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Jewish World Review May 12, 2004 / 21 Iyar 5764

Amity Shlaes

Amity Shlaes
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Let's face it, planning your life to reduce your tax bill is a time-honored and legal tradition | Is it possible to feel sorry for an accounting firm? If so, this might be the year to do so.

Ever since November, one House member, senator or judge after another has bashed away at accounting's Big Four. Much of the time, the charge leveled against the firms is that they have been too aggressive in their tax planning on behalf of clients. Or, as Sen. Norm Coleman (R-Minn.) put it, guilty of committing the tax equivalent of driving "a Brinks truck through any purported loophole."

Some of the firms are fighting back, and it is not hard to understand why. They may have broken certain existing laws at certain points and they may even have committed fraud, but, in many instances, they were giving clients advice that both parties thought was legal at the time.

After all, planning your life to reduce your tax bill is a time-honored and legal tradition. Judge Learned Hand determined specifically that there was "nothing sinister" about tax planning and that "anyone may arrange his affairs that his taxes shall be as low as possible. He is not bound to choose the pattern which best pays the Treasury."

There are even phrases in our legal language to mark the difference. Breaking the law to reduce a tax bill is illegal and has historically been called "tax evasion." Using legal devices to reduce the same bill is "tax avoidance" and is — or was — just fine.

All this would seem to make for an unchangeable bright line. Nonetheless, judges, IRS officials and lawmakers haven't been able to resist fiddling with it. There have been changes in statute, changes in interpretation and new precedents. Nearly all cut back the legal ground and widened what might be considered illegal. "Avoidance" is no longer safe — firms get hauled into hearings for it. Yesterday's legal "tax shelters" become today's "schemes" or "generic abusive tax products" — the latter being the phrase the IRS used to describe tax advice given by the accounting firm KPMG.

The reasons for these shifts are obvious. Tax collectors and politicians both want revenue. Politicians want to stir class rage. Everyone wants a scapegoat, especially after Enron and WorldCom.

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Rarely, however, do we talk about what it is about a tax culture that gives authorities license to get away with such frequent — even retroactive — rule changing. They get away with it because the tax code is so complicated. Or, to retrace the typical chain of events: Congress pushes up rates. High rates push up the demand for tax breaks by corporations and individual taxpayers — and Congress provides them. That, in turn, causes tax complexity and more gray areas to haggle over. Very few of us understand "Son of Boss" or "blips," to mention two shelters that have gotten accounting giants in trouble.

Few of us, therefore, can say whether these shelters are truly legal. What is clear is that the shelters are bizarre enough to serve as a wonderful hearing showpiece for grandstanding politicians. And that they offer yet another chance to fiddle with the rules.

This is not a new dynamic. During World War I, lawmakers pushed the top rate up to 77%. Tax breaks proliferated.

Andrew Mellon, the steel magnate, didn't care that breaks were legal. He disliked them, for he happened to be the closest thing his era had to a flat-taxer. When he became Treasury secretary, he compiled lists of shelters, dubbing tax-free municipal bonds "involuntary subsidy" by Uncle Sam. Mellon knew about the shelters because he used them himself. He believed that, by honestly pointing out the loopholes' absurdity, he could persuade Congress to close them and lower rates.

This proved naive. Mellon eventually retired from government, and the new man at Treasury, Henry Morgenthau, was not interested in fine distinctions. He wanted to string up plutocrats, and Mellon found himself being hoist by his own tax petard. Morgenthau actually prosecuted Mellon on criminal charges of tax evasion. Historian John Morton Blum reports that Morgenthau told Robert Jackson, who represented the government, that "you can't be too tough in this trial to suit me." He also said: "I consider that Mr. Mellon is not on trial, but democracy and the privileged rich, and I want to see who will win." So much for Learned Hand.

In fact Mellon won, but prosecutions like the one against him sent a chill over the nation's entrepreneurs, and the Depression lengthened.

Another such cycle came with the Cold War, when lawmakers pulled the top rate up to 91%. Again, the breaks proliferated. One allowed citizens to save thousands by making their offspring their business partners. In the 1960s came the inevitable hearings, which showed that 155 of the nation's wealthiest citizens paid no income tax. Lawmakers next passed the alternative minimum tax, a penalty tax to ensure that the rich paid their share. In the end, as with the Mellon action, everyone paid. Today, the AMT strikes at plenty of middle-class families.

In recent years, lawmakers have talked a lot about the effects of moving tax rates. But neither party has thought through the complexity problem. This is a shame, as much for civic reasons as for economic ones. After Enron and WorldCom, accounting firms have plenty to answer for. But so do the officious fiddlers in this story.

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JWR contributor Amity Shlaes is a columnist for Financial Times . Her latest book is The Greedy Hand: How Taxes Drive Americans Crazy and What to Do About It. Send your comments by clicking here.


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© 2003, Financial Times