A Simple Solution to the Health Care Problem

First, let me define the "problem".

Health care is too expensive and the cost keeps going up.

Obama and his progressive friends want to solve the problem by providing some kind of "insurance" for about 15 million currently uninsured people and by cutting back on what the government will pay to medical providers. It's beyond my comprehension how anyone can seriously regard that as a solution. This so-called solution will increase demand on the medical care industry while creating pressure to reduce the supply of service providers. Let's see now. More demand. Less supply. Isn't that the definition of what causes higher prices?

Meanwhile, the ultimate consumer of medical services is kept out of the loop.

Need another test? Sure. Why not? I'm not paying for it. Need an operation -- just in case? Same answer. I'm not paying for it. Is another doctor less expensive than the one I'm using? Maybe so, but I don't like to expose myself to another doctor. I'll stick with the more expensive one that I know because I'm not paying for it.

Who is paying for it?

Well for most of us, it's the insurance company selected by our employer.

Wait a minute. I choose my own auto insurance company, my life insurance company and my home owner's insurance company. Why is someone else choosing a medical insurance company for me? Oh, yeah! That's right. It's because my employer is paying for the insurance.

But why? Why don't I pay for my own medical insurance the same as my auto, home and life insurance?

Well, it's because when my employer pays for it, it's tax free. The company deducts the premiums the same as they deduct what they pay me and what they pay for other expenses. But I don't have to pay taxes on the cost of my insurance. And the benefits I get when I use the insurance is also tax free.

What about people who don't have employer paid health insurance? If they buy their own insurance or just pay for their medical expenses as and when they need to do so, they may be able to deduct those medical costs as an itemized deduction. Or they can set up a deductible health savings account and use tax free income from the earnings to pay their medical expenses and insurance.

Either way, most medical care in the U.S. is income tax free and isn't subject to the Social Security tax either.

Why? Part of the reason is because it is popular and because it didn't seem right that taxpayers had to pay income taxes on money used for medical care when the expenses were often such a large and uncommon burden. Also, it goes back to the second world war when there was a freeze on wages. So some employers came up with the idea of giving their employees some benefits because they couldn't give them a raise.

But in time, the system grew more and more popular. Unions jumped on the bandwagon and negotiated more and more generous medical benefits for their members. Eventually, only a very few employers didn't offer company paid medical insurance with generous benefits.

So now, we have a system where the consumer is divorced from direct involvement in the cost of his medical care and where comprehensive medical benefits are the norm. Thus, health insurance pays for small and recurring charges like an annual exam or prescription drugs that we need every month. And few people have any incentive to care about the actual cost of the medical care that is paid by the insurance company. Is it really a surprise that the costs keep going up?

So here is the simple solution to the health care cost crisis.

Eliminate the tax incentive for medical care entirely. No more employer paid free health insurance or medical reimbursement plans or tax free health savings accounts. And no more itemized deductions for medical expenses. Health care insurance won't be deductible, but the benefits received from the insurance company won't be taxed as income. That's the same approach that applies to auto, home and many other kinds of insurance.

But there should be a quid-pro-quo from the government to make up for the loss of tax benefits for health care. The government should be required to provide everyone a tax refund or tax credit to offset the extra taxes they would collect. That would help to buy some genuine insurance for major medical costs. And it would give the insurance industry an incentive to dust off some rarely used major medical policies they haven't been able to sell.

Also, the government should eliminate the state monopoly on not being able to buy health insurance from out-of-state insurance companies. I understand that insurance is regulated by the states instead of by the federal government, and I'm in favor of that. But I suspect the commerce clause in the Constitution could be used to end the state monopoly on health insurance.

Of course, I'm indulging in a fantasy of common sense rather than the reality of a socialist government. Don't lose any sleep over the prospect of losing the tax give-away for health care insurance and benefits because it "ain't goin' to happen" any time soon. And don't seriously believe that any other solution will really reduce the cost of health care.

Just my two cents.

Vern Jacobs

IRS Propaganda and Disinformation

The IRS fishing expedition for offshore accounts with the Swiss bank UBS is an example of a long standing IRS method of discouraging taxpayers from doing something without getting any kind of court decision or getting new legislation to support their efforts. I first noticed this disinformation procedure back in the late seventies when I was Editor of the popular Tax Angles newsletter. It hasn’t changed much in the last 30 years.

First, they identify some area of assumed non-compliance with their interpretation of the tax rules. Then they issue a press release announcing that they are going to study the problem. This will cause at least half the taxpayers who are considering this type of transaction to back off.

The next step is a press release announcing that they are going to investigate and audit taxpayers who are may be “guilty” of whatever the IRS is trying to discourage. This will often scare off about half the remaining taxpayers who have been considering use of the disputed tax avoidance device.

Then they look for a few egregious cases where taxpayers have blatantly ignored the law. This step can be described as shooting at crippled ducks. They then announce the results of successful tax collections, penalties and occasional criminal charges from these early cases. By this time less than 10% of those taxpayers who were considering use of the disputed tax device are willing to take their chances. As the IRS continues to prosecute those with the temerity to base their decisions on the law, they frequently encounter resistance from some judges who do read the law. But the cases they lose are never described in a press release. (Note: The percentages used here are not based on any measured research and are only a reflection of my observations over many years.)

Vern

Defining a Fair Share of Income Taxes

With few exceptions, my clients tell me they don't want to pay more than their "fair share" of income taxes. The implication is that they are willing to pay a "fair share".

But what is a fair share? And are we talking about a share of government spending or a share of the personal income tax? And how do we define a "share"? Is it an equal part of the total tax or the total spending? Or is it an equal percentage of the total? Those on the left of the political spectrum argue that income tax rates should be progressive -- meaning that tax rates should increase as income increases. Those on the right of the spectrum are more likely to argue on behalf of a flat rate tax or even for a national consumption tax.

The proposed federal budget for 2010 is $3.6 Trillion. There are about 310 million people in the U.S. So the budget works out to an average of about $12,000 per person. We have about 100 million households in the U.S., so the budget works out to about $36,000 per household. Is that how we should define a "fair share"? Obviously, a lot of households don't make that much or only make a little bit more than $36,000. But almost half of the households in the U.S. made less than $50,000 in 2009. The poverty level for a family of three is about $18,000 and about 15% of the households make less than that amount. We can't tax 100% of anyone's income and if a family with $50,000 of gross income had to pay $36,000 in taxes, the amount that is left would put them below the poverty level. But if you exempt those lower income people from paying any tax, then the total has to be divided among a much smaller number of households. (Actually, almost all of the personal income tax is paid by the taxpayers whose income is above the median.)

However, the government gets a lot of its money from sources other than the personal income tax. There is a corporate income tax and the Social Security tax and the Medicare tax and a few hundred diverse excise taxes. And the government does not base its spending on the amount of taxes it expects to collect. If the spending exceeds the tax revenue, the government borrows the difference -- which they call a deficit. (Instances when tax collections exceed spending are very rare.)

The taxes we pay are not based on what the government spends. It is based on the existing system of collecting taxes. Then the amount that can be spent is based on a combination of the estimated amount of tax revenue plus the amount that can be raised by issuing additional federal debt.

Therefore, government spending is a function of the taxes it can collect.

From time to time, the government will attempt to raise more taxes if they can find some sort of crisis (like a war) or urgent need (like health care or the climate) that will motivate the voters to agree to higher taxes. But when that amount gets to be excessive in the perspective of the taxpayers, they look for ways to reduce their tax burden. Some of them engage in political action like the current tea party movement. Others engage in tax evasion. Those who can afford professional help look for legal ways to restructure their assets to defer or avoid taxes. And a few choose to vote with their feet and expatriate.

Because the income tax is a body of law, I have concluded that a "fair share" is no more than what is required to avoid excessive fines or other sanctions like incarceration. What is excessive varies from person to person. Some taxpayer will tolerate a much heavier burden than others. So it comes down to what the law permits. As mentioned in an earlier memo, when tax rates are high, there are inevitably more "loopholes" or tax incentives available for those who wish to use them. The cash for clunkers and the first time homebuyer credit are only two recent examples. Not all available tax "loopholes" are worth the cost or the risk or even the time that is required to utilize them.

So it comes down to a process of identifying the varied tax breaks that are available and then exercising judgement and analysis to determine which of those tax breaks are suitable for a particular person or family.

A fair share is then based on finding the minimum amount of personal income taxes that are tolerable for a particular taxpayer.

And because there is no other logical way to determine what constitutes a fair share, there is no moral duty to pay any more than the law requires.

Vern Jacobs

www.vernonjacobs.com

How Much is Trillion?

With all the news and talk about taxes and deficits and such, I’d thought I’d share a few statistical perspectives with you – just for fun and cocktail conversations.

It’s hard enough to comprehend a million let alone a billion, but a trillion is almost beyond comprehension. To put the number in some perspective, there are approximately 300 million people in the U.S. as of July, 2007, according to the World Fact Book. A billion is 1,000 million, which means that a billion dollars is equal to about $3 per person in the U.S. and $1 trillion is equal to about $3,300 for every person in the U.S. Since there are about 100 million households, $1 trillion represents about $10,000 per household and $2.7 trillion is about $27,000 per household. That’s clearly more than the total income for a lot of households.

Based on an analysis of the 2007 federal budget, it appears that this budget total does include Social Security and Medicare tax collections, which represents about 1/3 of the total. Another 1/3 is from corporate income taxes and various excise taxes, with a little over 1/3 from personal income taxes. So that means that the average household would be paying about $9,000 of income taxes.

According to the National Taxpayer’s Union, the taxpayers in the top 50% (as measured by adjusted gross income) paid 97% of the individual personal income taxes in 2005. This means that about 50 million households paid nearly all of the personal income taxes. That works out to an average of about $18,000 of income taxes per household in the top half of the income category – which is in addition to their share of the payroll taxes and other taxes.

If we were to assume that the payroll taxes for Social Security and Medicare and the other taxes were shared equally, that would amount to about $18,000 per household. ($1.8 trillion / 100 million households) And the top half of the income earners would also pay an extra $18,000 per household for income taxes. But 60% of the income taxes are paid by the top 5% of income earners, which means that $600 billion of income taxes is being paid by about 5 million households. That works out to about $120,000 per household for those in the top 5% of income earners.

And some politicians are still saying that the “rich” aren’t paying enough taxes!

As John Stossel likes to say, "gimmie a break".

Vern Jacobs

A Lower Tax Profile for the Affluent

The IRS is developing a program to target what they call high net worth (HNW) taxpayers who have any form of foreign financial involvement for more intensive scrutiny. Since they don't currently have much information about net worth, what they are really targeting are taxpayers with a high income level. There isn't any information available about where the dividing line is, but it would be safe to assume that it will be somewhere above $250,000 a year of total income on page one of the Form 1040.

These audits will inevitably begin with a review of two or three years tax returns and the foreign bank account reporting (FBAR) forms. Laws that are currently being proposed may eventually require an annual disclosure of foreign based assets in addition to bank and financial accounts. If those laws are passed, the reports that are likely to be required will certainly be reviewed along with data in the IRS computer databases.

Once upon a time, moving assets offshore was a way to secure greater privacy from prying eyes. To a limited extent that may still be true with respect to non-government snoops -- such as lawyers who are contemplating whether to pursue some litigation on a contingent fee basis. But for the prying eyes of the U.S. government, greater privacy is now available within the U.S. Moving assets offshore is no longer an effective way to secure greater privacy and tax savings.

To minimize the potential for time consuming and potentially costly audits that are looking for unreported income from foreign investments, one solution is to reduce the level of foreign based assets to fall under the reporting thresh-hold. There is presently an exemption from reporting foreign bank and financial accounts that total $10,000 or less at any time during the calendar year. A husband and wife could each have somewhat less than that amount in an offshore account without having to file the FBAR form. The proposed law calls for a reporting thresh-hold of $50,000 of non-financial assets. And, it does not seem that direct ownership of foreign real estate must be reported. Storing collectibles in an offshore vault may also be exempt from reporting if access to the vault requires the presence of the depositor or an agent other than an official of the storage facility.

Another way to maintain a lower profile is to find ways to accumulate income in tax deferred arrangements and to consume after tax assets for necessary living expenses. For a very simple example, otherwise taxable interest income could be replaced with a tax deferred annuity. Then assets otherwise used to generate investment income could provide the cash needed for living expenses. Another tactic is to invest otherwise income generating assets in a variable life insurance policy and to use policy loans for some living expenses. For some taxpayers, these tactics will also reduce the potential for having to pay income taxes on some Social Security benefits. Other ways to minimize the income that is reported on a tax return depends on the specific facts and circumstances of each taxpayer. And in some cases, it is not feasible to avoid reporting a large amount of taxable income. But anything that can be done legally to defer income will usually decrease the potential for an intrusive audit or review of the income and assets of a high net worth (aka income) taxpayer.

Some additional tax saving ideas are available at http://www.vernonjacobs.com/ and my book on Legal Ways to Save Taxes Offshore and Onshore has about 100 different ideas for ways to reduce the tax bite and potential exposure to intrusive audits.

My book on the FBAR report is presently the most comprehensive source of information available about what must be reported and what the exceptions are.

Vern

http://www.offshorepress.com/legalways2save.htm

http://www.offshorepress.com/fbar.htm

Socialism Explained

Got this from an email that is being circulated. The alleged professor who conducted this alleged experiment is not identified, but the story is an excellent parable about the logical consequence of enforced equality. However, it seems unlikely that this occurred as recently as the last semester in 2008 or the first semester in 2009 when Obama's economic views were widely known and he was a clear contender or had won the election. That's why I describe it as a parable rather than as an actual classroom experiment. Vern

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An economics professor at a local college made a statement that he had never failed a single student before, but had once failed an entire class.

That class had insisted that Obama's socialism worked and that no one would be poor and no one would be rich, a great equalizer. The professor then said, "OK, we will have an experiment in this class on Obama's plan".

All grades would be averaged and everyone would receive the same grade so no one would fail and no one would receive an A.

After the first test, the grades were averaged and everyone got a B.
The students who studied hard were upset and the students who studied little were happy.

As the second test rolled around, the students who studied little had studied even less and the ones who studied hard decided they wanted a free ride too so they studied little. The second test average was a D! No one was happy.

When the 3rd test rolled around, the average was an F.

The scores never increased as bickering, blame and name-calling all resulted in hard feelings and no one would study for the benefit of anyone else.

All failed, to their great surprise, and the professor told them that socialism would also ultimately fail because when the reward is great, the effort to succeed is great but when government takes all the reward away, no one will try or want to succeed.

Tax Rates and Tax Loopholes

In 1975, when I started writing about tax loopholes, the top federal income tax rate was 70%.

And the tax law was full of diverse ways for different taxpayers to reduce their taxes.

Most people who didn't take the time or effort to look for ways to save income taxes referred to these diverse tax saving opportunities as "loopholes". The government called them tax incentives. Economists often referred to them as "tax expenditures" because they had the same effect as giving money to a select group of taxpayers. Quite often the select group consisted of members of an occupational group such as real estate developers and brokers or homeowners.

Taxpayers who had enough income to be faced with a 70% marginal tax rate were highly motivated to take advantage of as many of these "loopholes" as possible. In many cases, the loopholes required the taxpayer to invest in something (like a real estate venture) that would generate a deductible loss. By using borrowed money that didn't have to be paid back for many years, the taxpayer could secure the equivalent of a low interest loan in the form of a tax reduction.

In some cases, taxpayers could rearrange their business so as to qualify for some tax break they were not currently eligible to use. For example, a self-employed person was (back then) not able to get a tax break for his medical expenses comparable to an employee. But an owner and employee of a corporation could establish a corporate benefit plan that would pay the medical expenses of the employees and the owners. Businesses could qualify for substantial tax credits for an investment in business equipment. So some investors would put up the money to buy the equipment and would share in the use of the investment tax credits. Parents would loan money to their children (or to a trust for the benefit of their children) at a zero interest rate. The children (or the trust) would invest the money to earn interest, dividends or capital gains. The children were in a low tax bracket and the parents were in a high tax bracket.

At one point I had accumulated and documented more than 200 of these pre-meditated tax breaks. By "pre-meditated" I mean that the taxpayer generally needed to engage in some planning to identify which of the tax breaks were suitable for that taxpayer and then had to write a check or take some action to qualify for the tax break.

But in 1981, President Reagan pushed through a tax law that reduced the top tax rate to 50%. And that tax law eliminated or curtailed many of the loopholes that were being used to shelter income from high tax rates. Then in the Tax Reform Act of 1986, Reagan pushed through a reduction in the top rate to 28% -- along with a huge reduction in the many different tax shelters, loopholes and tax breaks that were still being used.

As tax rates have crept back up to a top rate of 35%, each new tax law includes new tax incentives -- often for various energy conservation or production investments. For many years the government has been trying to motivate small business owners to provide retirement benefits for their lower income employees. But the Congress also tries to restrict the ability of the business owner to benefit from the plan. The result is that the owners don't jump on the tax breaks and the Congress keeps raising the incentive. After the investment tax credit proved to be popular and was used by a lot of people, the Congress imposed severe limits on who could use it and it fell out of favor. But now, the Congress has increased the one year deduction of business equipment to $250,000.

But there is a pattern to the ups and downs of tax rates and tax loopholes. The higher the tax rates, the more loopholes the politicians will create to encourage investment in selected parts of the economy. And when tax rates are reduced, there is usually a compensating reduction in the variety and the appeal of various legislated tax incentives, aka "loopholes".

Vern Jacobs