Step One in Tax Shelter Reform, a (Very) Modest Proposal for Transparency

Today’s NYT article on how the Estée Lauder heir Ronald S. Lauder uses tax shelters to protect his billions reminded me of An Investment Manager's View on the Top 1%:

A highly complex set of laws and exemptions from laws and taxes has been put in place by those in the uppermost reaches of the U.S. financial system. It allows them to protect and increase their wealth and significantly affect the U.S. political and legislative processes. They have real power and real wealth. Ordinary citizens in the bottom 99.9% are largely not aware of these systems, do not understand how they work, are unlikely to participate in them, and have little likelihood of entering the top 0.5%, much less the top 0.1%. Moreover, those at the very top have no incentive whatsoever for revealing or changing the rules. I am not optimistic.

(Incidentally, there’s some other interesting stuff there, including a rich-person’s view of why the 99.5% and up are so different from the bottom half of the top 1% (ie. 99.0 – 99.5). That group is mostly very successful professionals who find their retirement prospects to be better than most, but still less certain than they would like. The top 0.5%, on the other hand, the writer says, are or were in finance.)

While it would be good to do some serious reform of the tax system, the vested interests are in fact all pushing hard the other way (e.g. the quiet concerted action to destroy the inheritance tax).

Perhaps, therefore, as a first step we could require that anyone who uses a tax credit or deduction that saves them more than, say, $250,000 in tax liability, must disclose what tax credit/deduction they used, how much they saved and have it recorded along with their names on a registry published online, in a nice searchable format, by the IRS. There is a long tradition of having tax returns private, but perhaps for this we should change it: if you want to keep your privacy, don’t take the tax shelter. Note that my proposal does not require that the taxpayer disclose either income or total tax liability, just the size of the savings and its source.

As I’ve said before, I’m not at all a tax lawyer. I invite people who know more about tax law to explain why this idea is unworkable, pointless, or fattening.

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8 Responses to Step One in Tax Shelter Reform, a (Very) Modest Proposal for Transparency

  1. jpe says:

    Lauder didn’t claim a deduction or credit; the tax trick here was that he took the position that the cash he received wasn’t (yet) income. It’d be tough to design a form to compel disclosure of absence of income w/o it being overinclusive and generating lots of false positives. The IRS used to have a tax shelter form (can’t remember which one) that was so overinclusive they were buried in forms disclosing legit transactions, and I think the form was discontinued after a year or two.

    A highly complex set of laws and exemptions from laws and taxes has been put in place by those in the uppermost reaches of the U.S. financial system.

    I think that’s exactly backwards, and the Lauder case is a perfect example of why: Lauder sold company stock short against the box, and then Congress passes a complex set of rules to prevent that sort of thing in the future. The code grows larger and more complex in order to prevent tax avoidance strategies.

  2. Vic says:

    Experience has taught me that as social systems grow more rule-bound and more complex in their structure, more loopholes are created, rather than extinguished, despite the stated intentions of the rule-makers.

    In other words: The more rules you create, the more ways to break them are codified. A simpler, less codified system is generally less corrupt.

    Perhaps the reason “the rich” appear to take advantage of the tax code moreso than the so-called 99% is that MOST of the 99% are not smart enough to suss out the loopholes available to them, and won’t hire a tax expert of any sort to do it for them. Though it’s most likely that “the rich” simply have more available loopholes since the tax law seems primarily focused on tweaking them (hence more complexity at that level).

    But I also have to wonder if the availability and widespread use of tax software levels the playing field somewhat – at least among those who pay taxes at a level more complex than the 1040EZ.

    • I think that most people have all or most of their income from salary. The serious tax dodges tend not to apply to salary income. You need other income sources (stocks, bonds, derivatives, property rental/lease, capital gains) before there’s any hope for sheltering via anything other than the most common deductions such as mortgage interest. So it is mostly a 1% thing (and a corporate thing) after all.

    • jpe says:

      In tax that’s not the case at all. Take Lauder: we have a general (and simple) rule stating that a gain on a sale is income. Simple enough, and it’s the simplicity that makes it easy to get around. So what did Lauder do? He simply deferred the closing leg of the sale. Consideration from one party transfers in year 1, and then consideration from the other transfers in year 5. Since our simple rule tells us that gain isn’t taxed until a transaction is completed, the tax is deferred until year 5.

      So what does Congress do? Well, they stop that technique with a new law. And all those new little laws that prevent gaming our simple rules accrete over time and create this behemoth tax code. That’s not a bad thing: that accretion precludes tax avoidance. It’s simply misinformed to claim that the complexity of the code is good for tax avoidance; the truth is the exact opposite.

  3. Vic says:

    Well I suspect that most people who derive all of their income from salary, probably also don’t pay a lot of tax (relative to others) simply because such a simple economic position (evidence by such a simple tax liability) suggests that they are also lower on the income scale (most people who have anything like a well-paying or professional job also have all kinds of bennies that involve 1099 forms, etc). So does a loophole really matter to them? Well, we’d all like more money, but when you are earning next to nothing and paying very little, your problems are not the tax code.

    Once anyone gets up to a professional level in salary, which in fact most people eventually do (only about 4% of the poor actually STAYS poor, the rest move up) various things we might loosely call a tax loophole come into play, as nearly any professional that is not just letting things happen around him, starts acquiring various money accounts, IRA’s, mortages, etc. that provide for some tax deduction. We might argue or disagree as to when a tax deduction evolves into a “loophole” but in the end, it’s really the same principle involved, even if technicalities differ.

    My point being confined to the simple principle that in ANY complex system, people tend to find the way that is least painful to them, whether it’s buying food, or paying taxes. To people who make a lot of money – and hence pay a lot of taxes – it’s more worth it to seek out dark areas in the law that allow them to avoid more liability. Perhaps to you, the trouble isn’t worth it in the end. But the same principle is in play whether you exercise the effort or not.

    I’m not sure jpe’s point refutes that principle at all since most people are in agreement that the tax code is more complex now than ever before, but there are many more “loopholes” than there were when we had a far simpler code, but the rich paid taxes at seemingly exorbitant marginal rates. And some folks who advocate radically simpler tax systems also claim that much more revenue would be collected (rightly or wrongly). Whatever the economic truths in play, I don’t think anyone with a straight face actually thinks that a behemoth tax code actually encourages compliance, so much as it codifies what constitutes the obligation to pay – which now codified, becomes avoidable with effort. People are people. If I say you have to pay me 15%, the math is simple and hard to argue against. But if I say it’s 15%…unless its cloudy outside, or you feel sick, or you owe someone else a significant amount of money, or your feet hurt, or… chances are I won’t get my 15%, and you will have a good case for denying me. Simple always gives less ability to corrupt forces. We all likely agree that simple isn’t practical though, so the trick is in finding a balance.

    • jpe says:

      There were many, many more loopholes in the older code. While the 1986 law cut the marginal rate nearly in half, the effective rates paid – and revenues collected – stayed approximately the same. This is because the new code blocked so many loopholes. Take the passive loss rules, which are probably among the more complex rules that impact regular-ish people encounter. That alone blocked any number of tax shelters, albeit at the cost of adding quite a bit of complexity to the code.

      • Vic says:

        Again, my theory may, or may not, be applicable to EVERY situation. I’m not a tax lawyer so I won’t pretend to have memorized the Code.

        But for a nice example, take a look at the San Francisco Happy Meal controversy. A certain segment out there sees giving away toys to kids in meals to be preying on them so they want to stop it. OK. But instead of simply stopping it directly (the simple solution) they make some stupid new law that REGULATES it instead (the complex solution). “You can’t GIVE away toys with a meal.” OK, says Micky-D’s, we’ll just charge a dime for the toy and donate that to our charity. Now the group that started it is furious, and Micky-D’s is just going to enjoy all the new money they provided.

        Yet one more example of the fact that when you create complexity in a non-trivial system, you codify loopholes more than anything else. When you expect PEOPLE to operate according to a non-natural system, they simply won’t as much as it’s possible. The Happy Meal fiasco is only unpredictable to the sorts of people who think they can just regulate everything they hate out of existence by fiat – the rest of us saw it coming a mile away.

  4. Vic says:

    (BTW, I don’t insist that I am RIGHT on any of this as specifically applied. I just see no reason to doubt that the laws of people-physics somehow suspend themselves when the tax code comes into view. People with enough incentive will avoid what perceived hardships they can with what tools are available to them. Nothing radical or revolutionary or really even controversial in that, I think.)

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