Suppose employees in an industry benefiting from federal tax subsidies received regular extra payments amounting to a significant share of their annual income. Would you want to tax them, perhaps requiring them to pay as much as 90% of those extra payments in taxes?
If the answer is “yes,” tell that to your waiter next time you eat at a restaurant.
Food is one of the most heavily federally subsidized commodities, with the Department of Agriculture spending about $55 billion for various food programs including food stamps and aid to farmers.
Tips -- whether a standard 15% to 18% of a restaurant check or more -- are a major source of income for waiters and waitresses. We would not think of taxing those tips at a higher rate than ordinary salaries. To do so, would be an abuse, perhaps misuse, of the nation’s tax code.
Yet, we think nothing of applying the higher tax to the bonuses paid to American International Group (AIG) executives because they are in an industry, indeed a specific company, receiving government assistance.
The effort to apply a special tax on the AIG bonuses is one of two attempts this week to target the tax system for a narrow purpose. Even as Congress was considering the special AIG tax (adopted by the House of Representative Thursday), the Internal Revenue Service announced special rules to apply to victims of admitted schemer Bernard Madoff and other Ponzi investors.
IRS Commissioner Douglas Shulman told Congress Tuesday the guidelines would apply to all such victims and allow them to recover taxes paid on “fictitious income.” Investors -- in fact, all taxpayers -- already have recourse on their tax returns through the ability to deduct theft losses. Those losses though are subject to a cap. Under the plan announced by the IRS, Madoff investors will be able to claim a theft loss equal to 95% of their investment less any withdrawals or re-invested gains.
Current IRS regulations allow tax filers to claim losses going back three years and forward 20 years. The new IRS regulations will allow Madoff investors to go back five years and claim the loss as having occurred in 2008.
Typically too, filers claiming losses are not allowed to include taxes they paid on what turned out to be phony income. Under the new plan, they will be.
And, not all scammed investors are being treated equally. In a briefing on the plan, an IRS official would not say whether victims of an alleged scam involving the Stanford Financial Group would be able to claim the same losses, explaining “to have a theft loss, there needs to be some evidence of criminal theft.” Stanford Financial, for example, has been accused by the Securities and Exchange Commission of engineering an $8 billion fraud.
The fuzziness of the IRS treatment of Madoff and Stanford victims -- as well as the hurried tax penalty to be assessed on AIG bonus recipients, is of concern because of the precedent it sets -- and we don’t know where it might lead.
To be sure, the tax system -- as all government spending programs -- is highly political, taking money from one segment of the population and re-allocating it. Yet, targeting specific groups -- for higher payments or special tax breaks -- appears to violate any semblance of fairness in the tax system, or efforts to provide incentives for specific behavior.
For example, we encourage homeownership by providing special tax deductions for mortgages and, until 1986 tax changes, had provided an incentive for purchasing a car by allowing a deduction for interest paid on auto loans. When the auto-loan interest deduction disappeared, savvy homeowner car buyers began to use home-equity loans to finance car purchases, putting their homes at risk to buy a car, a consequence not considered when the tax change was enacted. That they were violating a fundamental finance principle, financing a relatively short-term asset with a long-term loan, was a topic left for almost esoteric economic discussion.
It brings to mind another attempt to use the tax code to address a narrow tax loophole. In the Tax Reform Act of 1969, Congress tried to limit the use of tax benefits by high income households who, because of their ability to use the tax code, owed little or no taxes income tax.
Congress was able to identify 155 tax filers and wrote a complex provision to ensure they paid taxes. The households affected by the law now number in the tens of millions -- all subject to the Alternative Minimum Tax.
Mark Lieberman is the senior economist for the Fox Business Network. Prior to joining FOX, he served as first vice president and manager of economic analysis and research at Washington Mutual in New York. Before that, he served as senior vice president at Dime Savings Bank of New York (which was later acquired by Washington Mutual), where he specialized in credit and risk management. He is a member of the Executive Committee of the New York Association for Business Economics. He has a degree in Economics from the Wharton School of the University of Pennsylvania.
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