R
obert
Cay Johnston’s book
Perfectly
Legal
(Portfolio, 2003) discloses its main theme in its subtitle:
The
Covert Campaign To Rig Our Tax System To Benefit The
Super Rich—And Cheat Everybody Else
. This might seem surprising
coming from a business reporter at the
New York Times
, but
he has been one of their better journalists. Some, but by no means
all, of his facts and arguments presented in
Perfectly Legal
could have been read there. Still, it is interesting that his book
goes well beyond his efforts in the paper. In fact, Johnston often
sounds here like Ralph Nader or somebody still further left, with
statements such as: “that a tax designed to catch aggressive
rich tax avoiders [the minimum alternative tax] is being applied
to middle income families to finance tax cuts for the super rich
shows how both parties in Washington have become two wings of the
same party. The party of money.”
Not
being a practical manual on taxes,
Perfectly Legal
is of
necessity a work in political economy, and Johnston features the
flow of power from the super rich—which he sardonically labels
“the political donor class”—through legislatures
passing tax laws that have increasingly served the political donor
class to the tax collection agency, the Internal Revenue Service
(IRS). The IRS’s activities are sharply limited and directed
by those donor-friendly laws and the pressures and threats from
politicians and from donors who can activate the politicians to
bully the IRS. To this structure we can add a subdivision under
the donor class, which we may call the “tax cheat advisory
service,” consisting of bankers, security firms, tax specialists,
and others who have rushed to sell to the donor class accounting
or legal tricks by which their taxes can be reduced or eliminated.
It is a very good illustration of how well the market works to service
any money demand; here a demand for tax evasion services, with the
market producing a plentiful supply of talent for this constructive
effort.
One
other element in this political economy structure is the media.
While Johnston doesn’t offer any systematic treatment of the
media role, time and again he refers to important tax developments
to which the public should have been alerted that were ignored by
the media. This helps make this campaign of downward redistribution
of the tax burden “covert” and outside the sphere of public
debate.
Johnston’s
political donor class is only a few thousand very rich people. Sometimes
he focuses on the 400 top taxpayers ($174 million in average income
in 2000), whose 1.1 percent of all income in 2000 was double their
0.5 percent in 1992. Their federal tax income burden fell 16 percent
between those dates, whereas overall federal tax rates increased
18 percent (recall that this was the Clinton years). This understates
the case as the political donor class does not report all its income.
Johnston estimates that fully half of donor class income is unreported
and his book is focused on the upswing of upper class tax evasion.
Johnston notes the interaction between the increased income and
wealth of the donor class and their political muscle and ability
to subvert the tax system, which provides a pretty feedback system
that further enhances their wealth and ability to make the tax system
serve their needs.
He
also repeatedly points out how much the Democrats have contributed
to subversion of the tax system, even if the Republicans out-do
them in this race to the equity bottom. He refers several times
to the importance of the great increase in Social Security tax rates
in 1983, enacted by a Democratic Congress, which as he says was
“used to pay the ordinary bills of the government, making up
for the taxes that were no longer being paid by the rich because
of the 1981 income tax cuts.” He quotes Senator Moynihan calling
this tax increase “thievery,” taking from the poor to
pay for the tax cuts for the rich. (George W. Bush is offering a
variant of this earlier thievery: he is using even more brazen tax
cuts for the rich that produce deficits and an escalating debt that
may imperil the future of Social Security and calls this a “Social
Security crisis” when it is a Bush “borrow-and-spend crisis.”)
Two
additional major crimes in tax regression occurred in the Clinton
years. One was the agreement to give the IRS over $100 million a
year to audit applicants for the earned income tax credit (EITC)
to control fraud by the working poor. Under this program the IRS
in 2001 audited 397,000 working class applicants, 8 times as many
audits as it carried out for individuals with incomes of $100,000
or more. Johnston provides a case study of an IRS court proceeding
against Maritza Reyes, a domestic who worked hard to make $7,000
a year, with a $7,000 tax savings at stake. Johnston shows that
the IRS had no case, no witnesses, and no documents, just suspicions
based on an address that would have been cleared up by talking with
Reyes. Instead they forced her to trial and lost. He stresses that
the poor are easy targets, with few resources with which to defend
themselves, helping give the IRS a good “win” record.
Also, this is what the powerful Republican right wing, with some
Democratic allies, presses for—the same folks who aggressively
support tax cuts for the rich and IRS restraint in dealing with
the donor class.
The
other Clinton era service to tax regression was the IRS Reform and
Restructuring Act of 1998, signed into law by Clinton despite its
major effect being “handcuffing the tax police.” This
legislation followed well-publicized and hugely biased hearings
organized by right wing Senator William Roth that made out IRS personnel
to be “jack-booted thugs” threatening taxpayers with guns,
using subpoenas to embarrass people, making people pay taxes they
did not owe, etc. As Johnston says about this testimony, “Most
of it wasn’t true.” Some of it was true—he mentions
six IRS agents and a few outside experts who described not a rogue
agency, but one with problems created by Congress, namely, insufficient
resources; pressure to go after the weak to generate success numbers;
inability or unwillingness to pursue those with money to fight back.
But the media picked up on the “jack-booted thugs” claims
and gave “passing mention” to the serious internal complaints
about the effects of Congressional intervention and policy. Subsequently,
also, a report by William Webster on behalf of the General Accounting
Office exonerated the IRS from the jackboot accusation and found
that IRS cases were based on reasonable evidence. But the damage
had been done and a law passed that made it dangerous for IRS personnel
to pursue tax delinquents, who were provided with numerous bases
of complaint, the mere filing of which could mean a grueling round
of inquiries. The act was a windfall for tax cheats. Property seizures
and other forms of collection for tax non-payment plummeted. Low-level
IRS man- agers complained that the new message to them was “don’t
aggravate taxpayers,” excepting people like Maritza Reyes.
The
mistreatment of the poor by the IRS is further reflected in the
fact that in two-thirds of the audited cases against the poor they
get refunds, whereas overall statistics show that two-thirds of
audited cases result in more taxes being owed. The IRS is also free
to deny credit for two years or longer to EITC taxpayers, if they
deem an error on the return significant, and the IRS uses this power.
This is in spectacular contrast to the IRS’s treatment of errors,
fraud, and failure to file a return by the affluent. “Penalties
for errors are rare and those for cheating are often waived when
the IRS deals with the highest income Americans and the biggest
companies.”
Johnston’s
book is an extended recital of evidence of rich tax evaders getting
away with murder. He has an entire chapter on people—most importantly
business leaders and the wealthy—who refuse to file tax returns
(Chapter 14, “Mass Market Tax Evasion”). Some of them
brag openly about non-payment and many of them aren’t even
bothered by the IRS, which focuses on errors in the details of returns,
whereas claiming a zero income is not an error. Until 2000 the IRS
didn’t even try to identify and check out those who had filed
zero income claims. In dealing with a widespread business refusal
to collect and send in withheld tax income, the IRS not only dragged
its feet in taking any action, in one case, while failing to act
against the employer, it sent letters to the workers telling them
that they were still responsible for those taxes the employer was
refusing to withhold.
Johnston
describes case after case of gross abuse where the IRS did nothing
or started to investigate, but where the auditors were called off
by the higher authorities in the IRS because of their own bias or
because of political pressure from without. The investigation of
Enron was terminated in this manner in 1999, although Senator John
Breaux had noted, “Instead of drilling for gas and oil, Enron
was drilling the tax code, looking for ways to find more and more
tax shelters.” An audit of Unocal was called off by higher-ups
in the IRS, a point now known because one of the auditors was so
outraged he sued the IRS. In another major case involving Chevron
the IRS took the company to court, “briefly, until the auditors
were shut down on orders from the IRS national office.”
Mostly,
the tax cheats and evaders are not confronted at all, partly because
of fear of political repercussions, but also because of lack of
resources to deal with complex cases. Congress doesn’t allocate
$100 million to go after Chevron et al., as they did for Maritza
Reyes. Johnston cites case after case where money needed to investigate
major cheating avenues was not forthcoming. Thus, while some Senators
were allegedly appalled to learn that cheating was rampant among
partnership investors, “there were no hearings on national
television to expose the cheats and no extra funding was allotted
to hire and train auditors to hunt for these cheats.” Rich
folks who have shifted their citizenship to Belize or the Cayman
Islands—in tax-speak, “expatriation”—were still
required by law to pay U.S. taxes for the subsequent decade, but
Johnston points out that Congress provided no money to check on
these payments and the IRS has generally “ceased all compliance”
efforts checking up on this group that has not displayed much patriotic
ardor (Johnston’s chapter is entitled “Profits Trump Patriotism”).
As
IRS responsibilities have grown its resources have shrunk, illustrated
by a 30 percent drop in the number of auditors between 1988
and 2002. Johnston provides a table on “Tax Cheats and Debtors
Get Away Without Paying” that shows, for example, that 79 percent
of the cases of offshore tax evasion are not pursued, along with
75 percent of those who failed to file returns. As late as 2003
the IRS had never audited any of the 1,400 insurance companies that
operate free of tax.
The
IRS’s inability or unwillingness to pursue those with money
and political muscle has had wide consequences in the expansion
of tax evasion over the past decade. Johnston describes many modes
of evasion and implicit discrimination: (1) The ability of executives
to escape taxes through expenses, exchange funds, and the right
to virtually unlimited tax free pension savings, whereas a sharp
ceiling is placed on 401(k) savings by ordinary workers; (2) The
use of offshore business units to take income in low- or zero-tax
locales; (3) The proliferation of tax shelters and use of complex
organizational structures, including multiple partnerships, to inflate
income and hide expenses. These are often accompanied by “opinion
letters” from law firms explaining why the tricks employed
are legal; letters costing the tax evader up to a million dollars,
but giving them legal cover in case of IRS challenge. It is not
surprising that estimates of the “tax gap,” i.e., the
difference between taxes paid and tax obligations, now run to $300
billion and even higher.
Perfectly
Legal
is a text-book study of how a government agency can be
made incapable of properly carrying out its designated function,
forced to discriminate against the weak and allow serious abuses
by the donor class and others who benefit from their debilitating
impact on the agency. The mechanisms are simple and some of them
are features of a long-standing process by which regulators are
brought to heel and made serviceable to the interests of the regulated.
Here, with the IRS: defund to the degree necessary to prevent adequate
resources being devoted to big abusers; provide specific enforcement
funding only for tasks like going after Maritza Reyes; get loopholes
opened for abuses by legislation and have them kept open by donor
class-friendly legislators; fail to respond to new forms of abuse
with legislation or funding for study and enforcement; make the
IRS sensitive to donor class ability to get political assistance
when the IRS gets uppity; and use the revolving door with IRS officials
to help lobby the organization and make them think of the possibility
of a more prosperous post-IRS future.
Also
in the background must be a media sufficiently responsive to the
donor class to make sure that the IRS’s failures—the bias
favoring the rich and detrimental to the poor and ordinary citizens,
the huge and growing loss of tax revenue following from these failures—are
not reported and editorialized on to an extent that will make them
live public issues. That the media have met this standard is evident
even in Johnston’s references to the media, but even more in
the numerous cases and issues he discusses that are somehow not
news- or editorial-worthy. The system works beautifully for the
donor class and others, in the short-run grab-and-run mode, and
as an important element in the donor class’s accelerating class
warfare.
Edward S. Herman
is an economist, media critic, and author.