Risk & Other Four-Letter Words

Wriston, Walter B.

1986

The Ultimate Loophole: Spend Your Own Money

Anyone who has observed with sorrow the disappearance of the American handyman has had to learn some of his skills or watch the mechanical devices at home break down. In acquiring the requisite skills, one learns that a badly designed machine can never be fixed, even by an expert at tinkering. Something more radical is required-redesign.

This principle applies also to many patchwork legislative solutions to social and economic problems which have been pasted together over the years. It is the ultimate insult to say something looks as if it were designed by a committee, but to the extent we can use the word "designed," our tax laws fit that description. They were patched together by a multitude of committees over many years. All too often, changes were made without reference to what existed before. Since the beginning of time, no tax structure has ever won the plaudits of citizens. But there are few instances in history where all shades of political opinion have agreed unanimously that our tax laws are unfair, unclear and, indeed, beyond understanding. It is literally true that no one in the country knows for sure what our tax laws mean. And there is no policeman to read your rights to you if you run afoul of those laws.

It is a maxim of cryptology that what one man can devise, another can unravel. This principle keeps armies of tax lawyers and accountants employed, but adds nothing to our national productivity. The distortions in our society caused by the quirks of the law beggar the imagination. Companies that have lost money may be more valuable than others which make money. People with equal incomes pay unequal taxes. Often the heaviest burden falls on the working man or woman.

The blue-collar worker who has struggled hard to support his family, educate his children, and save his money suffers. This is the only group in our society that gets a plethora of kind words from Congress but laws that catch it in a double bind. Inflation pushes the blue-collar worker into higher tax brackets while cutting deep into his purchasing power. Savings melt under the heat of inflation, while the interest on his proposed mortgage rises beyond reach. Meanwhile, Congress increases the payments to the non-worker so that subsidies to the idle rise to meet the shrinking rewards of thrift and industry.

The issue is one of substance, rather than rates. We can fairly charge, as did our forebears in the Declaration of Independence, that taxes are "imposed without our consent." Again, we have taxation without representation because it is impossible to have your point of view fairly represented in a matter so complex that no one understands it. This lack of understanding is not limited to the ordinary person trying to pay his tax in accordance with what someone tells him the law requires. It is a pervasive malaise extending to our representatives in Congress who vote the laws in the first place. At a closed hearing on a tax bill once, several senators complained that they did not understand what they were being asked to approve. The chairman of the Senate Finance Committee is reported to have replied: "If every man insists on knowing what he's voting for before he votes, we're not going to get a bill reported out by Monday." Monday clearly had priority over clarity.

The Constitution says that Congress is to provide for the

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"general welfare." Instead, Congress pays more attention to special interests. Hundreds of bills are regularly introduced to amend some part of the tax code. Many of the bills seek to benefit a sector of our society which has persuaded a congressman that it needs help. Change is then effected by amending a section of the law, often referring to another section which itself refers to still another. A recent "simple" amendment to the tax reduction bill was "read by title." The title consisted of one sentence containing sixty-nine words. Nestled among them was a key phrase, "and for other purposes." That turned out to mean anything Congress chose to put in its "Easter basket"-a plethora of tax breaks for special interests.

No congressman, no lawyer, no accountant can tell the taxpayer his rights with any certainty. No one even bothers to try to make a case that the present laws are equitable. Any law that cannot be understood is, by definition, an assault on democracy. Whenever a legislator hard-pressed for a headline needs a little free publicity, he or she announces in a tone of outrage one or another of the legitimate consequences of the law. The results are often so bizarre that each new announcement merely reinforces the public awareness that the Congress has legislated a rip-off.

One of the hallowed rites of spring used to be a legislator peering earnestly out of the television screen and bewailing the fact that some people paid no income tax. What they said was true. At one point, according to the Internal Revenue Service, there were one hundred and seven people in the United States with incomes in excess of a million dollars who paid no federal income tax. Yet no one can assert that they did not obey the law. They did no more than their Congress mandated. Obviously, such a result made no sense. No one should go tax-free. The fault, however, was not with those who paid no taxes, but with those who turned taxation into a puzzle. You can be sure that some IRS officer built a government career auditing the returns of those non-taxpayers. A law that produced this result was obviously wrong, and a minimum tax was established, though other inequities in the tax

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laws were left uncorrected and new ones added year by year.

Since no one believes the present laws are fair either, it is worthwhile to inquire how we got into this mess. The economist Adam Smith laid down some basic principles. Taxes should be "certain, and not arbitrary ... clear and plain to the contributor, and to every other person." Today, taxes are uncertain, arbitrary, and unclear. Common sense has been stood on its head. We have arrived at our present absurd position because the original purposes of taxes as defined by Article One of the Constitution have been forgotten or ignored. The Constitution gave power to Congress "to lay and collect taxes" in order "to pay the debts and provide for the common defense and general welfare."

In the Constitution, no mention is made in any form of what has come to be called social engineering, a far different thing from the original idea, which was to raise money to pay the costs of government. It was a straightforward concept. Limiting taxes as a safeguard for individual liberty was much in the minds of the Founding Fathers. They knew that the power to tax was the power to destroy. They understood with great clarity that when the government takes a part of our income, it is commandeering the fruits of our labor.

As early as 1753, Benjamin Franklin suggested a standard. He wrote: "It would be thought a hard government that should tax its people one-tenth of their time, to be employed in its service." The fundamental principle laid down by our Founding Fathers has now been reversed. Today, the part of your income you succeed in keeping for yourselves is denounced as a "loophole." The ultimate logic of that assumption is that everything you earn belongs to the state. The benevolent Congress may permit you to keep a little, not as a right but only as a benefit.

Levying taxes to pay the government's bills is a sound idea. From the very start of our country, however, our toleration of taxes always has been tempered by a well-founded public awareness that government expenditures tend to be too high and to keep rising. When Thomas Jefferson won election as

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President in 1800, his campaign promise was to roll back taxes. George Washington was portrayed as a big spender since he had a federal budget of about 2 percent of the national income. The budget was then financed without income taxes. The well-to-do paid a tax on imported goods, but taxation in America remained light until an income tax was levied to help finance the Civil War. That income tax was repealed in 1872. The Supreme Court found the income tax of 1894 unconstitutional.

It took a constitutional amendment in 1913 to bring the income tax back into being. Even so, as late as 1935, only one of sixty citizens was required to pay any income tax at all. To bear the cost of the New Deal and of the Second World War, one out of every three-or just about every working adult began turning a portion of his income over to the government by the early 1940s.

No one has to remind you that federal, state, and local taxes now take more than a third of the money Americans earn. While the proportion is large and growing, the point I want to emphasize is that the tax burden does not fall upon people with any semblance of equity. The principal reason is that tax laws have not been used primarily to raise revenue. Rather, the purpose was to allocate private resources to achieve what were deemed at the time to be social priorities.

Tax policy aimed at social engineering, instead of raising revenue, inevitably provided individuals and organizations with a patchwork of deductions, exemptions, credits, and variable rates of such complexity as to boggle the mind. In moving along this path, Congress stretched the Constitution, which speaks only of the "general welfare." Far from looking to the general welfare, the tax laws help develop special interests and privileges. Doubtless, at the time they were enacted into law, each seemed like a good idea.

But our value systems constantly change. What was once thought to be good is now denounced as bad. The result is that today's social priorities will inevitably become tomorrow's tax loopholes. Examples abound: The oil depletion allowance was designed to induce people to engage in the financially risky

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search for petroleum because America needed supplies of energy. When Congress adopted a concurrent resolution in 1945 to allow a deduction for intangible drilling and development costs, the resolution was introduced with the words: "That in the public interest Congress hereby declares..." The Arab oil price increase blanked out congressional memories and turned on a spate of oratory which denounced profits as "obscene" and depletion as a "loophole." The list of special cases includes just about every category of business, labor, or voluntary organization and grows longer with every legislative tinkering. But the point is simple: When the unpleasant job of raising revenue is superseded by government allocation of resources through subsidies, exemptions, loopholes, and deductions, we end up with tax laws that are incomprehensible, and with good reason are perceived to be unfair to every sector of our society.

When a democratic consensus believes something is wrong, it is time for reform. Laws that are not only unfair but unintelligible should be repealed before social damage becomes irreparable.

The size of the IRS manual has grown to an incredible forty thousand pages. Clearly, we have arrived at the point where the tax machine has been so badly designed that no amount of tinkering can help. It is time to throw the machine away and return to the people the decision on how they wish to spend their own money.

Just as no-fault auto insurance, despite its deficiencies, leveled premiums for motorists and cut down on endless litigation in the courts, a no-fault tax policy would restore taxation to its original constitutional purpose of raising revenue and providing for the general welfare. There is much to be said for abolishing the whole complex of laws we now have and replacing it with a simple, graduated rate with no deductions, except for taxes paid to other political jurisdictions to avoid paying taxes on taxes. The exact rate is not as important as the fact that it would make the law clear, certain, and fair. It would eliminate loopholes that now make tax laws resemble a sieve and have turned tax defiance into a national pastime.

Since only people pay taxes, the present policy of differentiating between corporate and personal income taxes makes absolutely no sense. In reality, corporate and personal taxes are one and the same. A large percentage of the population has a stake in corporations by either owning shares directly or owning life insurance and pension funds that make the investments. In fact, the greatest asset the workingman has is a future claim on his pension. Directly or indirectly, the retired worker must rely on corporate payments for his pension. The majority of jobs in this country are provided by corporations. Whether or not one works for a corporation, everyone is a consumer, and in the end the consumers pay the corporate tax. If the tax is too high, the buyer pays more for the product of the corporation. If the buyer refrains from buying, then shareholders' dividends decline or evaporate and the workingman's paycheck shrinks or disappears. Since it is a truism that no country can be richer than what it can produce, income can be divided but not multiplied through tax laws.

If the tax rate were the same for corporations and individuals, the shareholder and the workingman would have more money to spend, not as the government decides but as they choose for themselves. Free people, making free choices in a free marketplace, form the wellspring of our economy. Business would be spurred to research, investment, and development. As a consequence, it would hire, compete, and produce more and more at less and less cost. This program would answer the fears of a capital shortage, because capital is nothing more than stored-up labor. To the extent that all people can keep more of the fruits of their labors, more capital is available to increase production and the quality of life.

This simple but fundamental truth has not been observed by those who determine our tax policy. Voted in response to populist pressure to tap the corporate exchequer, negative sanctions on saving and investment have depleted the public's pocketbook, thrown people out of work, and weakened the economy.

The cold fact is that the Congress, business, labor, and individuals have a vested interest in the complexity of the tax

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laws. The beneficiaries of tax breaks regard them as constitutional rights. Their proponents in the Congress use them as a means to court their constituents and ensure reelection. Out of habit, the homeowner thinks his deduction for mortgage interest is all that stands between him and foreclosure. The biggest subsidy of all goes to the people who live in suburban houses. They get a six-billion-dollar marker for interest on their mortgages. Those of us who live in apartments feel that is not equitable. The businessman insists that the investment tax credit is the only thing that stands between progress and stagnation. I think, for example, the bad-debt deduction is one of the finest ideas in the history of the world. That's my loophole. But of course, loophole is very unjust. Doctors and lawyers, farmers and laborers, young and old, rich and poor, all have been seduced by the psychology of entitlement. They have become habituated to look to government to subsidize, directly or indirectly, their education, their homes, their food, their medical care, and their retirement. Each person regards the other man's loophole as evil, but his own as essential. The universities, the hospitals, and all other charitable organizations have such faith in the American people that they say nobody would give them any money if it were not a tax deduction. That just isn't so. The greatest period for giving in American history occurred before the income tax. A Carnegie Library in every town in the Midwest testifies to that. I submit that if you and I could keep 80 percent of our earnings, we'd be delighted to continue to support the universities, the hospitals, and other charitable foundations. Congress, instead of placing a tax reduction under public scrutiny, all too often prefers obscure subsidies and loopholes with complex credits, deductions, and tax carrybacks; it fills the law with these and other riddles. As long as handouts to rich and poor alike are buried in the maze of our tax structure, public confidence in the fairness of the rule of law will continue to decline.

At a time when people grow cynical about all institutions that promise more than can be delivered, it is time for reform. What is needed is a simple, clear tax law, understandable to all, to reduce bias and restore balance. It is time to recognize

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that freedom and incentives-not tax dodges or loopholes are what inspire people to work, to save, and to invest. Let us return these decisions to the people by eliminating our present maze of laws and putting in a simple graduated rate unencumbered by exemptions, deductions, deferrals, loopholes, incentives, or disincentives. Perhaps then we can begin to repair the social fabric.

Freedom can be as effectively destroyed by a tax policy designed to allocate resources as it can by the repeal of the First Amendment. When business and personal decisions are not made on economic grounds, but are shaped by tax consequences, which may or may not make any economic sense, our American system of economic and political freedom is in jeopardy. The framers of the Constitution were well aware of this danger, since they were the victims of discriminatory tax acts promulgated from across the seas. Governments have not mended their ways any more than human nature has changed. Using tax policy to either force or induce people to do what the government wants, and not what the citizen exercising his free choice wants, is based on the assumption that government knows best. It reflects a distrust of freedom.

A paternal government permitting some favored section of our population to benefit more from the results of their labor than some other section illustrates a point made by the great Justice Louis Brandeis when he wrote:

Experience should teach us to be most on our guard to protect liberty when the government's purposes are beneficent.... The greatest dangers to liberty lurk in insidious encroachment by men of zeal, well-meaning but without understanding.

Our tax laws are written by people of zeal, and it is equally true that they surpass all understanding.