Tax Fairness? Forget About It


By Thane Peterson If you have any doubt that the U.S. is being run by louts and hypocrites, I suggest you page through the new book Perfectly Legal: The Covert Campaign to Rig Our Tax System to Benefit the Super Rich -- and Cheat Everyone Else (Portfolio, $25.95). In it, David Cay Johnston, a Pulitzer Prize-winning reporter for The New York Times, makes a powerful case that since 1980, Congress and successive Presidents -- politicians of every stripe -- have deliberately undermined the fairness of the tax system. It is biased to favor big companies and a few superrich individuals, Johnston claims.

The book also offers a warning that should alarm just about every BusinessWeek Online reader: Unless the tax system is rejiggered, any American who makes $50,000 to $500,000 a year is going to get hurt. Remember those huge tax cuts rammed through by the Bush Administration over the last three years? Most -- and in some cases all -- of the benefits are likely to be eaten up by new taxes, Johnston asserts, even if the official tax rate isn't raised.

People making less than $50,000 won't be spared, either. Besides, most of them are already being pinched -- especially if they're a member of the working poor or head of a family with heavy medical expenses or many children, he adds.

PARALLEL CODE. At the same time, the tax burden on the wealthy has plunged. People in the top fifth of the income scale now pay only 19% in taxes -- and that figure takes into account state, federal, sales, property, and all other levies. The poorest fifth of Americans pay 18%. The people in the middle -- the other three-fifths -- presumably pay considerably more (I certainly do), though Johnston doesn't give a specific number. He points out that the only ones who pay less are scofflaws, whose numbers are soaring.

How did America come to this pass? Much of Johnston's tale is familiar. Big cuts in dividend and capital-gains taxes have mainly benefited the wealthy, and powerful corporations have slashed their tax burdens (illegally, in cases like Enron and Tyco). Meanwhile, 90% of the population saw earnings drop 25% from 1970 to 2000.

Far more surprising is the pattern Johnston documents in largely overlooked changes in income tax and Social Security rules. Politicians of both parties have consistently stuck it to average taxpayers, usually while loudly proclaiming that they're cutting taxes.

SOCIAL INSECURITY. The big bogeyman for middle- and upper-middle-class Americans is going to be the alternative minimum tax (AMT). Added to the tax code in 1969, this is a sort of parallel code with its own rates and tough rules limiting what can be deducted. The AMT was originally intended to make sure the very wealthy didn't avoid paying taxes entirely. The AMT never achieved that goal -- the superrich have clever advisers who are always two or three steps ahead of the IRS -- but it has gradually ensnared more and more average Americans, ratcheting their taxes upward.

It's a prime example of how government rarely ever really cuts taxes for anyone but the rich and powerful. Because the Bush tax cuts didn't include any provisions to rein in the AMT, the U.S. Treasury Dept. predicts that the number of households paying it will soar from 1.3 million in 2000 to 35.6 million by 2010. By then, 30.4% of all taxpayers will be paying the alternative tax, estimates the Tax Policy Center, and it will add an average of $3,751 annually to their tax bill.

Typically, the wealthy will get the best break: Only 24.3% of people making over $1 million will pay the tax by 2010, the Tax Policy Center estimates.

BIGGEST HIT. Politicians -- mainly Democrats in this case -- have similarly gamed the Social Security system. Its taxes have soared because of changes made in the early 1980s that were supposed to keep the system solvent. Johnston calculates that from 1984 to 2002, the government collected $1.7 trillion more in Social Security taxes than it paid out. The extra money was supposed to go into a fund to help pay for baby boomers' retirements but instead was simply dumped into general revenue -- another way of saying it was used to fund tax cuts for the wealthy.

As a result, Social Security is now the main tax paid by most average Americans. The maximum tax has soared, from $327 in 1970 to $5,400 in 2003 -- and you have to make only $87,000 to get hit by the maximum. Three-quarters of all households now pay more in Social Security taxes than in income taxes.

Worse, the original purpose of the tax -- to protect the poor from destitution in old age -- has been lost. Shamefully, the Democrat-controlled Congress dropped the minimum benefit for the poor in the early 1980s as a cost-saving measure.

RAMPANT CHEATING. Equally shameful is the way conservative Republicans have gutted the IRS. No one much likes the IRS, but it's a necessary evil because tax cheats basically just take money out of the pockets of honest people who pay. Unfortunately, the Republican Congress doesn't see it that way. It has repeatedly scored political points by hammering the IRS and slashing its budget. As a result, while the number of tax returns filed increased by nearly 50% from 1988 to 2002, the number of IRS auditors plunged 30%, to 11,500.

Little wonder that cheating is rampant. Partly because of mismanagement and partly because of budget cuts, the IRS doesn't have the computers and knowhow to go after the complicated offshore trusts, partnerships, and other scams the wealthy use to avoid taxes. And new rules passed by Congress in the late 1990s require that any IRS employee accused of certain infractions go through an administrative hearing and face mandatory firing if found guilty. This is a good reform in theory, but in practice it has allowed tax cheats to tie auditors up in red tape or intimidate them with threats of a complaint.

More and more people are simply refusing to pay income taxes -- and few, if any of them, are being punished. An IRS internal report found that in 2002 "at least 152,000 Americans filed bogus tax returns stating they owed no taxes or even seeking money back from the government under a variety of tax evasions marketed by promoters," Johnston writes. That's 1 in 900 U.S. returns. The General Accounting office estimates that 7,500 U.S. companies now simply don't bother to withhold taxes from employees, probably as a form of tax protest.

PERUSE BEFORE VOTING. Powerful as Johnston's indictment of the tax system is, I can't recommend his book as a great read. Like many books cobbled together from newspaper articles, it's poorly organized and full of repetition and familiar material. It's also short on meaningful suggestions for reforming the system. That's too bad, because if Perfectly Legal were better done, it would be one of the most important books of recent years.

As it is, every American who wants to be well-informed before voting this fall should at least slog through the key chapters. Flawed as it is, this is a seminal book about some of the most important issues facing the nation.

(For another review of Perfectly Legal, see BW, 01/19/04, "The Great Tax Rip-Off".) Peterson is a contributing editor at BusinessWeek Online. Follow his weekly Moveable Feast column, only on BusinessWeek Online


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