an odd thought at the moment when so many mortgages are underwater. However, one sees no sign that the McMansion phenomenon has abated for reasons of unaffordability. John Q Public who can raise the cash for the down-payment and assorted fees and commissions is apparently finally snapping up very discounted houses in select markets which are probable to rise in some near future.

Now comes the question of tax enforcement. The secret of the payroll tax collection (Social Security plus income tax) machine is that your employer tells on you and also collects the money for the IRS. All the IRS needs do is collect, and do a cursory review of the annual tax returns submitted in April. Very efficient. Even the IRS’s creaking computer systems can track this one.

Can the IRS Track Purchase and Sales of Individual Homes?
No where does one report the acquisition price of your family castle. Is there any outside third-party reliable record available to the IRS of these two ends of the calculation to verify taxable profit available to the IRS? The obvious answer is no. So where is the enforcement mechanism similar to the payroll taxes?

There is no outside verification. Without this, the IRS computers have nothing to track. Sending legions of auditors to check every reported sale is prohibitively costly. No records – no data.

The FUD Issue
No where does anyone report the sale price of said castle except if one feels obliged to tell the IRS you have turned a capital gains profit greater than that allowed.  The system relies totally on self-reporting AKA FUD (fear uncertainty and doubt), a dominant part of the IRS  enforcement machine. So practically speaking, what are the chances middle American taxpayer will turn himself in? One should suspect widespread evasion. Even in America, the middle class can learn.

McMansion prices will rise because of this.
Until the IRS figures out a cheap and effective enforcement vehicle, housing will remain one of the only great profit opportunities in America. Taxes have reached a point that everyone carefully includes their considerable effect in financial calculations. We have become a real social democracy.

NINJA loan speculators and other flippers got caught in the great housing price collapse we just endured. They are gone, trailing sad stories behind them. But, the fools will be replaced by a much savvier generation of property investors willing to be landlords. That which must happen, will. FUD doesn’t work with these discreet folk.

An Aside: The New Super-1099 on Standard Financial Investments
Incidentally, this year it was no fun stumbling through the new-wrought complexity of capital gains 1099s on publicly listed mutual funds, stocks and bonds. Such is life – so I bought shares in Intuit whose tax program is the only way to deal with the mess, and who now pays a nice dividend. This is presumably part of the shovel-ready stimulus efforts of the government.

In the future do not even think about fudging on the profitability of stocks and bonds and mutual funds. The IRS has figured out how to enforce this one by laying off the work on the financial industry. We think.

The Curmudgeon expects that with too-big-to-fail federal home mortgage entities still alive, if on life-support, and the same old banks and financial intermediaries out there, we are at the very bottom of the next housing bubble. This skeptic suspects that the fine-print of recent loudly-trumpeted wave of enforcement settlements of dubious legal practices in this industry may have just sanctified some of these practices for the future.

Give it a few, and its off to the races again. Enjoy the next housing bubble.

PS – aspects of the issues raised here were discussed in blogs Mortgages, The Fed, and the Bubble: Part B of January 4, 2010 and  Buying a Home is a Poor Financial Decision  of December 1, 2010.

 

Gross Family Income $196,000: Your Income Tax Future

I am the great middle-of-the-road voter that does not vote the party line. Some days its a GOP candidate, some days its Democrat, whenever possible its an independent or other candidate, and some days I just stay home. I just wanted to get this bit out of the way of the following discussion.

Who is a Plutocrat?
Today’s news featured the campaigning incumbent President raising the populist flag of blame the rich, the evil 1%. His party has recently defined that as an income greater than $250,000. One suspects that is GROSS FAMILY income reported on your tax return. To generate some really good tax revenue, one suspects that $250,000 family income is not ADJUSTED GROSS INCOME (a much smaller number). Myself, like Google, don”t want to be evil. Heaven forbid.

Is it you?
I wondered if I might at some day soon find myself among the evil whom we middle-class all should oppose. Inflation happens. Salaries rise. So I went on the web and looked up a present value calculator. Simple and straightforward – if you happen to be an accounting and finance wonk.

I plugged in the numbers: Future Value $250,000; Discount Rate: 5% (a reasonable increase in the old paychecks each year); Years: 5 (how soon one might find oneself paying the evil rate).

If my family’s gross income from all sources on the 2012 income tax return is $196,000 right now, in five years I shall be an an evil plutocrat. Happily I am not.

Says Curmudgeon, All you now-evil college professors, doctors, salaried bureaucrats, and lawyers, TAKE THAT! Vote your pocketbook? Plan ahead?

PS – If you are single, and say, “my income on the tax return is only half that bad number $196,000”, don’t even think about getting married. Most families have two workers now. Half is $98,000. Multiply times two.

Tax Breaks That Expire Very Soon

I was looking at a table listing tax beaks that expire the end of December 2011. This of course does not include the legions of “fine print” tax items squirreled in past legislation, the tax code, and tax rulings to favor some special pleading.

Listed are these often important line items. Make your own call on their impact on the cash flow of the federal government, and inversely on that of citizenry who might take offense at the take-backs:

Social Security 2% Tax: More appropriately described as the payroll tax, this one hits everyone with cash income as paychecks across the land as all, repeat all, paychecks shrink by 2%. Except for that individual paycheck above $110,000. This does immediate good things for government cash flow in a big way since the cash collected goes directly into the general Treasury and is available for gnereal government purposes.

All that goes into the Social Security Fund is an IOU, like all the rest of the Treasury debt. No matter the marketing ploy in the name, Social Security Fund is an unfunded actuarily-estimated future-annuity contractual obligation of the overall government. I refer the reader to previous blogs Hoorah – Social Security Tax back to 4.2%? dated September 9, 2011 and Social Security Tax – Just General Revenues to Treasury dated July 22, 2011.

Alternative Minimum Tax patch: – Not to worry. Since this is the province of those who provide the day-in, day-out funding for political campaigns, it will be fixed and retroactively.

Charitable Contribution of IRA assets: See immediately above. Plus influential untaxed not-for-profits like this.

Special depreciation benefits: A toss-up to continue. Mr. Obama and US business are not on speaking terms but a lot of Senators of both parties are susceptible to persuasion. Renewal can be discreetly tucked into many bills.

State sales tax deduction in lieu of income tax deduction: Probably doomed. A bone tossed to the middle class. More valuable in mostly red low-income tax states.

Home Energy Tax Credit up to $500: Fuggidabutit.

Enhanced Conservation Easement Deduction: Very limited but vocal constituency.

Mortgage Insurance Premium Deduction: Low visibility low-dollar per taxpayer item so probably doomed. Uncle needs cash.

$4,000 higher education deduction: Possible retroactive renewal as this upper middle-income group of beneficiaries tends to be vocal about take-backs. Unfortunately expiration would generate a lot of cash for Uncle Sam.

Schoolteacher expenses deduction up to $250: No chance. Since the teacher unions are stalwart Democrat party workers and contributors, the GOP should not agree to reinstate this.

And then there is 2013:
The same table in the WSJ listed more that expire AFTER the great election circus is over but the end of 2012. Allowing for rearranging the seats in Washington DC, Handing out spoils of war appointments, organizing inaugural balls and parades funded by grateful donors, and all the other important aspects of transition – it will be a miracle if these don’t whack the taxpaying body politic smack right away.

This is just warm-ups. opines the Curmudgeon. The after-re-election taxpayer pain/federal revenue enhancement is the big banana (topic of another blog later).

Tax the Rich? – Millionaires gone Missing

Spent the last two weeks u-drive narrowboating on the Llangolyn Canal in Wales and England, and browsing the Financial Times UK edition – which does not seem to recognize the USA is the center of the universe. Our average speed past locks, lift bridges, sheep folds and stone cottages – about 1.5 mph. Sunny and cool too. Pubs. Cocktails on the fantail. What’s not to like…

In the meantime the stock market cratered. Doubtless, an evil plot by S&P, who shall be soundly investigated. One suspects that the realization sunk in rather quickly and widely that the debt reduction agreement included no debt reduction. Mr Market at times does not respond to smoke and mirrors, except in Greece of course.

Catching up on back issues of the WSJ, I encountered an interesting set of IRS-sourced statistics under the heading Recession and the Rich.

Tax returns for $200,000 and above dropped from 4,536,000 in 2007 to 3,294,000 in 2009 (down 12%). Tax returns for $1 million and above dropped from 390,000 to 237,000 (down 39%). Tax returns for $10 million and above dropped from 18,394 to 8,274 (down an astounding 55%).

Taxes paid by those with taxable income $200,000 and above dropped from $610 billion in 2007 to $434 billion in 2009 (down 29%). For $1 million and above taxable income taxes paid dropped from $309 billion to $178 billion (down 42%). For $10 million and above, taxes paid dropped from 111 billion to 54 billion (down 51%).

Some part of these extraordinarily rapid and substantial decreases may be from losses in the Great Recession. However, the handwriting on the wall has been obvious that taxes on taxable forms of income are going to take a rather large jump soon. We now have a date – 2013 immediately after the quadrennial contest of champions in Washington.

The less-than-plutocrat upper bourgeoisie ($200,000 and above) tend to include a lot of well-paid salary earners whose salaries are less able to hide. But either they have all died or gone broke, or lessons have been learned.

The top levels of income have access to a wide variety of very legal (and some extralegal) devices to convert income from taxable forms to non-taxable (a euphemism) forms. The numbers tell the tale. The well-to-do have already begun positioning for the millionaires tax, a bit of populist demagoguery lately heard often.

The Curmudgeon opines, a good tax is not one that is fair, but one that is easily collected and yields large revenues. Big tax increases (except on the law-abiding middle class wage and salary earners) don’t work.

Income/SS/Medicare/State Taxes on Income are Fungible.

The vast bulk of the federal government revenues are from taxes on income – largely wage earners. These taxes are variously labeled as income tax, social security tax, and medicare tax, and often state income tax. There is no difference in their impact.

The current tax system is extraordinarily punitive of “earned income” otherwise known as salaries and wages. While individuals may delude themselves at their own option that these taxes on their earned income are for different purposes, they are at heart no-way-around-it straight reductions in one’s cash received in exchange for work.

Additionally, the cost to an employer to hire an employee is the total cash wages plus benefits, plus taxes social security taxes plus unemployment compensation tax plus the cost to comply with assorted labor law plus, plus…. Is it any wonder that employers are progressively adding as few workers as they can within the US?

To the government, no matter the descriptive term for the tax, it is all cash income to be spent (cash is fungible – an important, big concept) as it will. To the taxpayer, these all accumulate as real reductions in cash received every payday. To try to argue the impact of these individually is as to pretend the Pacific is isolated totally from the Atlantic. Repeat, cash is fungible.

Intellectual Bankruptcy?
Too often one hears politicians (predictably) ranting about the terrible effect of or dire necessity to increase or reduce one component of these when the only real issue is the sum total of them all. One could expect better thinking of economists and the financial press, but….either they have become intellectually corrupt, or they are truly stupid. In this list one might include most of the shining lights of our universities, as well as most “think tanks”.

It is fascinating how various pillars of the intellectual (including Nobel economists) seem to be willing to making earth-shattering op-ed pronouncements putting their very reputations on the line about the impact of one or the other of these components of the tax on wages.


The Curmudgeon opines that to address the effects of these taxes individually is utter nonsense.

Offshore and the IRS

Yesterday’s WSJ included a small bit on the efforts of the IRS to rein in the offshore income tax dodgers, specifically citing the UBS case where a disgruntled “little bird” ex-emloyee of UBS decided to go for the whistle-blower bonus by finking on UBS American clients.

The Little Birds in the Bushes
I have always been fascinated how often higher-ups will aggravate subordinates and not expect malingering, if not reprisal. An amazing number of higher-ups seem to think they are immune from rules, and reprisal. But, there is almost always a “little bird in the bushes” waiting the opportunity to sing. The several times I have caught and fired employees who had their hand in the till, it was not the great accounting controls but “a little bird” who fingered them. In most organizations, it is well nigh impossible to do bad things without somebody knowing, and if disgruntle, telling. Moral: If you are going to go offshore, be very, very discreet.

And the Others
The article said the IRS was pursuing 15,000 persons as a result of its UBS adventures, and had found another 4,000 to investigate. This is an interestingly large number. This is also a list of failures at the art of going offshore. One suspects that the actual number is far, far greater – the list of the successful. Once tax rates hit punitive levels somewhere above 25% of ones income, the temptation to hide from the tax man becomes nigh irresistible. Greed has its own reward, even for governments when they get too greedy. As the Frenchman Colbert said, “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”

The IRS recently published a study detailing the amount of reported taxable income at different income levels according to its own numbers. The fascinating think to me is that there was a very large amount of taxable income according to their statistics at the very high end ($1 million and above) and a great deal at the higher salary-earner range (around $250,000), but very little taxable income in the range in between. How odd, thought I. How unlikely.

Europeans and indeed the rest of the known world have long been more sophisticated at dodging the tax man. As our levies have increased it may well be probable that Americans may learn the art as well.

The Curmudgeon has a small stock of interesting stories learned about artful tax avoidance during his years overseas. He is too lazy to indulge in it himself though.

The $600 1099 Goof

Last year, I was amazed that the IRS now wanted any business inside the USA to submit a 1099 form for every vendor that sold that business $600 of anything total during a full year. That is, $600 in a year. Wow, said I. I am not sure if this applies to non-profits as well but we are talking a veritable blizzard of paper floating through the mails.

I’m shocked, I say
My small honey business has at least three I can think of. It is so small that I have no employees and can not afford an accountant who would know how to do such things. I have no idea how to get the necessary tax ID for Walmart (a very cheap supplier of sugar which I buy in 200-lb. lots) nor where in Walmart to send the bit of paper.

This paper-chase could require many days, or even weeks, of research and probably would still fail to obtain the necessary vendor info. One doubts even mega-retailer Walmart is equipped to deal with the legions of form filers this would require. Maybe I could just hand my 1099 to the customer service desk? This is madness.

The IRS View
For the IRS, it is madness. Each 1099 sent to them has to be entered (they think we think) the giant database which will assemble each and every one to compare against each and every tax filer. Data entry costs money, even if they offshore it to India or Philippines. This is one heck of a lot of data entry. Can they afford it? It is going to have to generate a lot of new revenue to pay for itself, much less turn a profit.

The Taxpayer View
OK – not my problem. Don’t have a dog in this fight. To start with, the IRS, or someone up there in the ranks of “those who know better” think many independent tradesmen and other service providers (cleaning services, daycare) may not be confessing up how much filthy lucre they take in and sensibly do not report. Lust for income tax and even better, medicare/social security revenue arose. Catch those evil offenders. A threat to the American way, certainly.

I d not know about you but I always ask someone I pay by check, how do you want me to make this out. Not surprising, many say “cash” or their personal name. Really, I have no interest in helping the IRS collect money, especially from the lower-income strata. Verges on the immoral. And, even if I was feeling self-righteous, I would then in an amazingly large number of cases end up having to slog about doing a 1099 ($600 is not a lot of money any more).

Small Proprietorship View
We have not even touched smaller businesses who are careful who sees the accounts besides the owners. I spent a lot of time overseas in places where every small business is family-owned so play a cat-and-mouse time ducking the tax man. Banana republics. Europe. India. While Americans are amazingly fearful of the IRS and squeaky-clean about obeying laws, in recent years the incentives to reduce this cost have risen rather substantially. Given sufficient incentive, people respond. Now we are talking large collection issues for the IRS.

The trap for the IRS
Once you get past talking about civic responsibility and the cost of civilization argument and they outta pay their fair share (they?), we get down to the real issues. The IRS will find out, and take everything I own. True! Except for the phenomena known as “the emperor has no clothes”. Look it up in Wikipedia.

Once taxpayers realize that the IRS can not find out, then where is the incentive? Having everyone send and receive 1099s is going to let the cat out of the bag. This has awesome implications for everyone in the population does not have taxes withheld by an employer. Does the IRS have the ability to do this 1099 thing? Yeah, right-o, mate.

Not a few employees may decide that the black economy is a very interesting alternative. After all, can 10-million illegal immigrants without social security or tax-ID numbers be wrong? Yes, some get numbers and pay. Do you really think all do? Does the guy with the gardening service or window-repair service or day laborer? Can I sell you a bridge? Meet my friend Bernie M.

GOSPLAN Woke Up
Recently, the Senate passed a bill to cancel the $600 1099 requirement. Works for me, says the Curmudgeon of Staunton.