January 23, 1973
Page 1848
TAX REFORM ACT OF 1973
Mr. MUSKIE. Mr. President, I rise today to discuss the Tax Reform Act of 1973, a bill I will introduce shortly to reform the Internal Revenue Code and to restore the basic premise of our system of taxation – that taxes be measured by ability to pay and that citizens with equal resources make equal contributions to the costs of government.
When the Declaration of Independence voiced the belief that all men are created equal nearly 200 years ago, the concept was revolutionary. We have built a nation on that revolutionary doctrine,
struggling to put that basic faith into practice.
In many fields of law and government and custom we have done extraordinarily well. In others we have much progress to make. And in the area of taxation we have actually been moving away from the standard of equality.
The problems we have with the way we collect the income tax remind me of a bit of old doggerel:
The rain, it raineth all around,
Upon the just and unjust falls,
But more upon the just because
The unjust have the just's umbrellas.
Our taxes, too, fall around, but they fall hard and heavy on the vast bulk of low- and middle- income Americans, on the men and women whose main source of income is their salaries and wages or the earnings of their small stores, workshops, and farms. Too often, the wealthy have umbrellas.
We started with the idea of collecting taxes in direct proportion to ability to pay them. We have strayed from that path, and it is now time to go back to that sound beginning.
But with the elections over, we already see an effort being made to forget the campaign promises of tax reform. President Nixon, last June 22, said he would send Congress his reform proposals before the end of 1972. We have not seen them yet.
Instead, we repeatedly hear administration spokesmen tell us that reform will not produce much new revenue, that the tax code needs little more than simplification, that the 1969 reforms cured the worst of our problems. Those statements are wrong, and the American people will not swallow them.
First of all, the bill I am proposing, while a series of moderate reforms, will, if enacted, generate almost $19 billion a year in new revenue by 1975. That is not a small sum by any standard.
Indeed, it is almost three-fourths of the budget deficit for fiscal 1972.
More important than the added revenue is the need to restore fundamental fairness to our tax system. Americans' sense of justice can no longer be mocked by a tax structure which extracts large sums from the average working men and women while permitting many of our very wealthiest citizens to shelter themselves, largely or entirely from tax.
For example, a year after the 1969 Tax Reform Act was enacted, the Treasury Department acknowledged that 107 persons with earnings over $200,000 paid no 1970 income taxes, and a total of 394, whose incomes topped $100,000 that year, also avoided Federal income taxes altogether. Three of them were individuals with incomes of more than $1 million.
These non-taxpayers represent only the tip of an iceberg of unfairness.
In fact, there is good reason to believe that something over one-quarter of all Americans with incomes between half a million and a million dollars are taxed at effective rates of no more than 25 percent. A Brookings Institution study a year ago showed that effective rates on the highest income brackets – from $100,000 to over $1 million – actually were only about 30 percent. The Brookings study found that the effective tax rate on incomes of over $1 million was less than half the statutory 70 percent – only 32.1 percent, in fact.
Tax preferences – unexamined and increasingly unjust – have made it possible for a well-to-do minority to pay less than a fair share of the tax burden. Indeed, the weaknesses of the law have given birth to an array of institutionalized tax dodges, most of them technically legal and most of them repugnant to the foundation of our system – that a citizen's contribution to society match his ability to contribute.
One example has been detailed in a Washington Post article I will put in the RECORD at the close of these remarks. It is the Fat City Corp., a multipurpose enterprise built around cattle raising and the opportunities that activity offers for tax writeoffs. For absentee "farmers" whose incomes put them in the 50-percent tax bracket – six taxpayers out of every thousand – Fat City's new subsidiary, Steer-West Cattle Feeding Programs, has created a limited partnership arrangement that permits investors to put $10,000 or more into cattle they never see and take a 1-year tax writeoff that can equal as much as 140 percent of their investment. The idea is so attractive that a competing organization recently launched another partnership specifically designed to turn well-to-do doctors into vicarious ranchers – and successful tax dodgers.
Last summer, analyzing 14 such cattlefeeding partnership plans, the Agriculture Department computed that full subscription to the schemes would have permitted tax writeoffs of at least $150 million. Commenting on investments in beef-breeding herds, the Department last April issued an analysis which said:
The loss to the Federal Government, in terms of revenues not received, will continue to far outweigh the monetary benefits to non-farmer investors. This implies, all else equal, substantial loss to society.
But special tax incentives for whitecollar cowboys are only one aspect of the variety of preferences available to a tiny minority of American taxpayers. A whole new profession has come into being, composed of experts on tax shelters. They are marketing their wisdom wholesale – in slick brochures, in tape recorded lectures, in seminars for other tax advisers staged in such sanctuaries of serious endeavor as Miami and Las Vegas.
Next month, in fact, a prominent institute is presenting a 3-day workshop in New York entitled "Tax Shelters of High Income Clients." For $225 a lawyer can participate in what the brochure says is "a forum for lawyers whose clients face high levels of tax and who look for appropriate ways to alleviate these burdens." One morning session will be given over to discussing the following tax shelters: equipment leasing, cattle, motion pictures, vineyards and other agricultural investments.
Last year the same group promoted its seminar in three different cities with a circular that asked:
Has your shelter sprung a leak? And if so, do you know how to fix it – swap it – sell it – or give it away?
For $39.50, a firm in New York City sells a 4-hour series of lectures on tape cassettes titled "Corporate and Executive Tax Shelters." The advertisement for this handy service says,
You can actually hear the nation's most astute tax experts speaking candidly and in detail on effective ways to shelter income ... The opportunities for tax sheltered investments do exist for the individual or company with a knowledge of where to look.
Then there is another New York organization whose cable address is "Tax Shelter." A 1972 prospectus from that firm claimed to present "the most unique offering ever made in the tax shelter field, inasmuch as it offers a combination of tax shelters in a balanced and truly diversified program." The company's offer it turns out, "is limited to those participants who represent that they anticipate having, during their current tax year, taxable income, a part of which, in absence of such investment, would be subject to taxation at a combined Federal, State and local income tax rate of not less than 50 percent."
Or, there is the outfit which offers its special handbook, "The Way Executives Cut Taxes," as a free attraction to subscribers to its weekly "Recommendations," a publication that costs $36 a year. The handbook is said to offer information on avoiding tax through real estate investments and notes:
You have to know about this one to reap its sensational tax-free advantages. The tax rules say you must ask for it, it's not automatic. It allows investors in certain rental housing to sell their property and pay no tax on the profits – no matter how large the profits are – when they continue reinvesting and snowballing their earnings.
One brochure shows a family, called "Mr. and Mrs. Fortunate Participant," with taxable income of $64,000, saving $4,240 in taxes through a $10,000 investment in a diversified program of tax shelters. Another brochure, from a company specializing in oil and gas drilling, claims a family with $20,000 in income can save $2,560 in taxes on a $10,000 investment and says a family earning $100,000 can cut $6,000 from its tax bill with the same investment.
There was even one broker touting a device labeled the "Mexican vegetable roll-over." That is not a new diet fad for health food enthusiasts; it is another fancy tax shelter for the rich. Like all the shelters, it can be worth something to only 430,000 of America's 74 million taxpayers.
This flourishing business of peddling expertise in tax avoidance mocks any argument that the tax code works fairly and needs no overhaul. Obviously, it is still full of the loopholes which enable some to duck the obligation to pay their fair share of the costs of our society. The advantages given to a few are deeply unjust. They require revision of the law.
The Treasury statistics now being used to cloud the need for reform are based only on what is called the adjusted gross incomes of these individuals, Adjusted gross income does not include tax-exempt income. It does not include earnings from interest on State and municipal bonds; and it shows a taxpayer's income only after subtraction of such special deductions as one-half of long-term capital gains, depletion allowances on oil and gas investments, and depreciation on real estate – all major tax shelter categories.
Mark Twain said that:
There are lies, damned lies and statistics.
The Treasury Department statistics purporting to show that only a few hundred Americans actually manage to avoid their fair share of the Nation's tax load are really a smokescreen for the truth. The truth is that the progressive nature of the income tax breaks down in the higher income brackets, so that the 70-percent rate which is supposed to apply to income over $200,000 a year is rarely exacted.
Now that is the situation after the 1969 reforms, and it is the true measure of the fact that legislation has not yet caught up to the major inequities in the tax code. Let me give you a specific example.
Before the 1969 changes there was an American with an income of over $2.2 million. Two-thirds of his money came from oil and gas, and the rest from long term capital gains and from dividends, interest, and other miscellaneous sources. He paid no tax at all on that income before 1969. Even now the effective rate on a similar income would be only 6.7 percent.
In contrast to the millionaire investor, consider the taxes paid by a workingman. With a wife and two children to support on a $10,000 salary, he pays Federal income taxes at a 9-percent rate.
The nontaxpayer with $2.2 million a year was a real person. Let us take instead a hypothetical American with earnings of $710,000 a year, $50,000 in salary and the rest in long-term capital gains, dividends and income from oil and gas production. He can tally against his earnings the following deductions:
A quarter of a million dollars in the intangible costs of drilling and developing oil and gas wells;
$100,000 for the percentage of depletion of oil and gas resources; another $100,000 for real estate losses from speeded-up depreciation of his investments in luxury apartment buildings; and
$50,000 of personal deductions, including charitable contributions.
In fact, his deductions total half a million dollars, but since $210,000 of his income is tax exempt to start with, he pays no regular Federal income tax at all, and only a minimum tax of $32,000 – for an effective tax rate of only 4.5 percent.
A tax code which permits such blatant injustice invites the distrust of the average American and mandates the Congress to enact thoughtful reforms. The thrust of such reform should be the effort seriously and responsibly to review – and, where possible, remove or restrict – the preferential provisions in our tax structure which offer individuals and businesses with large resources unfair shelter from tax.
In many instances, these special arrangements crept into the tax code without conscious social or economic purpose. The special benefits for oil and gas exploration and development were not
initially adopted to encourage drilling for fuels. That rationale has only grown up after the fact and requires reexamination now. The favored treatment for real estate investments was originally devised to encourage industrial growth and not as a means of inducing people to invest in apartment houses and office buildings. Now that the preferences are part of the law, those who wish to retain them have found arguments that were not heard or understood at the time of enactment.
In some cases we did consciously use the tax code to deal in a roundabout way with problems we were not willing to meet head on. We wanted to hurry up the rebuilding of city slums so we put rehabilitation costs into a special tax category. We wanted to promote exports so we devised the
1971 DISC legislation which benefits only those industries that sell abroad.
I am not saying that the ends we pursued were wrong. But the means we chose were often mistaken. We did things through the back door that should have been done in the open, and the result has been to put money into the wrong pockets, waste very large amounts of Federal revenue, and permit wealthy corporations and individuals to avoid paying their fair share of the costs of our Government.
The further result has been to twist an originally sound idea – the progressive income tax – so far out of shape that it encourages social and class division in America and breeds suspicion and growing contempt.
By allowing significant tax preferences to continue unexamined and unchecked, we nourish an injustice which sets class against class in America, wounds the Nation and jeopardizes citizens' faith in their Government. A system which knowingly rewards the wealthy and the expert at the expense of others is a system which invites distrust and risks destruction.
So we must, for a moment, scrutinize some of the most important tax preferences we continue to permit. We must count their costs and weigh the policy concerns which call for their reform.
First, we have to look honestly at the way we tax capital gains. If a man buys stock today for $100,000 and sells it 6 months and 1 day later for $150,000, only half his profit is counted as taxable income. Moreover, the first $50,000 of a taxpayer's capital gain in any 1 year cannot be taxed at more than a 25-percent rate. Above $50,000 the maximum rate is 36.5 percent.
Who benefits and who loses by a tax system that treats income from capital gains differently from other earnings? Obviously, the working man who cannot invest any substantial amount of savings gets no benefit from the special treatment we give capital gains. It is the wealthy who can and do profit from this favoritism.
They also profit from the failure of our laws to tax unrealized gains on assets a man holds when he dies. Those gains are not taxed at death, and his heirs, taking over the properties, figure their eventual capital gains on the assets not at the original cost of the property, but at the value at the time of death or a year thereafter.
Favored treatment of long-term capital gains, like the provision that excludes the first $100 in dividend income from taxation, benefits those wealthy enough to invest their savings. Its direct impact, however, falls on the less fortunate – those who are denied essential government services – or the taxpayers who in 1971, had to make up the $6.2 billion in revenue lost to the Federal Government because of the present capital gains laws, the $300 million lost in dividend exclusions, and the $3 billion lost by failing to tax capital gains at death.
Second, we must examine the actual effect of our practice of encouraging State and local governments to issue tax-exempt bonds. In 1971, it has been estimated, the loss to the Federal treasury of income from interest payments on such bonds amounted to $2.6 billion. To whom did those savings go? Nearly $700 million in 1971 went to those individuals and corporations having large enough resources to invest in municipal bonds.
And the higher the income bracket, the higher the benefit. One bond yielding $5 in tax-exempt interest a year is the same, in terms of income before taxes, as a Federal subsidy payment of $11.67 to a taxpayer in the 70-percent bracket but only $1.25 to a taxpayer in the 20-percent bracket.
So the way we have chosen to help finance local government investments is the wrong way. It wastes many of the Federal dollars intended for that purpose in paying tax benefits to the wealthy.
Third comes percentage depletion. Within certain limits, it allows an individual with income from the sale of minerals to deduct percentages of that income ranging up to 22 percent for oil and gas. The deduction is unique in that it bears no relation to expenses or investment. Thus, when we tax a million-dollar investment in manufacturing plant equipment, we allow its owner to recover the cost of his investment – $1 million and no more. But someone who puts his million dollars into mineral-producing property can recover that million dollars many times over.
On the average, in fact, oil and gas operators get back in depletion deductions at the expense of the general taxpayer many times more than they put into their properties.
The special treatment for oil and gas operators carriers over into the way we allow them to deduct upwards of three-quarters of their drilling costs the year they incur them. A man who builds a factory gets no such reward. He has to treat his investment as capital and depreciate it over the years.
Between deductions for percentage depletion and for intangible drilling and development costs, an investor in oil and gas can avoid paying Federal income tax indefinitely. As long as he spends on drilling and exploring what he makes from producing wells, subtracting 22 percent of that income for depletion, he can shove his proper tax burden on to someone else's back. The Federal revenue loss in 1971 from these two special provisions on mineral depletion and development costs was over $1.3 billion.
Our depreciation rules – the standards by which we apply the cost of an asset such as a building or a production line or a corporate executive jet against the income it brings in – have also generated significant tax windfalls. The 1971 asset depreciation range system, for example, set industrial depreciation guidelines far too low and cost the Treasury an estimated 1972 revenue loss of $1.7 billion.
Depreciation preferences for investment real-estate like luxury apartment buildings, as well as the even faster writeoffs for rehabilitation of low-income housing, have given developers and absentee landlords tax benefits out of all proportion to the social needs being served by the incentives. The estimated revenue loss in 1971 from all real estate tax preferences was $1 billion.
All of these discriminatory practices in the tax code demand review. Some require repeal now. For others, a prudent course of gradual modification will enable us, over the years, to assess the impact of change and, where necessary, enact programs to provide directly the wholesome stimulus we mistakenly put into the tax laws.
Briefly, but specifically, let me outline the reform proposals I am making along with the new revenues such changes would generate by 1975.
First, I would repeal the provision that limits the tax on the first $50,000 in capital gains to 25 percent, and I would phase in over 2 years a provision to tax 60 percent of capital gains rather than only half. During the same period, the corporate capital gains rate would be raised from 30 to 35 percent. By 1975, these changes would bring in $2.1 billion a year.
Second, I recommend that we phase in-over a 5-year period that will ease the impact of the change a basic reform to require income taxation of the appreciation in assets transferred at death. Such income now escapes taxation entirely. This revision of the capital gains provisions will produce $2.4 billion in new revenues in 1975, the third year after enactment, and $4 billion once it is fully implemented.
Third, I propose letting State and municipal governments issue taxable bonds. To those that do, the Federal Government would pay a subsidy of half the amount of the taxable interest. This should encourage these local authorities to move entirely away from the tax-exempt bonds they now issue and, while representing a new Federal revenue cost of $300 million a year, it would end this diversion of Government funds to the wealthy and bring in, by 1975, an additional $900 million annually to State and local governments.
Fourth, I propose we cut all existing percentage depletion rates by one-fifth, a modest reduction which would still net the Treasury $300 million a year by 1975 and diminish the unfair advantage now enjoyed by the wealthy individuals and corporations who shelter their income in oil, gas, and other mineral operations.
Fifth, I advocate treating the costs of exploration and development of minerals the same as other investments, requiring that they be capitalized rather than deducted in full in the year in which such outlays are made. Such a change will bring $800 million more to the Treasury in 1975.
Sixth, I recommend modifying the asset depreciation range system to strike the provisions that permit businesses to calculate depreciation 20 percent faster than the industry average and that set future depreciation guidelines below the industry average. By tightening these depreciation rules, the Treasury would earn $4.2 billion in 1975.
Seventh, among several reforms in real estate taxation, I would go to straightline depreciation of real estate, limiting depreciation to the owner's equity in his property, and capitalizing interest and taxes on undeveloped real estate and on buildings during construction. At the same time, the useful lives of buildings for depreciation purposes should be carefully reviewed to determine whether they should be shortened. Such reforms would produce an extra $1.1 billion in 1975.
Eighth, it is necessary to repeal the 5-year amortization permitted for the costs of rehabilitating run-down residential property and the other such 5-year amortization provisions added to the tax law in 1969 and thereafter. The reform would bring in some $100 million in 1975.
The adoption of these last two reforms does not free the Government from the obligation to foster the construction of decent low-income housing and provide appropriate means to meet America’s overall housing needs. Indirect incentives have not served those goals properly. In their place, I will support direct programs of assistance that match our resources to our requirements without building tax shelters alongside housing units.
Ninth, in the field of foreign taxation, I propose retaining the foreign tax credit itself, but modifying it to eliminate features which permit more favorable treatment for investments abroad than for those at home. In addition, the Domestic International Sales Corporation provision that lets exporters defer half their taxes indefinitely should be repealed. So should the tax deferral on undistributed earnings of American-owned foreign corporations, the special treatment of businesses in U.S. possessions and Western Hemisphere Trade Corporations and the exemptions of income earned by Americans overseas.
In all, these changes would bring the Treasury nearly $1.3 billion in 1975.
Tenth, to protect real farmers but end the farming tax shelter enjoyed by wealthy nonfarmers, I urge limiting the deduction of farm losses against other income to $15,000 in any 1 year. The change will generate $100 million in added tax revenue in 1975.
Eleventh, I call for tightening the 1969 act restrictions on the deductibility of investment interest in two ways. The present $25,000 exemption should be cut to $10,000, and all of the interest in excess of the $10,000 exemption, the net income from investments and for the year's long term capital gains should be required to be capitalized. Such a tightening of this special benefit for wealthy borrowers would bring in $300 million a year in new revenue in 1975.
Twelfth, I recommend repeal of the deduction for State gasoline taxes, a system which now results in shifting some highway costs from the user to the general taxpayer. We do not permit deductions of Federal gasoline taxes, and an extension of this principle to State levies will bring in $700 million in new Federal revenues in 1975.
Thirteenth, I propose a 2-year switchover in the way commercial banks, mutual savings banks and savings and loan associations are allowed to deduct their bad debt reserves to make the actual losses experienced by these banks the measure of the deduction instead of the present system, to be phased out by 1988, that allows them to compute a percentage of their loans as bad debts. The change would produce $200 million more in taxes in 1975.
Fourteenth, I advocate revising the investment tax credit to make its stimulus on the economy more efficient by basing the credit allowed on net increases in investment. Once full employment is achieved, the credit should be repealed entirely, but, for the present, its modification will produce increased Federal revenues of some $2.5 billion in 1975.
Fifteenth, to make the minimum tax enacted in 1969 a stronger tool, I call for cutting the $30,000 annual exemption to $2,000, imposing a progressive rate rising from 10 to 20 percent tax rate of the present flat 10-percent tax rate and eliminating the provision that permits taxes paid to be carried forward 7 years. The revised minimum tax would produce $300 million in revenues in 1975.
Finally, for the long overdue revision of the manner in which estates and gifts are taxed, an area the Congress has not touched in 25 years, I have four related proposals.
First, the law should provide for a unified tax on gifts and estates so that one rate schedule and a single exemption of $25,000, taken before or after death, applies against the estate itself and gifts made from it during life;
Second, we must cut off the escape from tax by what are known as generation-skipping transfers of wealth, now a device enabling the very wealthy to decrease the tax burden on their estates;
Third, to protect the right to transfer wealth needed to maintain the income of a surviving wife or husband, we should expand the marital deduction to exempt not just half the estate but an additional $100,000 as well, thus keeping taxes from bearing too heavily on modest estates.
Fourth, we should restructure the rate schedule to provide a more level rate of progression, with new rates from 20 to 80 percent, and impose the highest rate on estates with taxable value above $5 million.
These combined proposals in an area the Congress has permitted to remain a major source of tax loopholes would generate over $2.5 billion in added revenues in 1975.
Further details of these reforms are spelled out in a memorandum I wish to insert in the RECORD at the close of my remarks. The specific provisions are in a bill I will shortly introduce. But in these general remarks I have sought to direct congressional and public attention to one overwhelmingly clear conclusion: the way our taxes operate now constitutes an unfair sharing of the Nation's wealth, putting unjust burdens on the average American and awarding undeserved protection to the wealthy few.
The reforms I advocate today and spell out in legislation are moderate ones. They do not contemplate a wholesale purge of the tax code to eliminate all indirect subsidies. They permit us instead to revise the most inequitable of the tax preferences while allowing us to replace them, where necessary, with straightforward programs that more efficiently serve the same ends.
In approaching tax reform it does no good to cry for massive changes without some appreciation of the secondary dislocations those changes might produce. We cannot know the precise effects of reforming tax preferences any more than we knew the precise effects of writing the preferences in the first place. So we must act with the restraint appropriate to the limits of our foresight.
But the need for the reforms I propose is clear. The inequities I have documented demand prompt remedy.
Last year tax reform was a campaign issue. This year the administration apparently wants to forget the subject.
But in a time of spiraling Federal deficits, it is sanctimonious and deceptive in the extreme to call for responsible spending limits without acting simultaneously to tighten our leaky tax code. In this decade, the Treasury has estimated, we stand to lose over $33 billion in revenue if we leave the acronymic ADR and DISC provisions unchanged. Allowing the law's provisions on taxation of capital gains to stand as they are would cost close to $100 billion in the same 10-year period.
Moreover, the benefits of our myriad tax preferences cannot be said to be fairly shared when they go overwhelmingly to the most powerful corporations and the most affluent individuals. It has been reliably calculated, for example, that in 1970 and 1971, seven giant companies whose dividend payments ranged between $33 and $78 million paid no income taxes to the U.S. Government. Other computations show that the capital gains provisions in the code now are worth only an average of $7.44 in annual tax savings to Americans earning between $5,000 and $7,000, but are worth over $2,600 in tax savings, on the average, to those with incomes between $50,000 and $100,000.
The poor – even middle-income Americans whipsawed by rising prices and higher taxes – own no oil wells. They cannot depreciate real estate they do not possess. They cannot collect tax-free interest on bonds they are unable to buy. They cannot write off cattle feed when they have to limit the amount of beef they eat at home. And they cannot enjoy the untaxed increase in value of securities they will never inherit.
Theirs is the cause of tax reform now.
Theirs is the appeal for a return to fiscal justice.
We cannot let it be said of America in the 20th century that it violated its most fundamental belief, the revolutionary inspiration of equality. To the extent that our tax code does damage to that faith, it requires immediate reform. We must stop using tax policy to promote social ends that can be better answered by other means. We must start again to use our tax system to strengthen our whole society and to redeem Americans' trust in the justness of their Government.
Mr. President, as part of my presentation on tax reform today, I ask unanimous consent that the following material be included in the RECORD at this point:
First. A memorandum explaining in detail the 24 specific changes I am proposing;
Second. An article from Newsweek magazine of January 1, 1973, on tax shelters by Adam Smith;
Third. An article from the Washington Post of January 14, 1973, about cattle feeding investments as tax shelters; and
Fourth. Two articles from the January issue of the Washington Monthly by James Fallows and Philip Stern on the inequities of our present tax system and the problems taxpayers have in actually discovering the way the laws operate.
I believe that interested Senators will find all this material worth studying as explanations of the problems we face and possible solutions to those problems.
There being no objection, the material was ordered to be printed in the RECORD, as follows:
SUMMARY AND EXPLANATION OF MUSKIE FEDERAL TAX REFORM PROPOSALS
A. INCOME TAX
1. Capital gains
a. Issue – Under present law, individuals who realize long-term capital gains are allowed a deduction of 50 percent of the total gains. Except for the minimum tax – a special 10 percent tax applicable in certain circumstances – the other half is tax-exempt.
Furthermore, a special maximum limitation of 25 percent is placed upon the tax rate applicable to the first $50,000 of an individual's capital gains. Because the alternative tax applies only where it produces a lower tax than the 50 percent capital gains deduction, the alternative tax is advantageous only for taxpayers whose tax bracket is above 50 percent – only, that is, taxpayers in the very highest brackets.
Corporate capital gains, are generally taxed at 30 percent, rather than the 48 percent applicable to most other corporate income.
The capital gains preferences for individuals permit those who have sufficient wealth to invest in capital assets to bear far less tax for a given amount of income, than individuals whose economic circumstances prevent the accumulation of wealth and compel the realization of income in the form of wages, salaries, and the like. Similarly, the corporate capital gains preference allows corporations and industries which can realize business profits in the form of capital gains to pay lower rates of tax than businesses with most other kinds of income.
b. Proposal – (1) Repeal of the provision permitting the first $60,000 of capital gains to be taxed at no more than 25 percent. (2) Requirement that individuals include 55 percent of capital gains in income in the first year and 60 percent of capital gains in income thereafter, rather than 50 percent as permitted under present law. (3) Increase the rate on corporate capital gains from 30 to 35 percent.
c. Revenue – $2.1 billion.
2. Gains at death
a. Issue – The existing income tax structure fails to tax gains in assets held by a decedent at his death, while at the same time allowing a step-up in basis so that on a subsequent sale this portion of the gain is not taxable. Very large amounts of capital gains thus escape federal income taxation altogether under present law. For 1966, the figure was approximately $11 billion.
b. Proposal – A tax should be imposed on the appreciation in assets transferred at death or by gift, with certain exemptions and exclusions. The proposal would close the massive loophole in present law by which large amounts of appreciation in the value of investments escape income tax entirely.
By permitting every taxpayer a minimum basis for all his assets, the effect of the tax could be limited to decedents with assets having substantial aggregate value. The reform should be phased in over a five-year period, permitting taxpayers dying in the first year after enactment to pay 20 percent of the tax due under the new rule, those in the second year, 40 percent, those in the third year, 60 percent, those in the fourth year, 80 percent, and those thereafter the full amount.
c. Revenue – 2.4 billion (In the fifth year after enactment the full implementation of the change would bring a revenue gain of $4 billion.)
3. Interest on State and municipal bonds
a. Issue – Unlike any other form of interest-including interest on obligations of the Federal Government interest on State and municipal bonds is exempt from all Federal income tax. The exemption is defended as a means of helping State and local governments raise revenue at low cost because the exemption of the interest on such bonds results in their being marketable at substantially lower interest rates than comparable grades of taxable Federal and corporate bonds.
However, the saving in interest costs to State and local governments is only about 70-percent of the revenue loss to the Federal Government, with 30 percent of the funds going to high income individuals who invest in tax exempt bonds. Because the tax advantage of the exemption is greatest for those with the highest incomes – and because low and moderate income taxpayers do not have the funds available for investment in such bonds – the exemption benefits upper-income taxpayers almost exclusively. A famous example was a Michigan widow whose annual $5-million income from such bond interest was entirely tax exempt.
b. Proposal – States and municipalities would be given the option of issuing taxable bonds. To those that do, the Federal Government would pay a subsidy equal to 50 percent of the interest rate of the taxable bonds. With the interest subsidy fixed at 50 percent, States and municipalities would be likely to move entirely to the issuance of taxable bonds.
c. Revenue – The proposal would cost the Federal Government $300 million a year in 1975, the subsidy payments to State and local governments being somewhat higher than the revenue realized by taxing the bond interest; but the proposal would generate an additional $1.3 billion for State and local governments annually.
4. Percentage depletion for mineral resources
a. Issue – For a whole range of minerals, the producer may deduct a flat percentage of the gross income from the sale of the minerals. In the case of oil and gas, for example, the percentage depletion allowance is 22 percent. This deduction is unique in the tax law because it does not require the taxpayer to expend or invest any funds. Every other business deduction provided by the Internal Revenue Code is limited either by the amount a taxpayer spends currently – as in the case of the deduction for ordinary business expenses – or the amount which the taxpayer previously invested – as in the case of the depreciation allowance for investment in a building or machinery.
b. Proposal – Uniform reduction of existing percentage depletion rates by 20 percent.
c. Revenue – $300 million.
5. Mineral drilling, exploration, and development costs
a. Issue – Most of the costs incurred in drilling oil and gas may be deducted in full in the year incurred. Similar deductions apply to the costs of developing other minerals. In contrast, the cost of plant equipment and other business assets must be capitalized and can be recovered only through depreciation over what may be extended periods of years. Using the combination of percentage depletion and intangible drilling and development deductions, an investor in oil and gas can avoid Federal income tax indefinitely. The investor first spends enough on drilling and development for oil and gas to offset his current income. When the wells reach production, the income from them is partially offset by percentage depletion, and the remaining portion can be offset by additional expenditures for intangibles.
b. Proposal – Require capitalization of intangible drilling and development and mine exploration and development costs, and adopt a recapture provision, similar to that now provided for machinery, operative when mineral properties are sold.
c. Revenue – $800 million.
6. Asset depreciation range system
a. Issue – The ADR system which the Revenue Act of 1971 adopted for business plant and equipment permits businesses to enlarge their depreciation allowances by employing depreciation periods 20 percent shorter than the industry averages which, under prior law, were used as guidelines – even though the prior guidelines were themselves quite liberal. Moreover, ADR increases depreciation deductions still further by requiring future guideline lives to be determined by calculating overall industry replacement experience and then utilizing the future representing the experience of businesses at the 30th – not the 50th – percentile.
The overall effect of ADR is to grant a major tax windfall to businesses which utilize depreciable assets.
b. Proposal – Modify the ADR system to repeal the 20 percent leeway rule and require establishment of future depreciable lives at the 50th percentile of industry experience, rather than the 30th percentile.
c. Revenue – $4.2 billion.
7. Tax treatment of real estate
a. Issue – The present highly favorable tax rules for investors in real estate (such as apartment buildings) have made investments in such property one of the most broadly used tax shelter devices. Although depreciation in general is a means of recovering the capital costs of an asset as it is consumed in use, accelerated depreciation on real estate results in most of the property's cost being recovered in the early years of its life, while it is still in productive use and, in many instances, while it is increasing in value. Furthermore, depreciation is computed on the full cost of the property, not the owner's equity interest. Frequently an investor has a very small equity in a property; he is computing his depreciation on the total cost of the property, including the mortgage; and his depreciation deductions quickly outstrip his own investment in the property.
The result is that, with a large mortgage loan, accelerated depreciation permits the owner to recover not only his own cost but also the lender's – and to do so much faster than he is obligated to repay the lender.
In addition to the depreciation advantage, investment in real estate allows the deduction of interest and taxes incurred during the construction of a building, or while undeveloped real estate is held.
These provisions allow the current deduction of items that are essentially capital in nature as a tax shelter for income from other sources during a period when no income is being produced from the building. Also, after the completion of construction, real properties are sometimes mortgaged in refinancing operations for amounts which exceed their depreciated costs. While the investor generally has no personal liability for the debt, under current law he is not taxed on the excess of the mortgage proceeds over his depreciated cost in the property.
b. Proposal – (1) Depreciation on investment buildings should be restricted to the owner's actual equity and limited to the straight line method; (2) Interest and taxes incurred on holdings of undeveloped real estate and during the construction phase of buildings should be required to be capitalized; (3) A full recapture provision should be applied to the sale of investment buildings; (4) The excess of mortgage proceeds above an investor's depreciated cost in investment real estate should be includable in the investor's income to the extent of depreciation previously taken, and (5) the useful lives for buildings should be reviewed to determine whether reduction is appropriate.
c. Revenue – $1.1 billions
8. Special five year amortization provisions
a. Issue – A special provision added by the Tax Reform Act permits the expenses of rehabilitating low-income rental housing to be deducted over a five-year period, which is substantially shorter than the expected useful life of the rehabilitated property. As in the case of accelerated depreciation for residential real estate, if the rehabilitated property is held for 16 years and 8 months, there is no recapture of the amortization deductions as ordinary income upon sale of the property. The tax characteristics which make residential real estate an attractive investment are considerably accentuated by the allowance of the special, abbreviated write-off period. Although the provision was adopted to encourage the rehabilitation of rundown residential property for use by the poor, its tax features seem likely to encourage investors to do as little as possible to maintain the property after their initial investment, while they await the expiration of the recapture phaseout, and the property deteriorates.
The 1969 and 1971 Acts added other special 5-year amortization provisions, including ones for railroad rolling stock and certified pollution control facilities. The effect of these provisions is to create additional tax shelter opportunities for those with high incomes, dissipating the revenue intended for social or economic objectives in large tax savings for upper-bracket taxpayers.
Where necessary, the policy objectives of these provisions should be the subject of direct government assistance programs, rather than tax preferences which allow wealthy persons to avoid paying taxes.
b. Proposal – Repeal the rapid amortization provisions introduced by the Tax Reform Act of 1969 and the Revenue Act of 1971.
c. Revenue – $100 million.
9–14. Special Treatment of Foreign Items
The revenue to be gained from the six changes outlined below would amount to $1.3 billion.
9. Domestic International Sales Corporation
a. Issue – The DISC provision enacted in 1971 permits the indefinite deferral of taxation of 50 percent of the income of a corporation engaged in selling goods for export, regardless of whether the export sales represent an increase over prior years' sales. In fact, the tax deferral is the rough equivalent of a tax exemption because tax is not payable as long as the DISC complies with certain requirements, and the untaxed profits can be used in the business of the parent-supplier by means of loans from the DISC. The stated purpose of the provision is to encourage expansion of U.S. exports; but there is no factual evidence that the provision expands exports, and the view of most economists is that it does not.
b. Proposal – Repeal of the DISC provisions.
10. Foreign tax credit
a. Issue – Subject to certain limitations, present federal law permits U.S. taxpayers who pay income taxes to foreign governments (or taxes in lieu of income taxes) to credit those tax payments against their U.S. income tax liability. In general, the foreign tax credit is a sound device for preventing double taxation of income earned abroad. However, various features of the existing law governing the computation of the credit permit use of the credit to achieve more favorable tax treatment for investments abroad than for those in the United States.
b. Proposal – The "overall" limitation on the foreign tax credit should be repealed. Taxpayers should be required to compute their allowable foreign tax credit subject to the "per country" limitation. Other structural revisions should be made in the foreign tax credit to ensure that it operates only as a device for achieving tax neutrality, and does not afford preferential treatment for business operations abroad.
11. Income of controlled foreign corporations
a. Issue – By operating abroad through subsidiaries, U.S. corporations are able to obtain deferral of U.S. taxation of income which is retained abroad in low-tax countries. In certain tax haven situations, Subpart F of the Internal Revenue Code taxes the undistributed profits of the foreign subsidiary to the U.S. shareholders; but even this tax can often be avoided. Consequently, under present law U.S. businesses operating abroad through controlled foreign subsidiaries enjoy a major tax advantage which is unavailable to businesses operating only within the United States.
b. Proposal – Eliminate the tax deferral available to United States shareholders of controlled foreign corporations by extending the present provisions which tax U.S. shareholders on their pro rata share of certain classes of earnings of such corporations to encompass the full yearly profits of those entities.
12. Income earned in U.S. possessions
a. Issue – Income of U.S. citizens or corporations from sources in possessions of the United States is exempt from Federal income taxation if such income equals at least 80 percent of the taxpayer's gross income from all sources over a three-year period and at least 50 percent of the taxpayer's gross income over the same period was earned in a trade or business carried on in a U.S. possession. The exemption extends to its beneficiaries an advantage unavailable to domestic taxpayers; that advantage is most valuable to those with high incomes and least valuable to those with low incomes; and the provision is unsupported by any factual demonstration of its utility to the economies of U.S. possessions.
b. Proposal – Termination of the preferential treatment presently afforded income derived from United States possessions.
13. Western hemisphere trade corporations
a. Issue – Corporations which receive 95 percent of their income over a three-year period from business carried on in the Western Hemisphere are taxed at approximately 34 percent, rather than the normal 48 percent corporate rate. The defects pointed out above with respect to the exemption for possessions income apply to this provision also.
b. Proposal – Repeal of the 14 percent point tax preference presently afforded Western Hemisphere Trade Corporations.
14. Exemption for income earned abroad
a. Issue – Individual U.S. citizens who either are bona fide residents of a foreign country or live abroad for at least 17 out of 18 months can exclude from their U.S. taxable income up to $25,000 or $20,000, respectively of income earned abroad during such period. Since the foreign tax credit is available to prevent double taxation of such income, there is no sound reason for these provisions; and they benefit primarily those with high incomes.
b. Proposal – Termination of the exclusions allowed citizens who live abroad.
15. Tax shelter farm losses
a. Issue – Congress in 1969 adopted a provision requiring persons with confirmed adjusted gross income in excess of $50,000 for a year, and a farm loss in excess of $25,000 for that year, to set up an Excess Deductions Account (EDA), in which all farm losses in excess of $25,000 per year are recorded. When farm property is sold, any income from the sale which would otherwise be treated as capital gain is taxed as ordinary income to the extent of the balance then existing in the taxpayer's EDA.
The 1969 provision has proved insufficient to prevent broad use of farming investments as tax shelters for non-farmers. Individuals whose adjusted gross incomes are below $50,000 --
including those who have large real income, but low adjusted gross income because of depreciation deductions, intangible drilling and development expenditures, and other such devices – are unaffected by the EDA provision. Even those with higher adjusted gross incomes are permitted an annual $25,000 deduction which is free of recapture, and even where recapture applies, the current farming deductions make possible extended postponements of tax.
b. Proposal – Deduction of farm losses against non-farm income should be limited to $15,000 in any year, with appropriate provision for carryover of excess losses for use against farming income in future years.
e. Revenue – $120 million.
16. Investment interest
a. Issue – Prior to the 1969 Tax Reform Act many taxpayers borrowed money to invest in securities or other property which produced little or no current income but had good growth potential The interest paid on the borrowings could be deducted from the taxpayer's other income, and when the property was sold the gain on the sale was taxed at the low capital gains rates – effectively both deferring tax and ultimately converging ordinary income into capital gains. The Tax Reform Act limited this device somewhat by disallowing, as a deduction, half of the amount by which an individual's "investment interest" for the year exceeds the total of (1) $25,000; (2) his net investment income; and (3) his long term capital gains for the year.
However, the 1969 restriction is insufficient to eliminate the abuse at which it was aimed. Both the annual $25,000 allowance and the deductibility of half of any excess investment interest can still be used to shelter other income. Moreover, in most cases interest paid on borrowings to invest in oil and gas or real estate-two of the classic tax shelters is not treated as "investment interest" for purposes of the provision and, therefore, is not subject to the 1969 Act's limitations.
b. Proposal – (1) The existing $25,000 exemption should be reduced to $10,000; (2) All investment interest in excess of the exemption level should be made subject to the limitation – not merely one-half as provided in the present statute; (3) The definition of the term "investment interest" should be expanded generally to include interest paid on passive oil and gas and real estate investments.
c. Revenue – $300 million.
17. Deducations for State gasoline taxes
a. Issue – Although the Federal gasoline tax has not been deductible in computing Federal income tax liability for many years, the comparable State gasoline taxes are deductible. Like the Federal tax, the State gasoline taxes are essentially user charges to finance streets and highways.
Their deductibility for Federal income tax purposes has the effect of shifting part of highway costs from the highway user to the general taxpayer. Elimination of the deduction would place that cost upon the persons who ought to bear it.
b. Proposal – Repeal of the present deduction for State gasoline taxes.
e. Revenue – $700 million.
18. Excess bad debt- reserves
a. Issue – Commercial banks are permitted to deduct an amount equal to a flat percentage of their eligible loans outstanding as a bad debt reserve – regardless of their actual bad debt loss experience. Although the percentage method is being phased out gradually, banks are still permitted a flat deduction of 1.8 percent of loans until 1976, 1.2 percent until 1982, and 0.6 percent until 1988. These percentages are very substantially in excess of banks' historical loss experience. In addition, mutual savings banks and savings and loan associations are allowed even more generous deduction rules for bad debt reserves in excess of their actual loss experience.
b. Proposal – Commercial banks, mutual savings banks, and savings and loan associations should all be allowed additions to bad debt reserves based solely upon their actual loss experience. The transition from their present reserves, which are considerably in excess of actual loss experience, to the proposed rule should be accomplished over a short period of time – perhaps two years.
c. Revenue – $200 million.
19. Investment tax credit
a. Issue – Reenacted in1971, the investment tax credit gives corporations and individuals investing in machinery and equipmeet a credit against their Federal income tax of seven percent of the cost of the machinery or equipment. While the investment credit has proved to be an effective tool for stimulating investment under certain economic conditions, it could be restructured to make its stimulative impact more efficient. Some of the substantial revenues which the Federal Government is now granting businesses through the investment credit could be made available for use elsewhere, while the revised credit is retained to encourage needed productive expansion.
b. Proposal – Restrict the allowable credit to net increases in investment.
c. Revenue – $2.5 billion.
20. Minimum tax
a. Issue – The 1969 Tax Reform Act adopted a 10 percent minimum tax on certain items of "tax preference." The minimum tax has several significant weaknesses; (a) it is imposed at a flat rate, rather than a progressive one; (b) the rate is fixed at only 10 percent; (c) taxpayers are allowed a $30,000 exemption per year; and (d) a 1970 amendment permits taxes paid to be carried forward for seven years to offset tax preferences otherwise subject to the minimum tax in those years.
b. Proposal – (1) The existing $30,000 exemption should be reduced to $2000. (2) The rates of tax should be graduated: as preference income escalates, so should the proportion of tax paid. A rate structure beginning at 10 percent and rising to 20 percent, in lieu of the present flat 10 percent rate, is proposed. (3) The tax carry forward should be eliminated.
c. Revenue – $300 million.
8. ESTATE AND GIFT TAXES
21. Integration of estate and gift taxes
a. Issue – Under present law, estates and gifts are taxed separately so that an individual may transfer portions of his wealth by gift during his lifetime, pay whatever gift taxes are due, and then have his remaining estate taxed without regard to the fact that a portion of his wealth has been transferred. The effect is to divide the individual's wealth and tax each part on a separate rate schedule with separate exemptions. Moreover, gift tax rates are lower than estate tax rates, and the gift tax itself is excluded from the estate. These features create substantial tax savings, particularly to the very wealthy, and the potential for savings through lifetime giving increases as the donor's wealth increases.
b. Proposal – The establishment of a unified gift and estate tax, making lifetime gifts and transfers at death subject to tax under one rate schedule with one exemption, which could be utilized during life or at death.
22. Generation-skipping
a. Issue – The very wealthy are in a position to give property either outright or in trusts to distant heirs – grandchildren and beyond – so that the family's wealth is taxed only once every several generations, rather than once each generation as is more commonly the case for less affluent decedents. These arrangements substantially lessen the impact of estate taxes on the very wealthy and take a good deal of progressivity out of the estate tax system.
b. Proposal – special tax imposed on generation-skipping transfers, approximating the tax which would have been paid by the skipped generation.
23. Marital deduction
a. Issue – Under existing law a deduction is allowed for property transferred to a spouse, but the deduction is limited to one-half of a decedent’s adjusted gross estate. For small or moderate sized estates, the estate tax can seriously deplete the funds upon which the surviving spouse must rely for her support.
b. Proposal – The marital deduction should be increased. A deduction should be allowed equal to one-half of the estate, plus an additional specified amount, such as $100,000. This approach will avoid completely the imposition of taxes on estates below the minimum amount, where funds are needed for the surviving spouse's maintenance.
24. Exemptions and rates
a. Issue – The present estate tax rates start at 3 percent on estates which, after all exemptions and deductions, do not exceed $5,000. The rates rise to 77 percent on taxable estates in excess of $10 million. These rate schedules should be restructured to increase rates and provide for a more level rate of progression.
b. Proposal – A unified exemption of $25,000. While this is less than the present combined estate and gift tax exemptions, the liberalization of the marital deduction proposed above increases the exemption where it is needed most. New rates would range 20 percent to 80 percent. The upper marginal rate would apply to estates which, after deductions and exemptions, exceed $5 million.
Combined Revenue (proposals 21-24) – $2.5 billion.
[From Newsweek, Jan. 1, 1973]
MY TURN: "GIMME SHELTER"
(By Adam Smith)
If you have an apartment project that is somewhat doubtful, an oil lease that needs some optimists, or some lean, red-eyed and hungry calves, this is a great time of year to bring in doctors, dentists and salesmen as partners. For this is the time of year when the people who are not on regular salaries count all the $20 bills in their cookie jars and realize they are going to have to pay more taxes than they thought, unless they do something quickly.
"Sidney," they say to their brokers, or their accountants, "I just looked in my bank account, it's been a good year, I don't want to pay the taxes on it, find me a tax shelter."
Sidney says gee, it's a bit late, there was an apartment deal that was floating through the office last week but it's all sold, there was a fella in with some oil leases who is supposed to have a good track record but he's gone, let me see what I can do.
And the classified pages of various business journals blossom with the heading, tax shelter.
GOOD THINGS
What is a tax shelter? A tax shelter, for the general public, is a business somebody else is in.
Somebody who has a good lobby in Washington. Congress writes the tax laws, and Congress in its wisdom and its collective desire to be re-elected has decided that some areas of endeavor are socially more noble than others, they are Good Things, and should be helped along. So, if you are a dentist, you take your dentistry income, not a Good Thing Congresswise, and put it into building an apartment house or drilling an oil well, two Good Things relatively easy to understand, and then you don't have to pay any taxes this year. The income is offset by the accounting charges from the Good Things. Some other year, when the Good Thing is sold, you might have to pay a capital-gains tax, but that rate is lower than on earned income and maybe you can find another shelter that year. Of course, if you are a dentist, you ought to ask yourself: would an apartment builder who has a good project really want a dentist like me as a partner? Why? Would a driller who thinks he has found a major oil field go right past Mobile, Exxon, Gulf and Union to little old me? Good questions, because, as they say in the oil business, the easy oil has been found, and some similar aphorism applies to every other kind of tax shelter. So tax shelters are for the marginal efforts. They do get you the write-off. The problem is that they don't necessarily get you your money back. For the promoter takes a hefty cut for having brought all the parties together. The lawyers and accountants add on their fees for making sure the deal is legal and accounted for. If a Wall Street broker is selling the deal, he will tack on a fat commission for selling it. (Wall Street firms like to sell tax shelters, because their profits on securities have been dampened by commission cuts and the commissions on tax shelters are much higher.)
Patents and Christmas trees and unharvested pecans are Good Things, nice capital gain things, and I and about 200 million other people are not in the club. If you want some genuine funny bedtime reading, try The U.S. Master Tax Guide. Having decided what was a Good Thing, Congress then had to decide what was Fair, relative to those Good Things. When does an unharvested pecan tree (capital gain) become harvested and not a capital gain, and what if different people own the pecans and the tree? It becomes like those old algebra problems. John is on a train that left Washington at 4:02 and has eaten six oranges and Mary is on another train that is going 42 miles an hour and she has five apples. What time is it?
A LITTLE DAYLIGHT
The Tax Reform Act of 1969 is said to have closed some of the old loopholes. I think it did. The Tax Reform Act of 1969 was also called – jocularly, mind you – the Lawyers' and Accountants' Relief Bill. Meaning that as long as the tax laws are as complicated as they are, the unemployment figures should include zero lawyers and accountants. I have been in some of the great law firms, with portraits of various dudes in muttonchop whiskers staring down at the pile carpets. Inside the legal factory, people are just as cynical about the tax laws as outside, except that they are professionals, and what the hell, professionals have a job to do. "That's Walt," they say, pointing to a character studying the tax code the way good souls used to study the Bible.
Walt is looking for nuances, interpretations, in the code, and is spoken of like a prized running back: "Give him a little daylight and he can go all the way."
During the election past, some of the candidates sensed that tax reform, or tax something, might be an issue. So Senator McGovern got a hand when he told a bluecollar crowd that their baloney sandwich wasn't deductible, but a three-Martini lunch was. I could see the change coming up in the tax code:
Reg. 1.166-34-6b (a) Martini, lunch. Cost of the Martini deductible to the taxpayer, shall be the cost less any olive entitled previously to an agricultural exemption, or the greater of one-half the combined price of the gin and the vermouth ... (b) Sandwich, baloney. The cost of toasting is disallowed since toasting does not add an approved commodity to the total ...
Now I am not about to get in a wrangle on what is a loophole and what isn't. We need oil – energy crisis and all that – and apartments – housing crisis and all that – and pecans – pecan crisis? – and all the other Good Things with lobbies and public-relations men. We really do. We might even need some things not classified as Good. But the way to go is not to get them a lobby and get them into the Good group.
WANTED: A NEW TAX LAW
Because what we need, quite desperately at this point, is a tax law that people believe is fair. The tax law is too complex to inspire the belief that it is fair. A simpler tax law might have some temporary inequities, but the erosion of confidence in the laws is far more dangerous. People do not understand the laws; what they do know is that nobody pays the top rates, and that people who can afford Walt – and the other run-today-light lawyers – can find ways to pay very little.
The Administration and the Congress think the tax laws are basically fair, so that the Tax Reform Act of 1973 will have few substantial changes. The laws are abstract and complex; the dissatisfaction with them is really felt rather than known. Nobody is out hauling the livingroom furniture into the street for a barricade, and nobody is boarding ships to throw the tea into the harbor, and there isn't another election for a while. If things are going to stay as they are, I am going to cultivate a lawyer like Walt, who can find daylight in the code, who has moves you wouldn't believe, and who can go all the way if he gets the tiniest break.
[From the Washington Post, Jan. 14, 1973]
COWBOY ARITHMETIC
(By James Rowen)
They don't raise beef cattle the way they used to. No, Sir. Now, from the Kansas plains to the Southern California desert, they've got big, automated feed yards, almost all of them built since 1960. You rarely set eyes nowadays on cattle grazing peacefully on the range for a couple of years, waiting for a trail boss and some cowpokes to drive them to Missouri. Mostly you see these automated lots where they make the cattle overeat all the time with antibiotics, hormones and piles of feed. Sometimes they even play music for the cattle to keep them happy. All this cuts down a steer's fattening time for the normal three to four years to just 12 to 18 months.
That's not the strangest thing, though. The strangest thing is these people who call themselves "farmers" – at least on their income tax returns – and who put up money for the big feed lots. To keep the yards jammed, which often means 25,000 to 50,000 head at a time, beef-producing outfits set up investment companies to take care of the raising, feeding and slaughtering of herds for the "farmers" you never see farming. These people may be shoe manufacturers or doctors or New York lawyers who have never been further West than Westchester. But at tax time, they're farmers.
Some call this whole process "cowboy arithmetic." What happens is that a cattle investment outfit sells "subscriptions," or shares, in cattle-feeding partnerships. The investment outfit acts as general and managing partner, while the investor, for as small a grubstake as $3,000 or $5,000, becomes a limited partner. That's how each investor becomes a "farmer," allowed to list his investment – which usually is used to buy cattle feed – as a "farm expense," and to deduct his "farm expense" from his non-farm income, which he may get as a dentist or an actor or whatever else he really is. That way he pays less federal income taxes than he otherwise would, which is the purpose of "cowboy arithmetic."
NO DRY HOLES
But that's not all there is to it. "Cowboy arithmetic" also lets these "farmers" write off for tax purposes more money than they put in. And they also can postpone getting any cash from their investments for three to six years, so they can take their profits in a year when it most helps them hold down their tax bills. If this income delay sounds like one of the advertised tax breaks of putting money in oil, that's because the benefit is in fact similar – only, as one cattle management outfit says, "Unlike oil, you never get a dry hole."
It's not everyone who can be a farmer who doesn't farm so he can feed cattle he never sees in order to write off more money than he invests and to collect profits he doesn't want for up to six years. You have to be rich to play "cowboy arithmetic." Specifically, because of some state laws covering partnerships, investment outfits managing cattle restrict the players to those either in the 50 per cent tax bracket or swearing to a net worth of $100,000 to $200,000. Only six-tenths of 1 per cent of American taxpayers are in the 50 per cent bracket, according to the Internal Revenue Service's 1969 tax survey.
"Cowboy arithmetic," of course, also helps the beef-producing companies that own cattle investment outfits, or else they wouldn't be organizing the game. Promises of an oversized writeoff and up to six years' income deferral attract a good number of takers for partnership shares bringing in cash that saves the parent company a trip to the bank. Bank loans are costly; partnerships are not only interest-free but they produce income. And the investment outfits take their profits off the top, which means they make money even if, for some unlikely reason, a partnership fails.
ADVENTURES IN FAT CITY
That's why outfits like Fat City Corporation in Monterey, Calif., are getting in on the action. Fat City and its affiliates – Bareback Cattle Co., Lucky Stiff Livestock insurance Associates, Maverick Land & Cattle Co. and others – buy and sell cattle and grain, insure livestock, sell manure, truck cattle and market carloads (40,000 pounds) of live cattle on the Chicago Mercantile Exchange.
Privately owned, big Fat City is run by Jim Marks, former manager of a meat packing company, who holds nearly 60 per cent of Fat City stock. Two of his sidekicks – Robert Swanston, scion of a pioneer cattle-raising family, and Eldon R. Hugie, an attorney and accountant – own almost all the rest, giving the three together 98 per cent of the stock.
After operating relatively small feed lots in Muleshoe, Tex., and Chowchilla, Calif., Fat City opened a massive yard, California's largest, in the Salinas Valley. Each Fat City lot, where 70,000 steers stand in narrow, 8-foot-deep concrete pens, get their feed in a trough filled by truck and, according to Fat City's receptionist, are soothed by music piped across the acres of feeding pens. "Their favorite," she says, "is Frank Sinatra," and "they like the kind of music kids listen to on the radio."
It was in 1971 that Fat City decided to get into the "cowboy arithmetic" game. It created a subsidiary, the Steer-West Cattle Feeding Programs, to take care of cattle for absentee, "farmers," making clear that this partnership plan would dominate the entire Fat City spread. "Most of Fat City's time and efforts will be expended on matters relating to partnership business," said the prospectus, and 80 per cent of its feed yard space will be used for partnership cattle. If fully subscribed, Steer-West will corral $19 million and take care of 315,000 head of cattle. To date, $5.8 million has been raised.
A 140 PERCENT WRITE-OFF
Of this money, a good chunk is cut off the top by Fat City and its affiliates. Each steer bought for the partnership, for example, brings a $3.50 "fixed fee"; for 315,000 head, this fee alone would come to more than $1 million. In addition, there is a buying commission that amounts to $20 for each 500-pound calf. Feed eaten by the partnership cattle is marked up a minimum of 25 per cent over Fat City's cost. And on top of numerous other daily yardage fees, financing fees, insurance premiums and trucking charges, 10 per cent of the profits – if the partnership brings in a return of more than 7 per cent – goes to the general partners, who are Steer-West and Fat City director Robert Swanston.
Meanwhile, the investor-"farmers," who must plow in at least $10,000 to become limited partners, are rewarded with "at least" a 140 per cent tax write-off for the year they put in their cash. They can do this because the partnership goes into debt by borrowing more money to buy more cattle. The limited partners are allowed to report as their tax write-off a share of the borrowed money, which is certainly "Fat City" to a high-bracket "farmer" looking for an inflated tax loss.
F. Michael Stone, a Fat City director and vice president of Steer-West, defends the write-offs for cattle feeding, preferring to call them "tax-incentive investments." "Someone will have to subsidize" public needs, according to Stone, and having the government directly pay the costs of programs like oil and gas exploration, housing development and cattle feeding would bring on the "superimposition of a bureaucracy."
His position is to let the government subsidize the rich cattle investor: "Who's best able to take that risk – individuals or the guy with the big dough? Let the guy who can afford to be burned – but you gotta give him an incentive."
Stone believes that the write-off provisions of cattle feeding "make good sense in entrepreneurial and capitalistic America," but he concedes that "we suffer from a bad press ... I think in the infinite scheme of things, a rational person will see he's really getting a break, because someone else is taking the risk."
THE DISAPPEARING LOTS
Small feed lot operators, though, don't think they're getting any break. While the tax law lets big operators gain from loophole cattle feeding, small lots happen to be going out of business.
Specifically, more than 15,000 feed lots with a capacity of 1,000 head or less – often small farmers trying to supplement their income – disappeared from the Agriculture Department's rural surveys in 1971. At the same time, big feed yards with a capacity of more than 16,000 head increased by 11. A number of farm groups, including the National Farmers Organization, have protested the big boys' tax-based advantage, but to little avail.
Nor do all parts of government think taxpayers are getting such a break. A July, 1972, Agriculture Department study estimated that if all 14 publicly offered cattle-feeding partnership plans were completely subscribed in 1970, $150 million would have been raised by the cattle- managing outfits. That would mean write-offs of at least $150 million for the well-heeled. The total writeoff would have to be higher, though, since many partnerships are offered privately, with public disclosure not required.
Last April, moreover, the Agriculture Deportent issued an analysis of beef-breeding herd investments, an area of tax-loss activity related to cattle feeding, and concluded: "The loss to the federal government, in terms of revenues not received, will continue to far outweigh the monetary benefits to non-farmer investors. This implies, all else equal, substantial loss to society."
And it is questionable, to say the least, whether consumers think they are getting any break. Not only are housewives paying some big fat prices for beef nowadays, but they are subsidizing the big cattle yard operators with tax dollars to boot.
The only ones who are without a doubt getting a break are the non-farming "farmers" investing in big feed lots and the lot operators who are in on the action.
WESTERN BEEF'S WAY.
The first outfit to offer a cattle management partnership plan was Western Beef, Inc. based in Amarillo, Tex. Though only four years old, Western Beef is the nation's second largest publicly held cattle feeding corporation, having fed more than 17,000 head in 1971 alone. Its empire includes:
The Clifton Cattle Co., one of the five largest U.S. cattle purchasing outfits.
Nine feed lots in Texas, New Mexico and California.
Five grain storage elevators.
Two meat packing plants in the Texas panhandle.
CNT Financial Corp., 66 per cent owned by Western Beef, Inc., and its directors.
In 1968 Western beef also set up the Western Beef Cattle Fund, Inc., as a subsidiary to take care of partnership cattle. The fund is currently offering a $6 million partnership program in six $1 million phases. Each subscription costs a minimum of $3,000, with additional shares available at $1,000 each.
Western Beef certainly makes good use of the partnership to make sure that its lots are stocked with cattle and that it and its affiliates stay financially healthy.
As the partnership manager, western Beef Cattle Fund takes an "initial 2 per cent management fee" and a 3 per cent charge from each subscription to cover the cost of the offering. In addition, the Fund takes a $1 commission from the partnership's money for each head of fattened cattle it sells to a packer (often Western's own subsidiary), and 10 per cent of whatever cumulative profits the partnership generates.
The Fund borrows from CNT, controlled by Western and its directors, with profits made on the interest charges. Then there are cattle to be bought: The parent's Clifton Cattle Co. is available for business. In fact, the Fund's most recently organized partnership bought 5,000 head from Clifton.
Partnership cattle also must be well fed: Western Beef has its nine feed lots and five grain storage elevators waiting to supply the grain to feed to the cattle. Fattened cattle must be slaughtered: Western has its two packing plants.
The investing "farmers" in this case are promised a 150 per cent first-year tax writeoff because of the additional sum they can claim as their share of the Fund's debt to Western-controlled CNT Financial.
PRESCRIPTION FOR PROFIT
Just how remote from farming can the new "farmers" get? Consider the Beef Builders Feeding Programs, a new cattle partnership operation set up primarily for the American doctor. It is a joint outfit run by two separate companies, Dallas Factors, Inc., of Dallas, Texas, and Physicians Equity Services, Inc., of New York City. When you untangle a network of subsidiaries and partnerships and company owners, you find Dallas Factors owned by O. Jan Tyler, a Texas lawyer, accountant, ranch owner, cattle manager, and, until 1967, a Justice Department trial attorney in the tax division.
"I was raised on a ranch and showed livestock when I was growing up," Tyler says. "Cattle is in my blood. Its like they say – you can take a boy out of the country but you can't take the country out of the boy."
Tyler sees nothing wrong with moving from Justice Department tax prosecutions to managing tax-shelter investments. "I don't think it's a valid criticism. No one ever raised the possibility to me that it was a detriment. When I finished law school I went to the tax division of the Department of Justice. I stayed four years. That was my commitment to them. No one ever stays longer than that."
In fact, Tyler views his government service as a plus. "I think the experience working with the Justice Department was very beneficial to me and to the clientele I represent. It makes my job a hell of a lot easier."
Physicians Equity Services' major asset is access to a mailing list of nearly 80,000 doctors and other professionals supplied by several New York City financial consultants. These consultants own nearly all the stocks in the Physicians Equity Services, founded in December, 1970.
Joseph Boneparth, president of Physicians Equity, is reluctant to discuss his cattle feeding operations. He refuses to talk about his company's structure or to identify its stockholders.
CATTLE AND LISTS
With Tyler's Texas cattle know-how and the doctor's golden mailing list, the Beef Builders Cattle Feeding Programs were born in October, 1972. The investment managers are the Diamond C Land and Cattle Co., a subsidiary of Tyler's Dallas Factors, and PEE Beef Builders, a subsidiary of Physicians Equity. The program is seeking an investment of $2 million, with each subscription costing $5,000.
Since neither managing partner owns a feed yard, the partnership cattle are placed in selected lots, and the partnerships are billed for the operating services. For their management services, the general partners take a 9 per cent chunk off the top of each $5,000 subscription, a "supervision fee" of $2.50 per head bought for the partnerships, a charge of 1 per cent of all loans obtained for the partnerships, and a payout of any profits in this order: From the first $10 per head sold for slaughter, the managing partners get 25 per cent; then 50 per cent of any additional profits.
The doctors gettheir tax breaks and the government loses revenue. The taxpaying consumer subsidizes beef production. The partnership managers – in this case outfits that don't even have feed lots – make their money. The small, family-farm lots keep going broke. "Cowboy arithmetic" has certainly changed the way they raise cattle these days. Yes, Sir.
[From Washington Monthly]
THE SCREWING OF THE AVERAGE TAXPAYER
(By James Fallows)
Late this month, as Congress reconvenes, Representative Wilbur Mills will announce that tax reform season is with us again. A year or two later, after debates, studies, vetoes, and compromises, a Tax Reform Act of 1973 or 1974 will emerge, advertised no doubt as a significant step toward tax justice, a boon to the average man, and the only way to cover the rising federal deficit. More likely, it will be yet another tax system, painting over areas where the acid has seeped out without doing anything serious about what's wrong inside.
The last time we went through this cycle, in the months leading to the Tax Reform Act of 1969, there were the same big promises and the same small deliveries. If there was ever a time when the federal tax system was ripe for overhauling, 1969 was it. The fiscal dream-world of London Johnson's last few years – when he wishfully imagined he could buy both guns and butter without raising taxes to pay for either – had come apart, spawning the inflation we now know as a permanent part of life. When the tax rise finally came, as a 10-percent surcharge slapped on in 1968, it was both clumsy – because it tried to squeeze more money from a tax system whose basic flaws had been known for years – and too late. This could have been the occasion for a new Republican President to take a swipe at Johnson by closing up the old loopholes or for Congress to insist that the surcharge be replaced with some real reform.
Instead, what touched off the "taxpayer revolt" and led to its product, the 1969 Act, was not so much a concern for the ills of the system as two immediate irritants. One was the result, simply, of the government's shortsightedness. When the surcharge was imposed, the income tax withholding rates stayed at their old, lower level. That meant that at the end of the year, families accustomed to a comfortable rebate from the Treasury found themselves owing hundreds of dollars in extra taxes.
At just this unsettling time, Treasury Undersecretary Joseph Barr added a second bit of fuel.
When testifying before the Joint Economic Committee in early 1969, he noted offhandedly that 155 people making more than $200,000 had not paid any income tax in 1967 – 21 of them with incomes of over $1 million. Barr wound up with warnings of a "taxpayer revolt if we do not soon make major reforms in our income taxes," and to be sure, there was a lot of talk about both revolution and reform in the following months. But, if revolutions are limited by the vision of their supporters, this taxpayer revolt was quickly stymied by the skin-deep perspective of most of its advocates. It was as if the French mobs had called off the guillotines and uprisings once they got a few crusts of the bread they had originally asked for.
The crust tossed out by Congress was a tax reform bill that removed the gaudier, more flagrant abuses – examples muckrakers could use in their stories, the no-tax illustrations that could drive a man mad when he looked at his own depleted paycheck – without tampering with the basic mechanism. To take care of the high-income tax dodgers, Congress invented a "minimum tax" of 10 per cent to be imposed on those who would otherwise owe nothing. Even more than other bits of congressional fence-mending, this contrivance set economists wondering whether congressmen ever thought about what they were voting for.
The minimum tax is a perfect example of cosmetic legislation, which admits by its existence that tax preferences sheltering the rich are not fair, but still refuses to change the preferences. The closest the Act came to tampering with the preferences was a dainty adjustment in the oil depletion allowance (lowered from 27.5 per cent to 22 per cent) and an equally mild rise in the tax rates on capital gains (increasing the maximum rate for gains over $50,000 from 25 per cent to 36 per cent).
BUYING OFF THE REVOLUTION
Then it was over, the energy of the taxpayer revolt spent almost before the bill passed both houses of Congress. To what end? Thomas Field, a former Treasury lawyer who recently resigned to set up Taxation With Representation, a public-interest lobbying firm, wrote shortly after the bill's passage that it "may actually have entrenched existing tax abuses more firmly, by reducing the outrageous excesses that scandalized the public, while failing to eliminate the basic abuses themselves."
In the years since, the old familiar loopholes have been joined, and perhaps overwhelmed, by a host of new ones, most of them the result of President Nixon's New Economic Policy. These corporate tax breaks, like the Asset Depreciation Range (ADR) system and the Domestic International Sales Corporations (DISC), will take billions from the Treasury – an estimated $80 billion in the next decade. In an administration that uses an axe on the federal budget, lopping off whatever it can, these giveaways show how far a faith in the trickle-down theory of business and government can take politicians.
Unfortunately, the latest taxpayer revolt has not come much nearer to the fundamental problems than the earlier one did, having been diverted instead to a few of the gaudier excesses. To many tax reformers, the "real" issues seem to be either unconnected questions, like property tax relief, or isolated cases of men or companies who have beaten the system. Unless this general tone changes dramatically, it is a safe bet that much of this year's tax debate will glide over the frozen surface of the tax system without looking at what lies beneath.
The tragedy is that now, even more than in 1969, the whole tax system needs the kind of change a taxpayer revolt implies. The federal tax code is not a leaking vessel in need of a few patches; it is a ship steaming in the wrong direction that must be turned around or sunk. Completely apart from issues of wealth and equality that the distribution of income has not changed in 15 years – the richest fifth of the population earns eight times more than the poorest fifth; two per cent of the people controls 43 per cent of the wealth – the problem is one of waste. The tax system has turned into the biggest and most profligate program of government subsidies, piping $55 billion out of the Treasury each year, most of it to the rich.
DON'T FENCE ME IN
When the income tax was first introduced some 60 years ago, the idea was simply to tax all income – without fancy distinctions between factory wages, profits from the stock exchange, real estate windfalls, or earnings from the farm. The tax rates have gone up and down over the years, but they still reflect the idea that those who can afford to pay more, should. In recent years, another reason for progressive tax rates has emerged: if the rich get the largest share of government subsidies and bask in the sun of government spending, then it's only fair that they pay for what they get.
After the earlier, common-sense definitions of taxable income, the lawyers and accountants ganged up to make the system complicated. Part of the tax system's story has been that of a closing frontier: larger and larger chunks of the income range have been tucked behind tax-free fences, safe from the government rustlers. Meanwhile, the remaining parcels are trampled on all the more heavily.
Behind this erosion of the tax base lies an essential difference in political faith. While liberals have acted as if government programs could solve any problem (taking more money in through taxes, then spending it), conservatives have placed equally boundless faith in tax incentives (not taking the money in the first place, then not spending it). However satisfying it may be to think of trimming back some government programs, tax incentives don't look like the solution to the problems. On the surface, tax incentives follow the logic handed down from Coolidge to Ayn Rand and on to Nixon that a dollar not run through the government mill is a dollar ennobled. In practice, they amount to income redistribution toward the rich.
The point easily overlooked is that tax breaks are really no different from government spending. From the Treasury's point of view, a preference that cuts tax receipts by $1 million is just the same as a new $1 million spending program. The money that doesn't come in from one group of taxpayers must be wrung out of the rest, or else taken from other government programs. This "tax expenditure" approach to the revenue system means, most importantly, that tax expenditures should be judged by the same standards of economy and efficiency that budget cutters apply to other federal expenditures.
THE NEW BUDGET
Until fairly late in the Johnson Administration, no one bothered to take the dimensions of the tax-expenditure programs. Then Stanley Surrey – the Treasury's assistant secretary for tax policy, who now teaches law at Harvard – drew up the first "Tax Expenditure Budget." His figures have attracted surprisingly little attention in the press, although they are as revealing as the regular federal budget, and far more outrageous.
The 1971 version of the tax budget shows a total of $51.5 billion in tax expenditures – more than the budget for any government agency except Defense or Health, Education and Welfare, dozens of times greater than anti-pollution programs, enough to give McGovern's much-loathed $1,000 grant to a quarter of the people in the country. The biggest single item in the budget is the revenue lost through special capital gains tax rates. This is estimated at between $6 and $9 billion, all nominally going as an incentive to investors. Another $2.6 billion is lost from the tax- free interest on state and local bonds, $2.7 billion from property taxes paid to local governments, and $2.4 billion from the clause that lets homeowners deduct the interest on their mortgages. The oil-depletion allowance gives the corporations a $1-billion break, and the investment tax credit provides about $1.5 billion.
To those receiving them, the tax payments have special appeal. Other government subsidies have finite time limits. When they run out they must be dragged through Congress again, past the perils of committee chairmen, eagle-eyed Office of Management and Budget auditors, and finally a tightfisted Executive branch, quick with the veto. But a tax break, once enacted, quietly does its work forever, becoming more valuable as tax rates rise. Until a few years ago, when Surrey's expenditure budget was first prepared, no one need have known about the tax breaks at all. No committees could hold hearings to find out whether the program was worthwhile; no General Accounting office could appear to check where the money was going.
Now that these programs are out in the open, they make for amusing comparisons with the normal federal budget. Government spending for low-income rent subsidies, for example, has shrunk in recent years from the $100 million Johnson requested in 1968, to the $50 million Nixon asked in 1969, to the $23 million Congress finally approved. Meanwhile, about 30 times as much federal money, $750 million, has been flowing out each year as rent subsidies for the rich, in the form of real estate tax breaks. This accommodating system not only guarantees the country an adequate supply of resort motels and luxury apartments, but also allows the rich taxpayer (through a device too complicated to explain) to save several times as much in taxes than he invests in real estate.
SLICK OPERATORS
It is not always clear that tax subsidies are the best or most effective way to use government money. The various tax breaks given the oil industry, for example, were intended to compensate the rugged drillers for their unusually risky trade, and to make sure that America always had enough oil in the ground to face with confidence a future of energy crises and angry Middle East governments. But, as shown by the report prepared for the government in 1969 by the CONSAD consulting firm, the tax break approach to the energy crisis was less than effective. Forty per cent of the tax breaks went either to foreign operators or to "non-operators" – people who happened to own oil bearing land but who hadn't done much to advance oil exploration. In all, the report concluded, the oil industry's tax breaks cost $1.4 billion but generated only $150 million in extra oil reserves. A simpler, cheaper solution might be to end the depletion allowance and pay a $150-million subsidy for the reserves. This does not seem to be part of the Administration's plans for cutting bureaucratic fat. As Nixon indicated last summer to oilmen gathered at a barbecue in Texas: "I strongly favor not only the present depreciation rate, but going even further than that, so we can get our plants and equipment to be more effective ... Let us look at the fact that all the evidence shows we are going to have a major energy crisis. To avoid that, we have to provide incentives rather than disincentives for people to go out and explore for oil. That is why you have depletion, and the people have got to understand it."
Nixon's host at the barbecue, John Connally, has waxed equally rhapsodic about the value of the capital gains tax preference, claiming that to end it would not only plunge the Dow Jones average below 500, but also permanently maim U.S. industry as it prepares for the economic battle with. the Germans and Japanese. Both dangers were avoided when, earlier in the century, capital gains rates were the same as ordinary rates. Even if the profit on IBM stock were cut by higher capital gains taxes, few potential investors would be likely to sulk and put their money in a sock, especially if other tax shelters were also dismantled. And, assuming the worst – that brokers all over the country go out of business and no one plays the market – the effect on industry would be less than crippling. As Philip Stern points out in his new book. The Rape of the Taxpayer (an excerpt of which follows this article), only five per cent of industrial capital comes from the stock market; the rest comes from industry's retained earnings. Those who would bleed on the altar of capital gains taxation are not the financiers of a stronger industrial America, but the speculators who buy and sell stock issued years ago. Perhaps worst of all, the present capital gains system gives an incentive to early death for those who can cling to their stock all the way to the grave, all the capital gains that took place during their recently-ended lifetime are declared tax-free. Whoever inherits the material only pays tax on gains from then on.
GUARANTEED INCOME
The moral of the capital gains story turns up again in the corporate taxes, only with bigger numbers, During the sixties, tax breaks like the Investment Tax Credit (ITC) helped drop the share of corporate taxes from 35 per cent of total federal taxes in 1960, to 27 per cent in 1969. Since then, corporate taxes have fallen by another 10 per cent, mainly because of the bag of treats Nixon passed out as part of his 1971 economic policies.
The longest-running of the major preferences, the ITC shows that the welfare ethic can destroy initiative and fiber among the rich as well as the poor. Since 1962, the ITC has proven its benefit to companies, giving General Motors an average of $40 million each year and the rest of American industry another $2.1 billion. Its success in encouraging them to create new jobs and boost the economy is harder to detect. As originally written by the Kennedy Administration, the ITC would give benefits depending on performance: the companies that tried hardest to invest more than before, to hire more men, would get the biggest breaks. But an obliging Congress changed that clause, so that any investment qualifies for the ITC – even if the company invests less than the year before, or uses its investment to automate a few more men out of work.
The ITC also has a knack of delivering its benefits where they're not needed and tugging them away from those who need them most. Few companies needed new investment as much as the Penn Central did, with its yards full of cruddy old machinery and its miles of rusty track. But because the Penn Central was losing money and paying no taxes, the ITC gave it no help at all.
The corporate tax measures Nixon announced in 1971– aimed at a booming economy, a foreign trade surplus, and a fully employed electorate – show the same combination of high cost and uncertain results. One of the proposals would have cost $6 billion in lost taxes, in exchange for the possible creation of 500,000 to one million new jobs. This works out to $6-12,000 per job, with no guarantee that the companies will use the money to hire more men.
Another innovation, the Domestic International Sales Corporations (DISC), was supposed to encourage exports. But, like the unfortunate ITC, the DISC gives benefits without demanding performance – companies get tax breaks even if their exports are falling. The star of Nixon's group, the Asset Depreciation Range system, which will cost an estimated $30 billion in the next decade, was aimed at expanding industrial capacity at a time when 25 per cent of the factories were idle.
FRIENDLY PERSUASION
The choice of these uses for public money – rather than public-works projects, or educational investment – may be explained by the groups buzzing around Nixon's ear at the time. As reported by Stern, the Presidential Task Force on Business Taxation, which was appointed in 1969 and eventually thought up the ADR, was made up of:
Four lawyers from corporate law firms (including former partners of both Nixon and Connally) ;
Two New York investment bankers;
Three representatives of corporate accounting firms;
Two top officials of large industrial corporations;
Three business-oriented economists.
As with other tax preferences, most of the corporate honey gets scooped out by those with the biggest paws. Eighty per cent of the ADR's billions will go to the top .002 per cent of the nation's corporations. Even before the 1971 tax breaks, the 100 biggest corporations paid only 27 per cent of their profits in taxes (compared with a nominal rate of 48 per cent), while smaller corporations paid 44 per cent. Several enormous companies have been able to pay respectable dividends to their shareholders without paying anything to the government.
Alcoa Aluminum, Allied Chemical, Standard Oil of Ohio, and a quartet of steelmakers – Bethlehem, National, Republic, and United States Steel – all paid dividends of between $33 and $78 million in 1970 or 1971, without paying any federal income taxes.
PERVERSION IN THE IRS
One reason for the grotesquely high cost of the tax-incentive program is the perverse logic of tax preferences. Reversing normal bidding procedure, the goverment buys services from whoever offers them and lets him set his own price. The tax deductions naturally cost the government more when a rich person rather than poor person uses them; a $100 tax write-off, whether for oil-well drilling or buying state bonds, costs $70 in lost taxes if the taxpayer is rich, but only $14 or $20 for people in the lower tax brackets. There is an economist's logic buried here, in the idea that rich people need a greater incentive to perform a task, but it makes sense for the government only if the rich person's oil well is five times as good as the poor person's.
The catch, of course, is that poor people don't have oil wells. Neither do they have capital gains or much property tax to write off. So, because most of the tax preferences are open only to the rich, and because each perference is worth more when you're in the 70-percent tax bracket, a healthy portion of the tax-expenditure budget goes to supporting our upper class.
A MODERN P. T. BARNUM
It may not always appear that way, especially if you look at the Administration's figures. Treasury Under-secretary Edward Cohen went to Congress last year to show who was getting the tax- expenditure money. There were the charts, broken down by income group. Sure enough, and Mrs. Middle America came out in front. Property tax exemptions, for example, spared families in the $10-15,000 income bracket $642 million in taxes, while giving only $240 million to those in the $50-100,000 bracket and $137 million to the $100,000-plus bracket. Even preferences aimed at the rich, like capital gains, seemed to avoid any gross imbalance.
The trick is that there are more people making $10,000 than $100,000, so the money goes further at the upper levels. Tom Stanton, a lawyer with Ralph Nader's Tax Reform Research Group, pointed out this ruse to the Senate Finance Committee last October. When the preferences are broken down on a money-per-taxpayer basis, they look a little different, more like feudal dues than anything else. The benefit from capital gains taxes, for example, are roughly these:
If your adjusted gross income is less than $3,000, you save an average of $1.66 in taxes each year.
If your income is between $5,000 and $7,000 (more than half the taxpayers make this much or less), you save an average of $7.44.
If your income is between $10,000 and $15,000, you save an average of $16.31.
If your income is between $50,000 and $100,000, you save an average of $2,616.10.
If you make more than $100,000, you save an average of $38,126.29.
The oil depletion allowance gives an average of 85 cents to the median taxpayer; an average of $847.24 to those in the $100,000-plus bracket. Deductions for charitable contributions are worth an average of 28 cents at the lowest brackets and $11,373.56 at the highest. In all, the system gives an average of $54.06 worth of tax relief to each taxpayer in the lowest bracket, $245.79 to those at the median level, and $76,042.86 to those making more than $100,000.
These preferences, loopholes, and rebates make the official tax rates less than reliable guides as to who actually bears the tax burden. According to a report by Joseph Pechman and Benjamin Okner of the Brookings Institution, taxes actually take only 32 percent of income at the upper levels, rather than the 79 per cent of narrowly-restricted income the charts show. If the tax base were widened – to include capital gains, bond income, and all other categories of tax-free income – it would be 35 per cent larger than it is now. This would mean either that current tax rates would produce $77 billion more in revenue – several times more than will be needed to cover the expected budget deficit next year – or that the entire rate schedule would be reduced. Pechman and Okner offer several alternate schedules, most of which would cut taxes in the lower brackets while imposing rates no higher than 50 per cent at the top. The secret is getting a wide tax base, so that the government takes 50 per cent of something, rather than 70 per cent of very little.
FAITES VOS JEUX
But until the tax base is widened, we are left with a system more like a roulette game than a dependable tithe of income. Its effect on taxpayers is like that of a court which imposes harsh sentences but only convicts half the defendants. The taxpayer's only rational behavior is to try to beat the rap, to hide portions of his income in the preference safety zones rather than paying at the official rates. Anyone who pays all his taxes is a fool or a sucker. By turning taxes into a penalty and rewarding those who find the escape clauses, the tax system encourages a pernicious social irresponsibility. More worry goes into devising each family's own tax shelters than in working to make the whole system more fair. If much of the backlash against government spending and high taxes comes from those who see the tax withheld from their paycheck each month, it may be because they are the only people who know for sure they will have to pay their full share of the government's expenses.
AL CAPP AS PHILOSOPHER
As its contribution to cleaning up the tax system, the Administration is relying on a classic one-two approach: cover up the little problems and pretend the big ones aren't there. The cover- up operation centers on encouraging the public to look at the bright side of the tax system, emphasizing the positive and keeping the reformers' complaints in perspective. Since an overt rise in tax rates – as opposed to camouflaged rises, in the form of Value Added Tax or otherwise – might undermine the public's faith, Nixon has tried hard to sell the unbelievable idea that taxes will not go up. So far, his psychology has worked well. As The New York Times reported in late November, Nixon has decided that the heat is off on tax reform because "the public is simply not as stirred up now about the alleged unfairness of the tax laws as it was earlier this year."
To handle the public resentment that won't go away. Nixon has applied several of his other proven political tactics. One useful method is to deflect attention from a serious question to a minor side issue – as the whole public discussion of civil rights has been focused on busing. The sideshow this time is property tax relief – a serious enough business, but not enough to steal all the attention from income tax reform.
Another ploy has been to breed fear of change among those who should welcome change. This was the message in Edward Cohen's tax-preference charts. "Look at those figures," Mr. Average was supposed to say to his wife. "We can't afford to have that mortgage-deduction taken away."
Thus everyone starts to consider the reformers a menace, and each group of taxpayers clings to its own loopholes and blocks those who try to blow the whistle.
This philosophy was expressed with rare precision by cartoonist Al Capp, writing in a recent issue of Saturday Review-Society as a "distinguished economic and social thinker." "What this country wants," Capp said, "is more tax loopholes, not less. Americans today don't want so much to soak the rich as to be rich." With every man looking out for his own special piece of the action, no one has a stake in cleaning out all the special deals. "Tax reform" becomes a code word for "cutting my taxes," and the "tax reform" bills are little more than a clumsy package of favors, designed to make everyone think he's coming out ahead.
But in this as in few other things, the President doesn't have the last or the most influential word. The important maneuvers will go on in Congress, most of them in the chambers of Wilbur Mills' House Ways and Means Committee.
PUNCHING ROLES
Last year's congressional skirmishes provide mixed omens for tax reform in 1972. This year was not the right time for a tax reform bill to get through, and so it may not mean anything that so many reform bills died at the end of the session. The fights that went on were on the other side of the field – trying to prevent new loopholes from being punched through the tax code.
Hole-punching long ago became a ritual in Congress, institutionalized in something known as "Members' Day." At this roughly annual event, members of the Ways and Means Committee sit around a table and take turns suggesting special-interest tax bills. Usually these bills sail through the House without trouble, but last year, for the first time in memory, they were stopped. The battle was prolonged, beginning with the Members' Day session in October, 1971, and winding up a year later when, almost by a quirk, conservative Congressman John Rousselot objected to one of Mills' attempts to get the bills through the House.
If Rousselot had not been seized at that moment by whatever purely parliamentary objection he had to Mills' bill, those who had been trying to block the bill – Wright Patman and Les Aspin in the House, William Proxmire in the Senate, Tom Stanton of the Tax Reform Research Group, lobbyist Ray Denison of the AFL-CIO and Richard Worden of the United Auto Workers – would certainly have managed to kill it themselves. Time was on their side, and Mills' heart was not with the bill. Getting a genuine reform bill through Congress will be harder.
Just how much harder depends greatly on Mills. As chairman of the Ways and Means Committee, he will decide when to hold hearings, what measures to bring up when, and how firm a push he'll give the bill in the House. If there were some reliable guide to Mills' beliefs or ideas, it might be possible to predict what kind of bill will get passed. But reading Mills' mind is like reading a weathervane: his homing instinct is toward whatever everyone else is likely to vote for.
THE AMAZING RUBBER MAN
Mills gave an impressive display of flexibility early last year when he suddenly decided that tax reform was a hot issue. Two veteran tax reformers – Congressmen Henry Reuss and Charles Vanik – felt frustrated by Mill's refusal to push a reform bill through his committee, and so they proposed their own reform measure as an amendment to the debt-ceiling bill. Not about to be outsmarted – especially when still running his quaint race for the presidency – Mills managed to block Reuss and Vanik by introducing a "reform" bill of his own. Called the "Tax Policy Review" bill (or later, the Mills-Mansfield bill, since Mike Mansfield cosponsored it in the Senate), it would have phased out 54 of the major tax preferences over a three-year period, 18 at a time.
Phasing out the preferences wouldn't kill them for good, but at least it would make Congress review each preference before reenacting it. That much in Mills' bill was encouraging, but its main value to him was as a stalling device. Such extensive changes, Wilbur pleaded, would take months and months of hearings, even though he had held hearings on essentially the same questions before, and was presumably familiar with the topic. The maneuver served its purpose well: Mills seemed to be on the side of tax reform, but he didn't have to support any specific reform, and he was able to squash the Reuss-Vanik bill.
LOST CRUSADE
Reuss will be back this year, with a "quick-yield" bill designed to close a few loopholes and get a fast $9 billion in extra revenue. More thorough reform bills are also ready, including one from California's James Corman that would wipe out most of the major tax preferences and replace tax exemptions with "tax credits," But because of the oddities of committee procedures, none of these bills will be debated on the floor as such. Instead, the Ways and Means Committee will start from scratch, looking over each item on the tax-preference list and deciding what sort of reform package to offer.
The resistance that Mills puts up this year may be more serious than last year's procedural bluff.
For him, the weathervane is swinging. Like Nixon, Mills has sensed a slackening in the taxpayer revolt. The public is losing interest and so is Wilbur Mills. In May, Mills sponsored a tax reform bill; in October, he said tax reform would be his committee's first order of business in 1973; but in November, he told The New York Times, that tax laws weren't really so bad: "if the income tax law is not unfair, and I know it is not, to the extent that some people have indicated it is, I want the American people to know that."
The one certain benefit of the next few months is the series of studies now being finished by the Joint Committee on Internal Revenue Taxation. Working from the 54-item list in the Mills- Mansfield bill, the committee plans to make thorough legal and economic analyses of the preferences – what they're supposed to do, how well they do it, and how much they cost.
Expecting more than this may not be wise. The Opposition will soon be in town: Wall Street lobbyists moaning about capital gains taxes, oil men warning of energy crises. By comparison to these business lobbies, the few existing reform groups are inexperienced, underfinanced, and overwhelmed. Aside from the unions – who in 1969 were virtually the only reform lobby – there are now several public-interest groups, like Common Cause, Field's Taxation With Representation, and Stanton's Tax Reform Research Group. Still the unions are the only one of these representing a sizeable bloc of voters, and while the union platforms recommend admirably thorough reform, its members are the very people Nixon is trying to seduce with property-tax relief. Unless there are signs that this year's tax "revolt" can resist the small rewards that sated previous revolutionaries, tax reform is likely to go the way of welfare reform and other lost causes.
DEATH OF THE CHRISTMAS TREE
One of the heartwarming moments of the 1972 tax season was the defeat of the" Christmas Tree Bill" in Congress. The bill, which started life as a minor change in insurance agents' taxes, ended up bedecked with many special interest baubles. As Congress neared adjournment, the bill was stalled in the House, and action shifted to the Senate. What happened is reported by the public-interest group, Tax Analysts and Advocates:
On Friday, October 13, Senate Majority Leader Mike Mansfield speaking to a largely empty chamber, warned that he might have to call up for debate "one or two bills" from the Senate Finance Committee, because a number of senators were interested in adding amendments to them.
That evening, Finance Committee Chairman Russell B. Long took the floor to "file a committee report." Instead, he inserted into the Congressional Record descriptions of 13 "legislative proposals." Some of these proposals were previously introduced bills; others were Treasury recommendations. In Senator Long's words, some had "been before the Committee for a long time," and some had "been discussed, but ... not ... proposed until recently."
Senator Long said that there wasn't time to hold hearings on the proposals but that an executive session of the Finance Committee had that week informally endorsed them. The proposals, he said, "involve a relatively small amount of money as revenue measures ordinarily go." Besides, he added, they were unimportant enough that the President could veto them if he wished. "For the most part, they are not matters of any great consequence. One or two of them might involve a substantial amount of revenue, but most of them are relatively minor amendments."
This innocuous description intrigued several senators. Lawton Chiles attempted to get a promise from Long that no votes would be taken until a report from his committee was available. William Proxmire took the summaries back to his staff and examined them. What Proxmire found irked him enough that the next day, Saturday, October 14, he announced he would "object and fight and oppose as long as I can, any amendments ... that have not had hearings ... and ... a report, where there is a revenue loss." In the face of this stand Senator Long dropped amendments that would have been worth an estimated $225 million to five special interest groups.
In the course of the ensuing floor debate, 19 more special-interest provisions were added to H.R. 7577. Not as spectacular as the debated items, they would nevertheless have caused a revenue loss of several million dollars.
For the benefit of West Virginia constituents able to itemize deductions, Senator Robert Byrd added a sales-tax deduction provision shaving $1.5 million off their taxes.
Senators Robert Griffin and Philip Hart sponsored an amendment bailing out the Archdiocese of Detroit for about $50,000 in interest on withheld taxes.
Senator Vance Hartke, acting as floor manager, then offered a series of tax amendments, the first of which was designed to benefit conglomerates that buy out minority shareholders.
A second Hartke amendment involved $1 million in penalties currently owed to Treasury by a firm which failed to comply with the advance-notice requirements of Section 367 of the Internal Revenue Code.
Hartke then offered an amendment dealing with the airline-ticket tax, and added the provisions of H.R. 11158 which would permit C. Brewer and Sons of Hawaii to deduct Puerto Rican sugar plantation losses. He also added language allowing Americans who control incorporated foreign-investment portfolios to escape taxation at the corporate level. Hartke disclaimed knowledge of who the beneficiaries were.
Further amendments included a three-month extension of unemployment benefits, permission to add more carbonation to American wines, and establishment of a Federal Financing Bank.
Though it was now 9 p.m. and a Saturday night, the amendments kept coming. Senator J. Glenn Beall, Jr. moved to exempt small shareholders from a "collapsible corporation" tax restriction. Senator Jacob Javits expanded a housing tax subsidy, and Paul Fannin added a tax on bows and arrows.
Finally, at 12:02 a.m. on Sunday, October 15, the Senate adjourned.
On Monday, October 16, Senator Frank Church picked up where his colleagues had left off by proposing (successfully) that authors and artists be permitted to deduct half the value of their private papers when given to charitable institutions. Senators Clifford Case and Ted Stevens added their own little clauses. Senators Paul Fannin and Clifford Hansen offered two further amendments, but Proxmire blocked them. Finally, on Monday afternoon, Senate consideration of the "Insurance Agents Tax Withholding Bill" ended and the legislation was sent to the House.
The next day, October 17, House Ways and Means Committee Chairman Wilbur Mills moved for a conference with the Senate on H.R. 7577 which would, in effect, mean passage of the bill.
House tax reformers, organized by Tom Stanton of Ralph Nader's Tax Reform Research Group, were on their feet to object. To their surprise, however, they heard the chair recognize southern Californian John Rousselot, who blocked Mills' motion because of a minor procedural irregularity. After a few minutes, Mills decided to abandon the bill. That ended the "Christmas Tree Bill" effort for 1972.
THE SECRET WAY THE RICH ESCAPE
(By Philip M. Stern)
Imagine and appraise for yourself the fairness of a courtroom trial that proceeds as follows:
The judge enters. Before him there is only one lawyer's table instead of the usual two. No press or members of the public are permitted.
A lawyer for just one of the opposing factions, whom we will call Lawyer A, rises and argues his case. Having heard but one side of the case, the judge declares the trial ended and retires to deliberate the matter. There is no Lawyer B to develop and argue the other side. That task falls to the judge, who is thus thrust into the awkward role of being both advocate and judge.
As the judge ponders the questions before him, Lawyer A makes repeated private visits to his chambers, pressing him with further arguments, rebutting any doubts he seems to have.
When he ultimately reaches and issues his decision, it, like the trial itself, is not open to the public, but is kept confidential, known only to the judge, Lawyer A, and the client.
If the decision is unfavorable to Lawyer A, he can appeal it to a higher court. But if it is favorable to A, no one else, no matter how aggrieved, may appeal. And so it stands, as final as a supreme Court decision (until and unless the Congress of the United States sees fit to change it).
The above is perhaps an oversimplified, yet surprisingly precise parallel to the manner in which the Internal Revenue Service hears and decides the tens of thousands of tax law questions put to it each year. These questions come mostly from business concerns, often seeking an in-advance- of-the-fact ruling about how IRS would apply the tax law to an upcoming transaction. Many of the requests for rulings are routine. But, as you will see, others involve tens, if not hundreds, of millions of dollars.
In theory – that is, technically speaking – rulings are available to any taxpayer who knows about them and submits a request. However, most average taxpayers are not even aware they can ask for an in-advance-of-the-fact ruling. (How many readers of these words know about them?) By contrast, rulings are well known to – and hence are mainly used by – businesses, especially major companies advised by experienced and handsomely-paid tax attorneys. This contrast could well give rise to the following two situations: For John and Esther Hale, the letter from Internal Revenue seemed not far removed from disaster. It dealt with their tax return of two years earlier and, in particular, with the sale of their house (for considerably more than they had originally paid). John was aware of the disadvantages of having his profit on the deal taxed all in one lump in the year of the sale (which would push him into a much higher tax bracket) and thought he had carefully worked things out so that the transaction would be treated as an "installment sale"that is, so that he could, in calculating the tax, spread the profit out over a five-year period. But apnarently he had run afoul of some technicality in the law, and Internal Revenue was taxing the whole profit in the year of the sale. The upshot was that the Hales had to pay a "deficiency" of a little more than $4,000, and if they didn't pay it before the end of the year, the government would start charging six-percent interest.
HASTE MAKES WASTE
Surprised and puzzled. John telephoned Internal Revenue. The IRS agent, while firm that John would have to pay the deficiency, was sympathetic, since, he said, a minor change in the transaction could have saved the Hales the extra tax. "It's a shame," he said, "that you didn't come to us with your contract beforehand. We could have told you that it wouldn't qualify for the installment sale, and could probably have told you how to change it to make it fit the regulations."
That was all very nice, but it didn't suggest to John Hale how he was going to come up with $4,000 before the end of the year.
In 1966, the Continental Oil Company had a tax problem of considerably greater magnitude than that of John and Esther Hale. It was, to be precise, a $175-million tax problem. But because Continental was counseled by influential and experienced tax lawyers, the company knew it could go to IRS to seek advance approval of its plan.
Boiled down to its simplest terms, Continental Oil wanted to borrow $460 million to buy up one of its major energy-source competitors, Consolidation Coal, the largest coal company in the United States. For some years, oil companies wishing to borrow in order to buy additional oil properties had been using an ingenious three-party device known as an "ABC" transaction, which involves basically, using one company as a front for buying another. That intricate triangular transaction had an enormous advantage: it enabled the companies to pay back the borrowed money with untaxed dollars, rather than having to use after-tax dollars, as most taxpayers do when they repay loans. If Continental Oil could employ such an arrangement to buy Consolidation Coal, it would save about $175 million in taxes. But while the ABC device had been successfully used in buying oil properties, it was unclear that IRS would approve such an arrangement for the purchase or "hard" minerals like coal.
Without IRS approval, Continental would have to make just about twice as many dollars of profits to repay the mammoth $460 million loan; thus, before any banks would put up the money, they insisted on knowing whether IRS would give its blessing to the ABC deal.
MAJESTY OF THE LAW
Accordingly, the highly prestigious New York law firm of Simpson, Thacher & Bartlett was engaged to present the facts of the ABC transaction to IRS with a request for a binding in- advance-of-the-fact ruling. In due course, on August 18, 1966, a piece of paper assuring Continental its $175-million tax saving went forward from IRS – a "letter ruling" approving the ABC transaction.
Thus was the way paved for the buy-up of the nation's largest coal company by what was then the nation's 10th largest oil company.
Thus was the precedent set, and the path made easier for other oil companies to buy up other coal companies – as in fact subsequently happened.
Thus was the $175-million tax saving assured the Continental Oil Company.
Thus was the shifting of a $175-million burden to the other United States taxpayers assured.
That letter ruling was but one of the roughly 30,000 issued every year. While most do not involve such prodigious sums (about 14,000 of them merely grant approval to changes in accounting methods), they often involve substantial amounts – occasionally far more than was at stake in Continental's case. For example:
On July 24, 1964, General Electric, Westinghouse, and the other major electric companies – whose 1960 conviction for price-fixing in criminal violation of the anti-trust laws subjected them to treble-damage claims by customers who had been overcharged – were granted IRS approval to treat their treble-damage payments as tax-deductible "ordinary and necessary" business expenses.
That is, not only would the general public have to bear the burden of any overcharges on the monopolistically-priced electrical equipment, but under the ruling, the public was also required to bear about half the cost of the companies' damage payments to aggrieved parties. As of 1971, it was estimated that this one ruling had cost the American taxpayers $400 million, the electronic companies alone having about $250 million.
On January 10, 1972, an IRS ruling permitted the Anaconda and Connect Copper Companies, plus a few others, a tax break on the losses they sustained when the Chilean government expropriated their assets, saving the companies between $75 and $175 million. Some tax experts acknowledge that the law on the question was close, but feel that IRS did some stretching of past law and precedents in arriving at the ruling.
On December 29, 1966 – just two days before a New Year's Eve deadline, an IRS ruling letter saved the United States Steel Corporation the discomfort of having some $60 mlllion of "excess foreign tax credits" expire, unused. As if the $60-million tax saving weren't enough, U.S. Steel also asked for – and Internal Revenue generously granted – permission to similarly whipsaw the U.S. Treasury for further losses in future years.
But the importance of IRS rulings often goes beyond the dollar tax savings assured the various companies, for while the rulings supposedly revolve around highly technical interpretations of the tax law, they can also decide very large policy questions.
CODDLING CRIMINALS
For example, in ruling that treble-damage payments by anti-trust violators were "ordinary and necessary" business expenses, and therefore tax deductible, IRS in effect made it just half as expensive to be caught violating the anti-monopoly laws. To put it another way, the IRS ruling effectively amended the anti-trust laws and cut the damage payments in half. After computing tax savings, the companies paid not 300 percent damages, but only 150 percent. From the companies' point of view, the effect of the IRS decision was no different than if Congress had changed the basic anti-monopoly laws. But the IRS ruling came in 1964 without congressional assent.
IRS' facilitating Continental Oil's ABC buy-up of Consolidation Coal also involved important anti-trust policy considerations. As mentioned, Consolidation Coal was one of Continental's major competitors in the field of selling energy, and so the merger of the two reduced competition.
The ruling in the Continental case also paved the way for other businesses to take over coal companies, using the lucrative ABC device: Connect Copper later ABC'd the Peabody Coal Company, the nation's second largest; and Occidental Petroleum bought up Island Creek Coal Company via an ABC transaction. By 1972, five of the top 10 had been gobbled up by oil companies, leaving only two major independent coal companies in the U.S.
After seeing how great an impact the ABC and treble-damage rulings had, Congress concluded that Internal Revenue had been wrong and passed laws reversing the rulings. In 1969, Congress unmasked the legal intricacies of the ABC transactions and passed a law taxing ABC's for what they are: pure mortgage loans which must be repaid with after-tax dollars. In that same year, Congress decreed that where criminal anti-trust violations are involved, two thirds of the damage payments are no longer deductible. Unhappily, in both cases, Congress did not act until the major horses had already fled the barn. (The bulk of the electric company treble damages had already been deducted and the important "hard mineral" ABC takeovers had already been consummated.
PRIVATE JUSTICE
The various ruling letters mentioned above were just fine for the companies that requested and received them, for they assured tens and even hundreds of millions of dollars of tax savings for General Electric, Westinghouse, U.S. Steel, Anaconda Copper, and others.
But were they equally fine for the general public, for the rest of the U.S. taxpayers who must suffer the consequences of what amounts to changes in the anti-monopoly laws?
Alas – and this is the crucial defect in the process – there is no opportunity for advocates for those "rest of the U.S. taxpayers," to argue their side of the case, either before or after the rulings are issued. There is no provision for public hearings on these rulings – even when matters of such high policy are involved. On the contrary, and even more serious, is the one-sidedness of the process after the issuance of the ruling letter. If IRS' decision is unfavorable to the requesting company, it can proceed with its intended course of action, refuse to pay the tax, and contest the IRS position in a court of law. If the ruling goes the other way – that is, if it favors the requesting company, shifts a major tax burden onto the rest of the taxpayers – they have no corresponding right to challenge the ruling in court, no matter how unjustified IRS action might be found there.
In that sense, Internal Revenue is, in effect, the Supreme Court. If IRS throws in the legal towel, the matter is settled until and unless Congress enacts a corrective law which is unlikely to happen with any promptness.
In normal legal procedures, lawyers who want to know what previous court decisions have held on any given question have comparatively little difficulty finding out; not only are court opinions made public, they are meticulously indexed. Thus, attorneys for both sides have equal access to past court interpretation and they are equally able to use old decisions to support their arguments.
But taxpayers and their attorneys cannot so easily discover the precedents for IRS ruling since the vast majority are known only to three parties: the IRS, the requesting company, and its attorney.
PUBLISH OR PERISH
Confidentiality is not supposed to be a problem, for in 1952, at the urging of a congressional investigating committee, IRS issued instructions that all rulings "of general interest" were to be made public, a commitment reaffirmed in 1960. Yet, out of roughly 30,000 rulings issued each year during the sixties, an average of only 480 – about 1.5 per cent – were formally published by IRS. In 1972, three practicing attorneys in Chicago were able to list some 30 major rulings that had been of sufficient "general interest" to have rated mention in legal periodicals, yet had never been formally published by Internal Revenue. "This list amply demonstrates [IRS'] lack of adherence to the formal commitment to Congress to publish [precedent-setting] rulings," said the attorneys.
The enactment of the Freedom of Information Act in 1966 was supposed to have a salutary effect, for on its face that law requires agencies such as the IRS to make public all actions of "precedential" value. But IRS found an ingenious means of circumventing that requirement: it merely obliterated the word "precedent" from all rulings thus categorized in its files and reclassified them as "reference" – a term not mentioned in the Freedom of Information Act. In 1972, a legal action was filed to compel IRS to make public not only the unpublished rulings but IRS' confidential card index of rulings and related correspondence covering the notorious oil-depletion allowances. At this writing, that action is pending in the courts.
IRS' exclusive possession of that card index gives government attorneys a one-sided weapon that they can use effectively against private taxpayers whose lawyers are in the dark about unpublished rulings. For example, in a court suit entailing more than $3.4 million of taxes supposedly owed by Allstate Insurance Company, the opinion noted, that "the government placed in evidence a number of private-letter rulings of the Internal Revenue Service over a 12-year period" to bolster its position. But, apparently only the government's attorneys were privy to those private rulings; Allstate's lawyers "disputed the existence" of the unpublished rulings.
The exclusive distribution of the unpublished rulings can sometimes work against the government. On one occasion, when the Treasury Department issued a tentative regulation that offended the china clay industry, a private attorney who had long represented the industry fished out of his files a contrary, unpublished ruling IRS had given one clay company 15 years earlier – a letter of which not even Treasury was aware. The earlier version, favorable to the china clay companies, prevailed.
The above portrayal of the revenue ruling process is, admittedly, a partial one that highlights what seems to me its defects and may suggest that the process is wholly without merit or utility.
Of course, that is not the case. With a law as complex as the Internal Revenue Code there is ample room for doubt about its meaning, and there are bound to be cases where companies would be paralyzed without advance knowledge of how IRS will treat a given transaction. In a system that relies on citizen honesty (since it is the taxpayer, not the government, who makes the initial calculation of taxes owed), it is important that the system meet taxpayer needs where it legitimately can. Moreover, to the extent these in-advance rulings avoid time-consuming and expensive court contests, they can benefit the government as well as the taxpayer. (The government also contends that the rulings offer helpful information on troublesome questions of interpretations and enforcement.)
Yet, while useful, the procedures for issuing rulings do suffer major defects: the process takes place in excessive privacy, thus inviting unseen and potentially improper pressures. It provides for only one-sided advocacy (by the requester of the ruling), and, because there is no public notice that the deliberation is even taking place, it offers no opportunity for comment by disinterested parties. And it thrusts the IRS into the dual role of both advocate and judge.
CLEANING IT UP
But perhaps the most serious aspect is the one-sidedness of the process after the ruling is issued (with an adverse ruling being appealable to the courts by its requester while a favorable ruling cannot be appealed). If IRS declines the requested ruling, it risks a court challenge; if it grants the request, all will be tranquil. Under these conditions, the only party checking up on the IRS is the company requesting the ruling, since it alone is in a position to lodge an effective protest.
What should be done to improve the rulings procedures?
Students of the problem have widely varying views, but many believe that the following changes would make the process far more open and balanced:
First, require that all IRS rulings be made public.
Second, provide opportunity for public comment before major rulings formally take effect.
Third, broaden the right of citizens to challenge particular rulings in court.
As to making all rulings public, it has been objected that such a step would result in disclosure of legitimate business secrets and would render the rulings process useless in the very cases where an in-advance ruling is most needed, namely, those involving delicate and confidential business negotiations (e.g., mergers) where publication of the facts would (or might) blow up the entire negotiation.
The answers offered to those objections are many. First, as Columbia law professor George Cooper has observed, where large public policy questions and/or large dollar amounts are involved, these ruling decisions are "not a 'private' matter in any but the most technical sense."
Second, those who request rulings are asking for what, in a court of law, would be a declaratory judgment, which legally would require public disclosure of all the facts involved. Third, in the case of mergers or acquisitions involving publicly held companies, the details of the transactions are ultimately given to the shareholders (and hence made public) anyway. Moreover, all rulings dealing with charitable foundations are made public without apparent public harm. Why not apply the same rule across the board? Doing so would make IRS more careful in issuing rulings that will have to stand the light of day; promote more even treatment among various taxpayers; and put all taxpayers on an equal footing, both with each other and with government attorneys, in having full knowledge of the precedents on which they can rely.
As to the second proposal, many protest that requiring (or even expanding the opportunity for) public hearings would overtax IRS and Treasury personnel and would so bog down the ruling process as to render it useless. That need not be the case if all rulings were to be made public on a tentative basis, to take formal effect in, say, 30 or 60 days unless a hearing were requested
by a given number of individual taxpayers, the number to be set high enough to discourage frivolous or harassing requests while still providing for public comment.
IF THE SUIT FITS
Finally, as to broadening the right of citizens to bring court challenges against particular IRS rulings, it will doubtless be objected that this would open the floodgates to frivolous, harassing suits. That is a specter traditionally raised by those who dislike public spats, and it usually is not as terrifying in actual practice as had been anticipated. For example, the Freedom of Information Act conferred broad rights upon citizens to bring legal actions in order to extract information from the government. Yet, in the first six years that law was in effect, not more than 100 court suits were brought. Moreover, the expenses involved in bringing and sustaining a court action usually dampen the ardor of those whose motives are purely frivolous.
Harassing legal actions are not inconceivable; yet common sense and experience say they are remote, rather than imminent, possibilities. And does that danger outweigh the disadvantages of the present one-sided nature of the post-ruling legal challenge?
The ruling process has its usefulness. Open it up and let in some fresh air (and even a little public argument and debate), and it can become a more balanced process, fairer not just to the one taxpayer requesting the ruling, but to all of those nameless (and, heretofore, voiceless) rest of the taxpayers as well.
Mr. HATHAWAY. Mr. President, first, I would like to commend my distinguished colleague from Maine on both the spirit and the substance of the legislation he is introducing. As has been the case so often in the past, the senior Senator from Maine is taking the lead on an issue of vital concern to the ordinary citizens in every section of our country.
Reforming the inequities in the present Federal tax system has been a matter of special interest to me ever since my first term in the House 8 years ago. This interest has been given greater impetus over the course of the past year as I had the opportunity to visit with citizens in every community, large and small, in my State. Invariably during these visits, the conversations turned to taxes; surprisingly, it was not the burden of taxes that caused the most concern, but their perceived inequity.
After all the discussion of tax reform in the last several Congresses and during last fall's political season, I do not need to belabor the damage to our social fabric done by this widespread sense of the unfairness of the present tax structure.