Yet Another Reason to Hate the IRS (and OCC)

Photo by SC Fiasco

As if it weren't hard enough to get banks to offer workouts to overindebted consumers! While I find the premise of the following story hard to believe, apparently major credit card lenders want to forgive significant portions of credit card debt that borrowers can't currently repay, but the Office of the Comptroller of the Currentcy and the IRS have conspired to prevent this.

Currently, when overburdened debtors (or their counselors) call up asking for a workout, credit card lenders will generally only agree to reduce interest rates and penalties and perhaps extend repayment terms to reduce payments. I had always attributed this to avarice and irrational refusal to accept the economic reality that borrowers would repay more if only they were given a bit of a break. As it turns out, I might well have been wrong, as explained in this letter describing a new pilot program to expand credit card debt forgiveness. According to the Financial Services Roundtable (whom I don't trust, by the way) and the Consumer Federation of American (whom I emphatically do trust), lenders appreciate the economic reality point, but the OCC and IRS inhibit lenders from offering significant reductions of principal. They do this by (1) requiring OCC-regulated lenders to demand payment of reduced principal amounts (and book the loss) within three to six months maximum, which (2) triggers a requirement that lenders send a 1099-C "Cancellation of Debt" tax form to borrowers, which in some cases might require the recently forgiven debt to be recognized as taxable income to the hapless debtor [NOTE: most debtors in this position will have been insolvent before (and probably still after) the forgiveness, in which case the COD/forgiveness "income" is excludable from taxable income, see IRS Pub 4681].

For decades we've been trying to convince lenders to act more reasonably in extending workout terms to borrowers WAY over their heads in debt, and now this. Just when you solve one problem, the IRS and some other regulatory agency create another one.

Though the accounting principle in play here doesn't strike me as so intrusive as to have prevented realistic debt forgiveness by banks, I nonetheless hope the OCC and IRS go for this proposal to eliminate the problem, however slight. The FSR/CFA letter promises that "virtually all of the largest national credit card banks" have agreed to offer "significant reductions in the principal [credit card] debt owed" to see if collections increase (my bet: they will!). Speaking as a proud paternalistic supporter of government intervention, I really hope the OCC and IRS get out of the way on this one!

Update 11/12/08: The proposal was rejected in what seems to me like record time for government bureaucrats. Hmmm.

Marginal Tax Sleight of Hand

Photo by Kyknoord

I have had it with the misleading rhetoric on comparisons of the McCain and Obama tax plans! Whatever your political persuasion, I hope most of us (about 99%) can agree that the "marginal tax rate" is just irrelevant, though this comparison continues to occupy center stage because it's an easy target.

A recent W$J piece (hat tip to Paul Caron at TaxProf Blog) compares . . . yet again . . . the McCain and Obama tax plans based on marginal rates; that is, the highest rate at which your LAST dollar of income will be taxed in our graduated (progressive) income tax system. One's first dollars of taxable income are taxed at 15% up to a limit, then 25% beyond that, then 28% beyong that, etc., until the highest "marginal rate" of tax on one's last dollar(s) is reached. Not suprisingly, the marginal income tax rate under McCain's plan is reported to be 35% (just as under current law, NOT rolling back the temporary Bush tax cuts from the former 39.6% rate), while the Obama plan's marginal rate is higher (the W$J suggests it's 41%, but this must represent a combination of the 39.6% reinstituted marginal rate plus losses of deductions and exemptions for high earners). So, the average person considering this issue might be concerned that an Obama administration would "spread the wealth around" by taking 5%-6% more tax from our last dollars--oh, my!

Here's the rub: how much do I have to earn, you ask, to break into the highest marginal tax "bracket"? The answer, in 2008, is $357,700 (either single or married filing jointly)! I don't know about you, but I'm FAR from having to worry about the highest marginal tax rate. I can't imagine that more than 1% of the U.S. population (even the U.S. taxpaying population) receives this much taxable income (remember--deductions, etc., allow particularly high earners with big deductible expenses to pay tax on only a fraction of their income).

Two observations follow from this. First, this talk of marginal rates is just silliness. Can we just agree that all of the extremely fortunate people who make (even combined-earnings couples) more than $350,000 of taxable income would prefer a McCain tax approach and leave it at that (though I see WAY more Obama signs in the yards of the rich suburb of River Forest, just north of where I live in Forest Park, outside Chicago)?! Marginal tax rates are utterly irrelevant for 99% of the population, and they show whom each candidate favors tax-wise: McCain favors high earners to offer incentives to produce jobs (trickle-down economics), while Obama favors middle-class earners and those who depend upon social programs (funded by wealth redistribution from the rich 1% to the not rich 99%). This is not news, it seems to me, and all the chatter about comparing tax plans is pointless. Far too much attention seems to be paid to the thin margin of "high-earner-not-rich-yet" (HENRY) people out there (and come on--if you make more than $300,000, you're wealthy in the mind of most Americans!!).

Second, the rate that matters is the effective rate; that is, the combined average rate applied to every dollar evenly. Effective rates vary greatly, too, but I would really like to see a more nuanced analysis of how the effective rate of the "average American" (or groups of them) would fare under McCain and Obama. I suspect effective rates would remain largely unchanged for all but the wealthy for McCain (that is, the Bush tax rollbacks would be made permanent, perhaps with a kicker cut for the wealthy), and effective rates for most people below the top tax bracket or two would go down under Obama (with tax shifted up to the higher earners).

I just can't imagine that the average U.S. voter really cares about this marginal tax rate issue--or at least, s/he wouldn't care if s/he realized how irrelevant the issue was for her/him. I would bet that the percentage of people who pay the marginal income tax rate is lower than the percent of U.S. voters who have lost a friend or relative in the war in Iraq, who are or know someone who has been victimized by immigration authorities or over-zealous federal prosecutors, or who are or know someone who has been wrongly convincted and is sitting on death row. The number and percent of people who pay marginal tax rates is clearly lower than the number and percent of voters who lack adequate health insurance and access to quality education. Aren't these issues far more important than marginal tax rates?

Update: Check out this cool CBO report on effective rates (its complexity suggests why we haven't seen more of this type of analysis).

Update 2 (10/29/08): Ask and ye shall receive! This CNNMoney story offers the sort of info I suggested would be more helpful . . . and it confirms my unsurprising speculation about how the candidates' tax plan effects would shake out (McCain blasting all taxes, with a big gift to the rich; Obama sticking it to the ultra-rich, favoring everyone else). For an even better discussion, see this paper by Citizens for Tax Justice.