The Fine Print: How Big Companies Use "Plain English" to Rob You Blind (35 page)

When Mitt Romney disclosed his tax return for 2010 it showed he made more than $21 million and paid less than 14 percent of that in federal income taxes. His campaign, responding to a question I framed, also acknowledged in writing that the Romneys paid no gift taxes on the $100 million they put into trust for their five sons. At the time the transfers were made, the maximum they could give free of tax would, to anyone consulting the tax code, appear to be $2 million or less. The Romneys got around this limitation by giving assets that the IRS says cannot be valued, like a share of the future fees known as “carried interest” that Romney was due for deals he made while heading Bain Capital Management.

The Romneys got another sweet deal in the way they arranged this gift. They put their money into what is known as a “defective” grantor trust. Defective means Mom and Dad pay the income taxes on the trust-fund earnings and the children get their money tax-free. And it’s all perfectly legal.

But the best deal of all for hedge fund managers and others among the already rich is tax-free living by simply not reporting income.

The corporate executives who defer income cannot use that money because the company has it. But in a business that depends on massive bank loans, hedge fund managers can. The hedge fund manager with a few billion in his offshore deferral account just gets a loan from his banker when he wants a few tens of millions to buy a new mansion and a Modigliani to hang over the fireplace. Typical borrowing rates? Two percent or less. That is a lot less than even the discounted 15 percent tax on withdrawals from a hedge fund. And as long as the hedge fund account
keeps growing faster than the interest rate, why cash in and pay any taxes?

Almost anyone who is already very rich can live this way. Consider Frank and Jamie McCourt, former owners of the Los Angeles Dodgers baseball team. The real estate developer and his wife got into a messy divorce, with shouting matches and accusations about affairs (hers) with limo drivers. The court records that resulted contain some eye-popping numbers.

For one, from 2004 to 2008, the couple spent $109 million on their lifestyle.

Another? In petitioning a judge for $1 million a month in support for Jamie McCourt in 2009 to keep her lifestyle going while the divorce proceedings dragged on, her lawyers revealed that “the parties have not paid any federal or California income taxes since they moved to California in 2004.”

The court papers also show that the couple lived on a budget, albeit an impressive one. The budget prepared for 2008 anticipated spending of $43 million. That included $25 million in new loans to fancy up two of their homes and $18 million from borrowing against Dodgers ticket revenues, which came with the added benefit of creating tax-deductible interest expenses.

The McCourts are far from unusual among people who have built up billion-dollar fortunes. Many Americans are spending millions, even tens of millions, each year while paying little or no income tax. And it’s all perfectly legal, thanks to the tax regulations applicable to the richest among us. It’s only surprising that the outraged voices of Occupy Wall Street only began to be heard in 2011.

An IRS Statistics of Income report known as Table 1.4 showed that nearly 322,000 taxpayers reported incomes of $1 million or more in 2008. Of these, 2,054 paid no income taxes. Their average income was $3.8 million. The number of such high-income individuals who pay no taxes has been growing rapidly. There were 959 of them in 2007. Back in 1997 they numbered just 173. Many others pay a smaller share of their income in taxes than families who work as schoolteachers and cops, nurses and truck drivers.

Terrence Wall, a Wisconsin developer, filed financial disclosure forms when he ran in the 2010 Republican Senate primary. They showed that his income was in a range between $3.5 million to $14.2 million in 2008 and the first ten months of 2009. Wall paid no income taxes and hinted that he had not paid any for years. The
Milwaukee Journal Sentinel
asked
the candidate whether it was fair to the middle class that they pay taxes while he lives tax-free. Wall said, “Everyone should pay less in taxes.”

Wall has all the obliviousness of a modern-day Marie Antoinette. The reality is that everyone
else
must pay more in taxes when the McCourts, Wall and thousands of others pay little or nothing.

The upward pressures on your taxes, and the downward pressure on your wages and fringe benefits, are not the only problems created by tax rules that rarely make the nightly news or even the best newspapers. Your job may have been destroyed by a tax trick—and Congress may soon double down on this ploy.

19.
Imagine, for a
moment, that you are a member of Congress in fall 2004, eager to go home to campaign. Voters are not exactly thrilled with the economy, and that makes you anxious, given the long tradition of Americans voting their pocketbooks.

Their concerns are real, as the economy is far from robust. While the 2001 recession was mild and lasted only eight months, the jobs lost were not replaced for almost four years. Job growth in the country remains mired far behind the numbers needed to serve its growing population. Those who have been working found raises rare and minimal, except at the very top. The average income of Americans fell in 2001 and again in 2002. It slipped a tad more in 2003, bringing the real average income 12 percent below the previous peak year of 2000. Even though average income has grown a bit in 2004, measured in 2010 dollars it stands lower than 2000 by $4,631 or nearly 8 percent.

Republican politicians have been reminding voters that companies that have been laying people off left and right will require more tax cuts in order to resume hiring. Democrats tend to focus on frozen pension plans, reduced health-care benefits that cut into workers’ already shrunken paychecks, and fat executive pay plans.

So, as a representative or senator up for election in 2004, you’re faced with delivering bad economic news. Now, imagine you have an opportunity to spend $93 billion to make things better. What would you do?
Specifically, what would you do involving the very first power the people granted you, the power to tax? Let’s make this simple, with three options.

The first option would be to give voters a big, one-time tax break. You could let everyone in the bottom half pay no income taxes for 2004 and everyone in the next best-off quarter of Americans cut their income taxes by two-thirds. That way, seventy-five out of every one hundred Americans would get a benefit, but it might not help you get reelected (lower-income people are the least likely to vote). Or as a variation you could just grant everyone an 11 percent across-the-board income tax cut for 2004. That way every taxpayer would get a benefit, including those most likely to vote and those most likely to be campaign donors.

These tax savings could be achieved by simply adding a line to individual tax returns with a directive to multiply the tax owed by zero for everyone with an adjusted gross income under $31,000 and by 0.33 for those making from that amount up to $66,000 in the first case; or, if the cut was across the board, by having everyone multiply their initial tax bill by 0.89.

If you believe what President Reagan said for years on his way to the White House, you would choose the broad individual tax cut to win votes. Reagan, relying on remarks he attributed to a British judge from two centuries earlier, often said this:

Now, for your second option. You could do nothing. The government has been running chronic and worsening deficits following the 2001 and 2003 Bush tax cuts, which did not result in the promised creation of jobs. As a politician you might decide that active intervention in the economy to stimulate demand is not such a good idea.

If you are a fiscal conservative worried about deficits, you will find cutting revenues bizarre. You’ve long since grasped the fact that, if taxes are cut and spending keeps growing, you must borrow to make up for the shortfall and that the debt thus incurred is an implicit tax on future income. So if you’re a real fiscal conservative, you might be inclined to the second, do-nothing option.

The third choice would be to give a one-time tax break to multinational corporations with untaxed profits held offshore, provided they brought the money home. So long as these profits stay offshore they remain tax-free, but if they were returned to the United States, a 35 percent tax would come due. Say the tax break you’re considering would slash the rate to a tad more than 5 percent. That’s an 85 percent discount, which the Bush White House told everyone would mean jobs, jobs and more jobs.

There are other voices in Washington that favored this. Senator John Ensign (a Nevada Republican not up for election in 2004) claimed that these repatriated funds would be used “to strengthen the financial stability of U.S. companies, for expansion, for new hires and for research and development.” He calls it “common-sense legislation” and predicts “the creation of more than 660,000 jobs [will] result.” Ensign’s jobs estimate was actually the brainchild of Allen Sinai, the economist who founded Decision Economics and formerly was the chief economist at Lehman Brothers. Creating 660,000 jobs would be a huge boost to the economy, providing work for about one in twelve jobless workers. Sinai, the source of Ensign’s numbers, told me his figure is based on history and how many jobs tax reductions have generated in the past. Yet the per job price would be huge. At $455,000 per job, it would take the average American, paying the average 2004 income tax rate of 13.4 percent, sixty-two years to pay $455,000 in taxes. So even if all those jobs materialized, they were not worth anything close to the cost of the corporate tax break. But, for the moment, that was left unsaid.

So, imaginary lawmaker, which option would you choose? A broad individual tax cut to curry favor with the masses as taught by Reagan and George W. Bush; the second option of no tax cut for anyone because government was already spending much more than it was collecting in revenues; or would you vote for the third option, a highly concentrated tax cut for a few giant companies that supposedly would create jobs?

This is an essay question, by the way, because you’ll need to explain your reasons for your choice, along with what steps, if any, you would require be taken later to determine whether you made the best choice or even a smart choice.

Actually, no, you don’t have to answer the question. Congress already did, when a majority of actual lawmakers voted for the corporate tax cut called the American Jobs Creation Act of 2004. The final House bill got yeas from 205 of 221 Republicans, but just 75 of 199 Democrats. In the Senate, 43 out of 46 Republicans and 25 out of 39 Democrats voted yea. (Not all lawmakers voted.)

Since that decision is fading into history, we can examine its ramifications. I’d tell you what Congress learned, except the politicians forgot to include any requirement to follow up with reports from the companies that got the tax break, so they assembled no data from which lessons could be drawn. But the IRS did make a study from which much is to be gleaned. Multinational companies liked the Jobs Creation Act so much that 843 of them brought home $312 billion that qualified for the deal, escaping almost $80 billion of taxes, according to a report by Melissa Redmiles of the IRS Statistics of Income division. You’ll notice that the amount of actual tax savings was less than the $93 billion estimated, but not so much less that it undermined the basic premise or the promise of many new jobs.

Much of the money came from tax havens such as Bermuda and the Cayman Islands. Firms that brought home untaxed profits from high-tax countries like Canada and Britain got an extra opportunity to take advantage of the deal because of some technical features of the law.

What was the money actually used for? That was beyond the scope of the IRS report, but studying the fine print of annual 10-K reports that companies file with the Securities and Exchange Commission yields some answers.

By far the biggest beneficiary was Pfizer. As soon as President Bush laid down his signing pen the drug maker brought home $37 billion of untaxed offshore profits. It saved $11 billion in taxes, roughly one out of every $7 saved by all 843 corporations.

Many of those profits were offshore because of earlier tax tricks. When Pfizer scientists saw promise in a new drug, like a bloodstream medication (later named Viagra) that had an unanticipated effect on male staffers, the company sold the rights to the drug to itself in a foreign jurisdiction. A drug in early stages of development has only a small value, so the price to transfer intellectual property offshore from one pocket of a company to another is small.

When Pfizer brought Viagra to market in 1998, each one of the little blue pills it sold came with a royalty to be paid to the offshore subsidiary that had acquired the rights to the formula. Pfizer listed those payments as an expense on its American corporate tax return, lowering its taxes in America as it piled up tax-free profits offshore. The 2004 American Jobs Creation Act let Pfizer bring those profits and more home at an 85 percent discount with the promise that this would mean more jobs and more research, which is vital to job growth.

So how many jobs did Pfizer create, thanks to the American Jobs
Creation Act? Well, actually, zero. Not one. In fact, Pfizer closed whole factories and fired more than a third of its employees. At the end of 2004 Pfizer employed 115,000 people, but by 2009 the workforce was down to 74,000. So a tax break that was supposed to create jobs instead was followed by the destruction of 41,000 at just one company.