David Cay Johnston

By David Cay Johnston
The author is a Reuters columnist. The opinions expressed are his own.

If the U.S. government voluntarily defaults, how are you going to get that tax refund? Or get paid for the work your company did for Uncle Sam?

While a last-minute agreement to raise the debt ceiling could still be reached, the risk of default as early as Tuesday is causing jitters in global financial markets and anxiety among people who depend on Social Security to eat.

Without an increase in the debt ceiling, the president is faced with an irresolvable conflict between faithfully executing those laws passed by Congress requiring payments for services and benefits and his inability to borrow more.

As William A. Galston of the Brookings Institution neatly put it: “We would be in uncharted legal territory and uncharted constitutional territory.”

Anyone whose bill was not paid when due would be able to sue. The federal government issues about 100 million checks a month. Default would spawn an explosion of litigation, overwhelming the courts, especially if the Supreme Court sticks by its animus to class action litigation.

The Constitution’s framers gave Congress the power to pay the government’s debts, but the only debts Congress was obligated to pay were those incurred during the first American Republic, the Articles of Confederation government that failed because it could not tax.

VALIDITY OF PUBLIC DEBT
The only other guidance comes from the 14th Amendment, ratified in 1868, to make sure freed slaves received due process of law. “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned,” the relevant language states.

One problem with the president invoking that clause to ignore the debt ceiling is that the current Supreme Court might interpret the provision as applying only to Civil War debts, perhaps citing the confederation’s unpaid debts clause to buttress such a narrow interpretation.

The White House has publicly rejected the 14th Amendment argument, but that may be a negotiating tactic to keep Obama’s options open. A senior Treasury official declined to say anything about what had turned up in legal research, promising only that as the actual day of default approached, its counsel to the president would become known in stages.

Much of what the government pays out anyway is not a “public debt,” so the 14th Amendment argument seems of little help for benefits payments. The Supreme Court decided in 1960 that Social Security benefits, routinely called entitlements on Capitol Hill, are not a property right. The high court held that imbuing Social Security with a property right “would deprive it of the flexibility and boldness in adjustment to ever-changing conditions which it demands and which Congress probably had in mind when it expressly reserved the right to alter, amend or repeal any provision of the act.”

What must be paid are the full salaries of federal judges and the president because the framers decided that their compensation may not be diminished. The framers did not treat soldiers with the same regard, nor senators and representatives, until ratification of the 27th Amendment in 1992, which says their compensation may not vary until the next House election.

OBAMA’S CHOICE
So how would the president deal with the conflict between his obligation to faithfully execute those laws requiring payments and the law placing a limit on the federal government’s debt?

Jerome Powell, who was Treasury undersecretary for finance in the George H. W. Bush administration, suggests a purely mechanical approach. On the first day the government hits the ceiling, it pays as many bills as it has cash to cover, deferring the remainder to the following day and so on. “You just rack them up in chronological order,” said Powell, now a visiting scholar at the Bipartisan Policy Center in Washington.

Powell created a handy cash flow analysis on how he sees such a pay-and-delay approach operating. He estimates that between Aug. 3 and the end of the month the government will owe $307.6 billion, but have only $172.4 billion to pay bills. On Sept. 1 the government would have $135.2 billion of deferred bills.

One thing the president cannot do, says Laurence H. Tribe, the Harvard Law School constitutional scholar, is pick and choose who gets paid for political reasons.

In a way that is unfortunate.

Since the Tea Partiers like to remind us that actions have consequences, what would be a more fitting consequence of default than for the president not to pay the bills that come due in the districts of those very members of Congress who voted against raising the debt ceiling?  (Editing by Howard Goller)

By David Cay Johnston
The author is a Reuters columnist. The opinions expressed are his own.

Painful as it feels to have a lot of hard-earned income taken from your paycheck for taxes, a new Illinois law does something Americans may find surprising. It lets some employers pocket taxes for 10 years.

You read that right — in Illinois the state income taxes withheld from your paycheck may be kept by your employer under a law that took effect in May. Continental Corporation, the big German tire maker; Motorola Mobility, the cell phone maker; and Navistar, the maker of diesel trucks for industry and the military, are in on the deal. State officials say a fourth company is negotiating a similar arrangement.

Chrysler and Mitsubishi arranged deals with the state in the depths of the Great Recession in 2009; Ford got one in 2007, since revised to let it keep half of its Illinois workers’ state income taxes. (See chart below.)

Instead of paying for police, teachers, roads and other state and local services that grease the wheels of commerce, Illinois workers at these companies will subsidize their employers with the state income taxes they pay.

The deal to let employers keep half or all of their workers’ state income taxes represents a dramatic expansion of a little-known trend in the law: diverting taxes from public purposes to private gain.

Throughout the United States, big box retailers like Wal-Mart, Lowe’s and Cabela’s, and in some cases entire shopping malls, often negotiate deals to keep sales taxes that customers pay at the cash register, using the money to finance construction of their stores. This gives them a huge advantage over retailers without such subsidies, while reducing revenue to local governments, which in turn creates pressure for higher taxes.

COMPETITION BETWEEN STATES
The pipeline industry, a collection of legal monopolies with rates that are regulated, gets to include the federal corporate income tax in the rates charged customers even though nearly all pipelines are exempt from the federal corporate income tax because they are organized as master limited partnerships. Evidence in one federal court case showed that collecting this tax, plus state income taxes, and then pocketing the taxes increased ultimate net after-tax profits by 75 percent.

The Illinois deal shows how competition between the states, and with other countries, helps big corporations wring subsidies from state governments even as the states are being forced to fire teachers and other public workers because of a weak economy that has cost jobs and tax revenue.

Why would the state let companies do this? Most big companies pay little or no state corporate income tax, because companies arrange to take expenses in higher tax states and profits in states with little or no corporate income tax. So the only way to finance incentives without the state writing a check is to let the companies pocket their workers’ state income tax.

The Illinois deal also shows how government, rather than the market, picks winners and losers. While America promotes the dream of a free market and competition, this sort of corporate socialism has been around since before the founding of the republic and has played a key role in the rise of many industries, including railroads, aircraft, as well as computer hardware and software.

Warren Ribley, director of the Illinois Department of Commerce and Economic Opportunity, said “it’s a fair question” as to whether taxpayers should be subsidizing businesses. He said elected leaders and the public should debate the issue.

“In the meantime,” Ribley said, “I am out there competing every single day with states and countries across the entire globe and I have got to have the tools and I have to use the tools provided by the General Assembly,” as the Illinois legislature is formally known.

State Representative Jack Franks, a Democrat from the northern end of Illinois, said the deals “are fundamentally unfair” to taxpayers and other companies.

“Our current governor had the genius idea of giving to Motorola and Navistar and others, he said to retain their business here, yet he is allowing Navistar to fire up to 25 percent of their workforce and still get millions from the state” by holding onto the income taxes of employees.

OTHERS LIKELY TO FOLLOW
The Illinois law lets companies retain all of the income taxes withheld from the paychecks of workers whose hiring expands the payroll and half of the taxes for existing workers whose jobs are retained.

For Continental the deal means $22 million over 10 years diverted to its coffers from the state income taxes withheld from worker paychecks to help pay for a $224 million expansion of its Mount Vernon tire plant in southern Illinois. The deal will retain 2,500 jobs and create 400 more rather than prompt the plant to move to Mexico, Brazil or another state.

The hourly tire workers, under a two-tier pay scale that means lower wages for new hires, make either $19.35 an hour or $16.31 an hour. For a year that is pay of just under $34,000 to $40,000.

Based on a 3 percent average Illinois state income tax rate for people in that income range, and assuming Continental’s 2,500 hourly workers remain at the higher wage rate and 400 new workers are hired at the lower wage rate, the annual diversion of their income taxes would be as much as $1.9 million of the average $2.2 million annual benefit from the deal. Taxes paid by supervisors and managers, and expected higher wages in future years, account for the other $300,000 per year or so for the next decade.

Navistar is getting the deal even though its application shows it plans to reduce its workforce of 3,100 to about 2,200.

Ribley said companies that got earlier deals in which they avoided the state corporate income tax and then failed to create or retain jobs as promised have actually paid back the benefits.

The three companies that got the deal are not named in the law enacted in May, but the language of Public Act 97-2 defines them by describing the industry, employment level and other specifics that show how the law was tailored to benefit just them.

Here’s a prediction: other states soon will also authorize diverting income taxes withheld from worker paychecks to their employers, if some have not done so already — unless, of course, voters speak up on behalf of competitive markets and against this sort of corporate socialism.  (Editing by Howard Goller)

By David Cay Johnston
The author is a Reuters columnist. The opinions expressed are his own.

The long-term shift in tax burdens from capital and corporations to individuals and their activities is perhaps best illustrated by the rise of state lotteries, the most heavily taxed consumer product in America.

Because gambling is voluntary, there is little organized opposition to levies on gambling winnings. Contrast that with the ferocious, well-organized and well-financed opposition to income taxes, especially corporate income taxes.

In 11 states, lotteries provided more revenue than the state corporate income tax in 2009, Tax Foundation data show. The Rhode Island lottery netted the state more than $3 for each dollar of state corporate income tax in fiscal 2009. (See chart.)

State income taxes typically equal five percentage points or so of income recognized in a state, whether paid to individuals or corporations. Overall, lotteries pay out only about 62 percent of their revenue as winnings, an implicit 38 percent tax rate on lottery tickets. On top of that, people who win $600 or more have their take reported to federal and state tax authorities and must pay income taxes of up to 45 percent on their windfalls.
This shift from corporate to lottery revenues was unimaginable just half a century ago, when gambling was a crime everywhere except Nevada — the residue of scandals in the 1890s that killed off widespread legal gambling.

HIGH TAX RATES
These days the 44 states with lotteries (plus the District of Columbia and Puerto Rico) get 44 cents from this form of gambling for each dollar of state corporate income tax. On top of this are taxes in those states that license temples of chance.

Even more remarkable is the continuing popularity of state lotteries despite significantly high tax rates, noted Charles T. Clotfelter, a Duke University professor of law and economics who co-authored pioneering studies of lottery winners two decades ago.

Americans spent $50.4 billion on lottery tickets, video lottery terminals and the like in fiscal 2009, according to the North American Association of State and Provincial Lotteries. The 44 states with lotteries, plus the District of Columbia and Puerto Rico, pocketed $17.6 billion of lottery profits. In fiscal 2010 profits rose slightly to $17.9 billion.

On top of the 30 percent profit margin, administrative and promotional costs total about 8 percent of sales, according to David Gale, executive director of the lotteries association. That is an implicit tax of 38 percent, with 62 percent of lottery sales going to winners.

On top of that, people winning $600 or more had their income reported to state and federal tax authorities. Federal and state income taxes combined could take as little as nothing to close to 45 percent of the win for those in the top federal brackets in high-tax places such as New York City or Hawaii and who either do not itemize or fall under the alternative minimum tax. The greatest number of Americans, however, would face a federal tax of 15 percent plus the state tax of about 5 percent.

POLITICAL SENSE
Fred Thompson, a Willamette University professor of public management who has served on two Oregon commissions on state revenue, sees the rise of lotteries and the relative decline of state corporate income taxes as “something of an outrage,” but one that he said makes perfect political sense.

Like many other public finance economists, Thompson sees lotteries as a tax that falls mostly on the working poor, albeit voluntarily. And Thompson is among those who see the corporate income tax as a levy mostly on corporation owners, who by definition are wealthier than most people.

So why have lotteries, seen as a vice half a century ago, become ubiquitous today? “Because there’s no resistance to them, while taxes, especially corporate taxes, are opposed,” Thompson said. Plus, it’s an easy way to raise revenue.

More state-sponsored gambling seems likely, said I. Nelson Rose, the Whittier College law professor who wrote a book describing three waves of American gambling — colonial times, the late 19th Century and our own times starting in 1963. No state that started a lottery has rescinded it since 1963.

“Gambling has become so acceptable that when the states get into trouble, and all but four or five of them are in trouble, it is the first thing they turn to for money,” Rose said.

He noted that the shutdown of the Minnesota state government in a dispute over taxes and the budget cost the state $1.5 million per day in sales, “some of which is benefiting neighboring states like Wisconsin” as people cross the state line to buy lottery tickets.

NO REVENUE SURGE
The trend toward easy reliance on expanded lotteries, however, has not meant a surge in revenues as the economy has made modest gains.

State corporate income taxes at the end of calendar 2010 were 17.2 percent higher than a year earlier, the Nelson A. Rockefeller Institute of Government in Albany, New York, estimated recently. The $17.9 billion in fiscal 2010 state lottery profits was nearly the same as a year earlier.

But as states add more games, allow more video lottery terminals in bars and restaurants and spend to encourage gambling, it is likely that revenues will rise. Dan Sarro, who handles finances for the Rhode Island lottery, noted that traditional lottery tickets provide less than 6 percent of state lottery profits, while the video lottery terminals, which work like slot machines, are available at just two locations, but produce 94 percent of the state’s gross lottery profits.

The historic progression, Rose said, is from complicated paper-form lotteries like the one New Hampshire instituted in 1963, setting off the return of lotteries, to video games to full blown casinos.

State governments have never been particularly heavy taxers of corporations.

Back in 1963, when lotteries were still illegal, so lottery revenues were zero, state corporate income taxes raised about $10.4 billion in today’s dollars. That’s almost 60 percent of the $17.9 billion or so that state lotteries bring in today.

With global competition to attract capital, and no more resistance to what had been seen half a century ago as the evils of gambling that would bring ruin on us all, expect more state-sponsored gambling in the years ahead. It is almost certain that in the future more than 11 states will rely on a voluntary tax paid by those hoping to strike it rich to bring in more revenue than taxes on corporations. (Editing by Howard Goller)

By David Cay Johnston. The opinions expressed are his own.

Readers, I apologize. The premise of my debut column for Reuters, on News Corp's taxes, was wrong, 100 percent dead wrong.

Rupert Murdoch's News Corp did not get a $4.8 billion tax refund for the past four years, as I reported. Instead, it paid that much in cash for corporate income taxes for the years 2007 through 2010 while earning pre-tax profits of $10.4 billion.

For the first time in my 45-year-old career I am writing a skinback. That is what journalists call a retraction of the premise of a piece, as in peeling back your skin and feeling the pain. I will do all I can to make sure everyone who has read or heard secondary reports based on my column also learns the facts and would appreciate the help of readers in that cause.

No excuses. But I will explain how I made such a bonehead error.

The other facts I reported remain:

* Among the 100 largest companies in the United States, News Corp has the third largest number of subsidiaries in tax havens, a Government Accountability Office study found in 2009.

* On an accounting basis, which measures taxes incurred but often not actually paid for years, News Corp had a tax rate of under 20 percent, little more than half the 35 percent statutory rate, its disclosures show.

* Murdoch has bought companies with tax losses and fought to be able to use them, which reduces his company's costs.

* News Corp lawyers and accountants are experts at making use of tax deferrals, though the company's net tax assets have shrunken from $5.7 billion in 2007 to $3.3 billion last year as the benefits were either used or expired.

CHECKING THE RECORDS
Tax is my beat, and I was simply looking for what the record showed since Mr. Murdoch is much in the news these days. Some of his British journalists hacked into voicemails, paid off cops and interfered in a murder investigation. Having a long career writing not just about tax, but also about journalistic misconduct, I wondered if there was anything of interest in News Corp's annual disclosure reports, known as 10-K forms. I examined them back to 2004, the year that it switched from an Australian to an American company.

What I found was four years of big negative numbers in the "cash paid for taxes" line in the footnotes to the consolidated statements of cash flows.

The most common convention is to report tax payments as positive numbers and to use negative numbers to report net refunds from government to a company.

Professor Ed Outslay, who teaches graduate accounting at Michigan State University and is an authority on extracting tax information from disclosure statements, teaches his students "normally 'parens' mean a tax benefit, not an expense."

While that is the norm, it is not universal and I knew that. Some big companies report "cash paid for taxes" with payments in parentheses and refunds as a positive number. This reversal makes sense from a company's point of view, though few companies do it that way.

I saw that over the seven years that News Corp has been a U.S. company it reported "cash paid for taxes" as positive numbers in 2004 through 2006 and then as (negative) numbers for 2007 through 2010.

ERROR ALERT
The first suggestion I had erred came in the middle of the night when a post at taxprofblog (I teach at Syracuse University College of Law) said I had made an error. I checked the disclosures and then wrote back that the poster was in error. Still, the note troubled me and before dawn I was reviewing every document. As I was rechecking my work, Robert S. McIntyre of Citizens for Tax Justice, who is respected across the political spectrum for the care he takes with numbers, sent me a note saying I had it wrong. News Corp, he said, was using negative numbers to report outflows, rather than tax inflows, starting in 2007.

Here is how the same number, in millions of dollars, for "cash paid for income taxes" for its 2006 fiscal year was reported in News Corp's 2006 annual disclosure report and then in the 2007 report:  $558 $(558)

Add up the negative "cash paid for taxes" number for the years 2007 through 2010 and you get the negative $4.8 billion number I reported as tax dollars flowing to News Corp instead of to governments, as they actually did.

How did I miss the switch in convention for reporting positive and negative numbers? The company disclosed in its 2007 annual report that it was changing the way it reported some numbers. Here is the entire disclosure, from Note 2 on Page 87:

Certain fiscal 2006 and fiscal 2005 amounts have been reclassified to conform to the fiscal 2007 presentation.

COMPLEX STATEMENTS
I do not recall if I read that line, but even if I had I would not have connected it to the switch from positive to negative numbers in the "cash paid for taxes" line. In its profit and loss statement News Corp uses almost all positive numbers, even for costs. It lists revenues, for example, and operating expenses as positive numbers even though expenses, like cash paid for taxes, flow out of the company.

But in the "cash paid for taxes" and some other lines in the same document, I know now, it follows a different convention and that it switched conventions four years ago. Indeed, another journalist pointed out to me that within one of the tables in its latest disclosure News Corp made inconsistent use of positive and negative numbers.

Disclosures are complex statements, but they also are intended to inform investors and regulators, not confuse as can happen when mixing and matching positive and negative numbers. Here is a question for the SEC: Should companies be allowed to use inconsistent conventions on positive and negative numbers in the same document?

Before even writing my column I called News Corp. Neither of the News Corp spokespeople so much as coughed when I said my first column would be about News Corp making $4.8 billion from the tax system in the previous four years. I also instantly emailed my spreadsheet, at News Corp's request, though the company says it did not get it. The company did not get back to me -- they were, after all, besieged with other calls from journalists -- and I did not check back again, though I should have.

SETTING THE RECORD STRAIGHT
As a further check, when I enter numbers in spreadsheets I use a yellow background to remind me that at least a second check needs to be done before publication. When I later examined the spreadsheet against the source document the numbers matched so I changed the background to white to indicate to myself that I had double-checked the numbers.

To keep my column as simple as possible I limited the graphic I roughed out to the four years starting in 2007. When the 2005, 2006 and 2007 numbers from the 2007 disclosure statement matched what was in my spreadsheet I clicked to the white background. I should have checked the earlier years where what was negative had been reported as positive.

When more than a day after the column was posted, a News Corp publicist called me, I had already discovered the mistake and told her it was being withdrawn and a correct column written. She also helped me tie down some crucial details, like finding that 2007 disclosure.

I often write tart notes at the Romenesko blog for journalists, the Columbia Journalism Review, Nieman Reports and elsewhere about what I consider flawed reporting by others. I lecture to young reporters around the world on the duty of care they need to take with facts and teach how to check and cross check. Until now I have never made a big mistake, but this is a painful reminder that we all put our pants on one leg at a time. The measure of character, I say in my posts and lectures, is whether when an error is found you forthrightly and promptly correct.

So I hope readers will trust that while I made a whopper of a mistake, it has been corrected forthrightly and promptly.