- The Washington Times - Wednesday, October 24, 2001

Amending the tax code to allow an individual Net Operating Loss (NOL) and carryback deduction for two to three years into the future would provide an immediate yet temporary boost to the economy while we deal with the aftershocks of the Sept. 11 attacks and transition to our new war.

The U.S. Labor Department's September employment and unemployment report, which was released on Oct. 5, indicated that the economy lost 199,000 nonfarm jobs during the month. According to the report, the number of unemployed workers is now at 7 million and the unemployment rate is the highest it has been since 1991. Because of the survey methodology and measuring periods, those figures did not include the effects of the layoffs in the aftermath of the Sept. 11 attacks. As stated in the Labor Department's Bureau of Labor Statistics statement accompanying the report, "It is likely that the events of September 11 had little effect on the September employment and unemployment counts." However, foreshadowing the job losses it expects to see reflected in its October report, the bureau's statement goes on to indicate that the number of persons who wanted to work full-time but whose hours were cut back to part-time work increased by 860,000.

With the dislocations of the Sept. 11 attacks and their aftermath still reverberating through the economy, it is now clear that the economy will undergo further cyclical destabilization before any improvement may occur in the intermediate term. It is to be expected that consumer and household confidence will dip during the next 12 months. As the earnings of various industries in the business sector erode further, there will be additional layoffs and unemployment will soar which will, for a period, lead the economic recession to feed on itself. In this type of economic environment, in addition to capital expenditure incentives, immediately getting money into the hands of the household and consumer sector must be a vital component of any well thought-out congressional economic-stimulus package.

The Internal Revenue Code (IRC) of 1986 could be amended to provide exactly such a tax-cut stimulus for households and consumers.

The mechanism that could be used is a variation on the individual, income- averaging concept that used to be contained in the IRC of 1954. The IRC of 1954 used to contain provisions that effectively permitted individual taxpayers to average their income over a four-year period. Because of the way those sections worked, they were targeted toward taxpayers who had widely varying year-to-year incomes, but whose incomes had risen by at least 20 percent from the prior year. Therefore, the old, income-averaging sections worked to smooth out year-to- year incomes, for purposes of application of the income tax rates to figure out the amount of income tax due.

During a time period when we expect to face declining incomes, and substantial unemployment and therefore taxpayers with reduced or no gross income during certain taxable years an income averaging approach needs to be designed to immediately put funds back into taxpayers hands. In order to design such an income-averaging provision, it needs to provide individual taxpayers the equivalent of what corporate taxpayers have, that result in their ability to compute a net operating loss (under IRC section 172) for a particular tax year, along with a deduction of a loss in a previous tax year when the taxpayer had income. During periods of unemployment, individual taxpayers still have expenses that would qualify as tax deductible, such as student loan interest, mortgage interest, real estate taxes, medical insurance and medical expenses, casualty losses, etc. Taxpayers who do not claim itemized deductions are eligible to claim the standard deduction for their return filing category.

Application of the NOL carryback and allowing it as a deduction in computing taxable income in a prior year would then reduce the taxable income for that prior year and result in a tax refund. Because incomes were rising during the period of 1997 through 1999, permitting carryback of the individual NOLs to three or four prior taxable years would immediately generate refunds for taxpayers who had taxable incomes in those prior carryback years.

This approach also helps low and moderate income individuals who paid payroll taxes, but not income taxes. This approach also helps the individual owners of most forms of businesses that are structured as pass-through entities and incurred losses at the entity level which the owner otherwise would absorb in the year the losses are incurred.

Congress should recognize that for individuals, as for business taxpayers, incomes are subject to the vagaries of the business cycle and the arbitrary measuring period of a 12-month taxable year has the artificial effect of inflating tax bills and removing productive-purchasing power from the consumer and household sector. By its nature, such a mechanism is designed to assist those whose incomes decline, so it helps bolster sagging consumer spending.

Rohan Samaraweera is an economist and lawyer who practices in Boston and Washington.

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