No More Free Lunches

On January 21, President Reagan asked his top assistants to find another way to reduce the federal budget deficit than by increasing excise taxes on liquor and cigarettes. Later, in his State of the Union Address, he stated that he would raise revenue by closing "tax loopholes" and not by imposing higher taxes. He and his assistants could recommend a simple way to reduce the deficit by billions: tax the now untaxed recipients of business inducements, and thus close the largest personal tax loophole existing today. This would both increase the supply-side by augmenting business funds for capital goods formation and maintain, if not increase, the expenditures by business to the restaurant and entertainment industry. It would certainly reduce the upcoming deficit and eliminate much waste and fraud in business deductions now taken for food and entertainment.

Each day millions of dollars are spent, and later legitimately deducted from income as business expenses, for food, liquor, sports tickets, airfares and club memberships. When businesses and individuals provide food and entertainment to further their business, they should deduct fully the necessary and proper expenses. However, these deductions, when not correspondingly reported by the recipient as income, substantially reduce the amount of money collected by the Treasury Department by several billions of dollars every year When the recipient of the "free lunches" fails to report the inducement as income, the expected deficit the administration faces grows larger. There is a solution to this problem: report and tax recipients of business inducements just as recipients of taxable bank interest

First, let us look at the problem A not too uncommon scenario follows

Arden and Jo meet each other for lunch twice a week Arden works as a real estate agent Jo is a bank executive. They have been friends for years and eat at their favorite fancy restaurant down town. Oftentimes Arden brings a prospective buyer with him. Sometimes Jo brings a major depositor of her expensive dish--shrimp or lobster Rockefeller when in season; Jo, the filet mignon Jo likes the $3.95 cheesecake for dessert and usually orders it saying "I'll log it off on the way home." Because Arden rents a new Mercedes Renz cash year to drive buses around he drives to work lacks exercise and does not eat dessert because "I'd rather just have an Irish coffee and keep glib and trim."

Their lunch, with the usual guests, ordinarily costs $100, including tip Who pays for this lunch? Once a week Arden says. "I'll get the bill." Once a week Jo says, "I'll pick up the tab, it's on me." But who actually pays for their lunch? Arden's real estate firm? Jo's bank? The prospective buyer or hefty depositor?

Well, yes, The bank or real estate firm pays part of the bill. Does the buyer or depositor pay the other part? No the federal government "pays" for it by uncollected income taxes. The hefty depositor and prospective buyer get a free lunch, without reporting it to the Internal Revenue service.

Jo and Arden greet each other with smiles, order lunch from the clean, bright mean, chat about high interest rates on mortgages, blame the federal deficit and government spending in the red talk about the last and upcoming weekend, eat, and depart with a pleasant handshake saying "thank you."

This scenario presents a poignant reason today to change the tax loophole in the Internal Revenue Service regulations. Each day, businesses, individuals, law firms banks and consulting companies buy free lunches for their customers clients, friends, and fellow business persons. Often they swap lunches every other day by saying, "tomorrow your firm or business will buy me lunch" The lunch, or business inducement. Is now tax free to the recipient without an IRS definition that it constitutes "income from whatever source derived" as the income tax statute states. This means that the recipient gets a free lunch or "income," without having to pay taxes on it. The lunchers must discuss some "business matters" for the business or individual buying the meal to deduct it as a business expense."

As a deductible business expense the meal saves the company, individual or corporation money on the income tax bill it would otherwise pay to the United States Treasury. The amount not paid in income taxes equals the percentage income tax rate of the business or individual multiplied by the amount of the meal In other words, it the tax deducted lunch of three business people cost $100 it "costs" the federal budget $50 in uncollected taxes if the business or individual deducting the lunch were normally taxed at a 50; rate.

This "cost" to the government for free lunches and tax-deductible food and entertainment to individuals would be a fine idea if it created capital goods formation to stimulate the economic recovery of the United States. But it does not. In fact untaxed income from inducements often distorts business choices in a free, competitive market. It also unfortunately adds to the federal deficit when the recipients do not report the inducement as income.

The solution to the problem of this tax loophole and resulting loss in revenue from the billions of dollars a year deducted as "necessary and proper business expenses" for food and entertainment that goes to someone (usually other affluent business persons) tax free, would be to require each recipient of the free and part federally funded lunch to report it on his or her income tax form. This arguably, should be done now under existing law and judicial definitions of income under the Internal Revenue Code.

The reporting and subsequent tax accounting could easily be done just like reporting taxable in interest from bank savings accounts: the recipient of the free lunch tells to the generous lunch purchaser his or her social security number In order for the business to deduct the "necessary and proper" expense, the business would have to record and report the recipient's 9 digit social security number. At the end of the year the recipient would get a form similar to the W 2 or 1099 tax form which shows the dollar amount of free lunches, or free airfares, or free dinners, or free sports tickets that the person received at the ultimate expense of the federal deficit. Then that amount should be reported as income to the recipient because it increases not only the recipient's life style but also income. This reported income taxed, could help the President balance the budget. That could hold down government borrowing to make up for the deficit, which could lower the interest rate to taken down each time Jo buys Arden's lunch Even if it causes some additional paperwork, any cost benefit analysis would support such a reasonable tax policy.

Arden and Jo might think twice about trading lunches at company expense if it will show up on their taxable income. But it would be fair beneficial to reducing the federal deficit, and helpful to the administration in getting the government out of the free lunch business and on to the economic recovery of our nation, and its real concern of encouraging capital goods, formation. When Jo's bank doesn't pay out as touch of its money for free lunches to its agents or wealthy depositors, it will have more cash to loan businesses and individuals the money for needed investment and proper expenses, like building a better factory.

Unlike earlier and misguided efforts to reduce the amount or quality of food and entertainment which could be deducted by business and individuals for inducements the proposal presented here allows unlimited business deductions, encourages voluntary inducements, carries out existing law, and places "revenue enhancement" on those who receive "free lunches" and who can most afford it.

President Reagan and his top assistants can act immediately, under existing statutory authority, to change the current IRS regulations which allow the tax loophole increase the federal deficit, and decrease the supply side of money for investments and capital goods.

"The new budget proposed to Congress does not now appear to account for closing this major tax loophole."

M Charles Mason, who graduated from Harvard Law School in 1949, is working toward a Ph. D. in English literature at Stanford.