I have been reading David Kay Johnston’s new book Perfectly Legal. It’s very informative but slow going. I read a chapter and get so mad that I have to put it down for a few days. (It also gets a bit technical.) Nonetheless, it is a worthwhile read. Johnston’s message is that business interests and the very rich (but not all of them) have been buying politicians to rewrite the tax code to their benefit.
When the income tax system was established in 1913 there was a political consensus that taxes should be progressive. Since then special interests and well heeled donors successfully lobbied Congress to give us the system that we have today wherein the middle class bears the lions share of the tax burden. Most of these change occurred, with an accelerating pace, after the start of World War II. Although both parties share responsibility for today’s tax code and a toothless IRS, the Republicans are currently out front in shamelessly promoting the interests of the the donors who support their election. Conservative rhetoric notwithstanding, the Bush tax cuts benefit the few not the many. (Check here for a description of the lates tax breaks currently being enacted by Congress.)
Rather than promoting a meritocracy the current system is well on the way to producing a two class society consisting of a protected aristocracy and the rest of us. Our tax system requires a complete overhaul so that it is fair, efficient, and effective. For both political and technical reasons it won’t be easy. Obviously, there are powerful vested interests who don’t want that to happen. Further the tax code is very complicated, and even a ‘simplified’ code wouldn’t be all that simple. Changes to the code all too often have unintended consequences that someone can find a way to exploit.
In any rational discussion about the tax code it is essential to separate the questions of how government generates revenue and how government spends revenue. Those are two very important questions worthy of serious public debate, but they must be disentangled if we are to make any progress on either. We cannot, however, disentangle tax reform and election reform. I have to agree with Ralph Nader when he says that we have to fundamentally overhaul campaign finance in order to fix the tax system. Tall orders indeed.
The rest of this is mostly from Johnston’s book, but it does include some information that I obtained from the Congressional Budget Office web site.
Miscellany—some quotes and near quotes from the book and from Johnson’s on-air interviews
–Taxes are what we pay for a civilized society. Oliver Wendell Holmes
–We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity . . . (Emph added)
-Taxes should be based on the ability to pay—Plato, Aristotle, Adam Smith (ca. 1723-1790, The Wealth of Nations), David Riccardo (1772-1823, comparative advantage and free trade), and John Stuart Mill (1806-1873)
-The original tax regime (1913) taxed the economic elite—their incomes, gifts, and estates. These taxes came with the explicit promise that the basic means of sustaining life would not be taxed.
-To pay for WWI we taxed more “surplus income.” The estate and gift taxes were expanded and the income tax was applied to a larger, but still small percentage of Americans.
-After WWII taxes were expanded to apply to most Americans. (An initative by the Democrats that was supported by many Republicans. Pay as you go was very seductive.)
-Factoid. When the Income Tax was instituted most people were still part of a farm economy, and discussions of the the Capital Gains tax took into consideration the life cycle of a cow.
Where are we today with respect to income? The rich get fabulously richer(1)
-When corrected for inflation, wages for the bottom 99% of Americans have been flat for three decades (1970 – 1999)—actually they decreased by -.1%. In contrast the average income of the top 10% rose 88.6%
-The share of national income for the top 10% rose from 33% to 48%. Whereas, the share of the bottom 90% fell from 67% to 52%
-The higher up the income ladder you go, the greater the disparity. The richest 400 families earn in five days what most families earn in a year.
Where are we today with respect to he tax burden? It has been shifting to families with income between $50,000 to $500,000(2)
-From 1970 to 1999 taxes on individuals (income tax and social security tax) increased 23% faster than the GDP while corporate taxes fell 38% with respect to the GDP.
-In this same period contribution of individual taxes to federal revenue rose from 70% to 82% while the contribution of corporate taxes decreased from 18% to 10%. (It is now less than 10%)
-Considering all taxes that individuals pay (state, sales, gasoline) we essentially now have a flat tax—that is in broad terms. The richest 1% are taxed more lightly than the middle class, the poor are taxed almost as heavily as the rich and more heavily than the super rich. Meaning that the working poor struggle to survive, the middle class struggles to stay even, while the rich accumulate more and more wealth.
What will happen if voters don’t demand reform? Things, vis a vis taxes, will get worse for the individual, unless the individual is rich.
The rest of the book—Chapters 4 – 20
–Big Payday: Some tax code perks for corporate executives and how those perks detract from the health of the corporation and reduce tax revenue.
–Plane Perks: How corporate executives get free rides on corporate jets.
When the Old Man is dead and Buried: Misconceptions about the estate tax (caused by the fog of rhetoric) and a discussion of the estate tax and gift tax.
–The Stealth Tax: How the alternative minimum tax is likely to eat your lunch, unless you are among the rich
–How Social Security Taxes Subsidize the Rich. How revenue from Social Security taxes is diverted from the trust to fund government operations in order to offset the revenue lost because of tax cuts for the rich.(3)
Preying on the Working Poor: The disadvantages that the system imposes on the working poor and how they are ripped-off if they seek professional help in preparing their taxes.
–Handcuffing the Tax Police: How special interests and their lackeys in Congress operated to make it difficult if not impossible for the IRS to audit corporations and the rich, and to go after law breakers.
–Mr. Rossotti’s Customers: Rossotti reorganizes IRS in such a way as to reduce the agency’s ability to conduct audits.
–For Want of a Keystroke: How an IRS investigator could not find management support to electronically record the data from one key field on Partnership returns—doing so would have facilitated finding cheats. Also how IRS doesn’t share data on Partnership returns with the States.
–Mr. Kellog’s Favorite Loophole: How the 1986 Tax Reform Act allowed rich investors to own tax exempt insurance companies (originally formed to help farmers and rural merchants obtain casualty insurance) and operate them, in a way that an insurer would not, to their benefit.
–Mass Market Tax Evasions: How tax evaders use Section 861 of the tax code and other scams to justify their criminality.
–Getting Off the Hook: How an IRS investigator goes after tax cheats and loses his job when he gets too close to the donor class.
–Profiting Off Taxes: Case study of a particular off shore stock trading scheme. Court overrules a bad court decision(4) on a single loophole but neglects deeper problems. It is still possible to separate legal and economic ownership of capital.
–Profits Trump Patriotism: Congress bans corporate HQ moves to Bermuda for corporations but not for their subsidiaries.
–Letters to Switzerland: Case studies of off shore trades that take advantage of tax differentials and often use under the radar accounting practices and deal sweeteners, and the tax advantages of moving intellectual property off shore. After some Legal and Financial Firms had problems of their own making, Congress granted them special protection in 1988 by allowing them to form as LLPs. Now they longer any incentive to self police—meaning that they have no disincentive to sell shady Swiss Tax Shelters to unwary investors.
–Gimme Shelter: How various tax shelters for the rich operate: wrapping an insurance policy around an investment portfolio, laws in some states establishing trusts in perpetuity, life insurance trusts that legally allow investors to lie about the rates they pay, long term tax deferments for the profits on portfolios worth more than $5M, exchange funds that allow the rich to diversify a single security portfolio tax free, separating legal and economic ownership of stock, and more.
–Only the Rich Deserve a Comfortable Retirement: Describes how corporations: shift from defined benefit to defined contribution pension plans(5), reduce workers benefits in defined contribution plans, shift risk to employees while protecting executives, pump up executive pension by crediting years of service not worked and by basing pensions on salaries plus bonuses, and avoid taxes by contributing company stock to 401-Ks. Describes how Congress does not enforce rules requiring pensions plans to be run for the benefit of the employees.
1. The first two sub-bullets are based on an analysis of data from the National Income and Products Accounts. (Thomas Pickerty and Emmanueal Saez: NBER working paper #8647 available at the Saez Web site.) The third is from an on-air interview.
2. I worked up the quantitative data from revenue information available at the Congressional Budget Office Web site. I wanted to do a constant dollar analysis but was unable to find a source for the Gross Domestic Product (GDP) index. The observations about the reality of a flat tax are from Johnson’s book. The final sentence in the third sub-bullet is mine.
3. After the largest tax cut in history, Reagan had to raise revenue. He referred to increases to excise taxes (which included the gasoline tax) as “revenue enhancements.”
4. The judge whole ruled in favor of the corporation in this case is famous for having ruled that a defendant received a fair trial in a death penalty case even though his lawyer slept through parts of the murder trial.
5. In addition to lowering costs, corporations can use this as a form of union busting.