What it said was:
Amounts received from the assignment or release by an employee, after more than 20 years' employment, of all his rights to receive, after termination of his employment and for a period of not less than 5 years (or for a period ending with his death), a percentage of future profits or receipts of his employer shall be considered an amount received from the sale or exchange of a capital asset held for more than 6 months if (1) Such rights were included in the terms of the employmerit of such employee for not less than 12 years, (2) Such rights were included in the terms of the employment of such employee before the date of enactment of this title, and (3) the total of the amounts received for such assignment or release is received in one taxable yeaer and after the termination of such employment.
Amounts received from the assignment or release by an employee, after more than 20 years' employment, of all his rights to receive, after termination of his employment and for a period of not less than 5 years (or for a period ending with his death), a percentage of future profits or receipts of his employer shall be considered an amount received from the sale or exchange of a capital asset held for more than 6 months if (1) Such rights were included in the terms of the employmerit of such employee for not less than 12 years, (2) Such rights were included in the terms of the employment of such employee before the date of enactment of this title, and (3) the total of the amounts received for such assignment or release is received in one taxable yeaer and after the termination of such employment.
Lundberg - The-Rich-and-the-Super-Rich-by-Ferdinand-Lundberg
S.
Rosensteil of Schenley Industries made $1,267,000, 2-1/4 times regular salary; and W.
R.
Stevens of Arkansas-Louisiana Gas Company got option benefits ten times regular salary.
It would take a separate book to list all such option benefits.
As salaries are taxed at standard graduated rates, it is only natural for corporate officials to prefer compensation in some untaxed or low-taxed form.
But the potential gain of outstanding options, as yet unexercised, is tremendous. For U. S. Steel executives it was recently $136 million, for Ford Motor executives $109 million and for Alcoa officials $164 million. 39
There are various arguments on behalf of the option system, all of which fall apart under analysis. 40
One is that the options attract and hold high-powered executives. But one firm gave more than half its optional stock to nine executives averaging more than sixty years of age and thirty-five years of service.
Watson of IBM at the time of his option purchase already held more than $40 million of the stock, which he had largely inherited. Would he have left the company without the option allotment? Was the option necessary to make him feel a proprietary interest?
Actually, the option scheme was only a method of passing to him a large bundle of additional no-tax or low-tax money.
Another argument is that the options enable companies to compete for executive talent. But as more and more companies come to have option plans no competitive advantage actually accrues.
A third argument is that executives with a big option stock interest will make the company boom. But, as Stern shows, even as a company's position is deteriorating, its stock often rises sharply in price under buying in speculation on a recovery, enabling officials to cash in on options. In a comparison between the performance of companies with and without option plans, more companies without option plans did well than companies with option plans. 41
Still another argument is that the option plan enables officials to become stockholders and thus have a strong personal interest in the company. But many officials sell out their option stock as quickly as they can and in fact hold no continuing ownership in the company. They are simply profit-hungry.
It is further contended that the options make company officials work harder to make a good showing. But there have been cases, as with Alcoa, where the stock has moved down in price and the option price has thereupon been moved down. The option plan has often worked profitably for insiders whether the stock goes down or the company deteriorates.
Again, it has been charged that company officials, in order to kite the price of the stock in the market and thus make possible an option "killing," have reduced necessary company outlays in order to show misleadingly high and entirely temporary profits.
Objections to the option schemes, particularly to their tax shelter, far outweigh any alleged public advantages, as one can see by reading Mr. Stern's analysis. The option schemes are simply a method of passing tax-free or low-tax money into favored hands and are often voted into effect by their own direct beneficiaries. But they always dilute the equity, reduce it, of nonparticipating stockholders. When an option plan is introduced into a company the book value of all nonparticipating stock is shaved or clipped, much as gold and silver coins used to be clipped by money dealers before governments introduced the milled edge.
In some cases minority groups of stockholders have successfully gone to court to have option plans of big companies either set aside or modified. This has been done in American Tobacco, Bethlehem Steel and General Motors, among others. A General Motors option plan in one instance was set aside by court order on grounds of fraud. 42 But most small stockholders cannot afford to go to court and many big stockholders go along with the option plan on the ground that if officials were not able to chisel in this way they would find some other arcane and possibly more subversive way of nibbling into the property.
As, in theory, a purely money-oriented person, a top big-corporation official is by definition pretty much of a tiger. The stockholder wants him to be a fierce hunting tiger vis-a`-vis the world in general but a tame tiger toward his masters. Yet a tiger, as many
cases in corporate history show, has a strong tendency to direct himself toward the fattest and nearest carcass, the company itself. The option scheme partly deflects this purely theoretical tiger by giving him at least a piece now and then of this rich carcass which he is supposed to guard and enhance.
Well paid, the top company official is supposed to be a faithful servant, dedicating himself to his master. But history knows of many cases of well-paid servants who for their own profit undercut their master's interest. Companies in the corporate jungle have been looted by psalm-singing, God-fearing paid officials.
Options, among other things, are held to be cheaper for corporations, although not for stockholders, than straight bonuses. On this point one must disagree with Mr. Stern, who believes that the corporation pays some tax. Whatever a corporation pays out in cash bonus is so much paid out of net return or added on to price; it is not merely an additional cost of operation reducing a true taxable income. On a stock option the corporation has no out-of-pocket expense at all. But while not costly to the corporation, the stock option is costly over the long term to the nonparticipating stockholders.
Something to notice about the stock option is that it is one of the valuable perquisites of company control. Earlier it was noted that control of a company may be exercised with from 5 to 100 per cent ownership. Whatever the percentage of ownership, control is control. The bigger the ownership stake, of course, the more is the retention of control assured. But a 5 per cent control is as effective as 100 per cent.
Among the advantages of controlling a company are these: (1) Dividend payout rates may be determined, and for large stockholders the smaller the payout rate and the larger the tax-free reinvestment rate the richer they become by evading taxes on dividends. (2) Cut-rate stock-option plans may be adopted, with the controllers participating and, indeed, increasing their degree of control by diluting the equity of nonparticipants. (3) In making outside investments with company money, properties personally acquired for song can be unloaded on the big company at a high price, thereby making concentrated personal profit but spreading the inflated price among many other persons. (4) Personally beneficial expense-account features can be arranged such as renting a tax- deductible permanent luxury suite in some tropical hotel which, when not used for allowable business purposes, may be used for extracurricular pleasures. (5) Relatives to whose support one might be expected to contribute may be placed on the payroll, often at a substantial figure, thus allowing others and the public to pay for their support. And this is only the beginning.
Control, of and by itself, is valuable because it is a means of directing tax-favored revenues toward oneself.
Depletion and Depreciation Allowances
We have not yet touched upon some of the more spectacular congressionally sanctioned large-scale special tax dispensations.
One of these is the oil depletion allowance. And at the outset it must be made clear that this depletion allowance applies to far more than oil. While it began with oil it now includes all the products of the earth except, as Congress finally stipulated, "soil, sod, dirt, turf, water, mosses, minerals from sea water, the air or similar inexhaustible sources. " But it does include farm crops, trees, grass, coal, sand and gravel, oyster shells and clam shells, clay and, in fact, every mineral and naturally occurring chemical or fiber on land.
The percentage depletion, according to the Supreme Court, is an "arbitrary" allowance that "bears little relationship to the capital investment" and is available "though no money was actually invested. " 43
But as more than 80 per cent of depletion benefits accrue to the oil and natural gas industries, the discussion can be confined to them.
Dating back to 1919 but with many tax-evading embellishments added since then, the depletion scheme works as follows:
1. The original investment by a company or individual in drilling a well--and under modern discovery methods three out of five wells drilled are producers--is wholly written off as an expense, thereby reducing an individual's or corporation's tax on other operations toward zero. Investment in oil drilling, in other words, offsets other taxable income. If an ordinary man had this privilege, then every dollar he deposited in a savings account would be tax deductible. The law permits, in short, a lucrative long- term investment to be treated as a current business expense.
2. As this was an investment in the well there is to be considered another outlay, or development cost, for the oil that is in the well. This cost is purely imaginary, as the only outlay was in drilling the well, but it is nevertheless fully deductible.
3. There remains a continuing, recurrent deduction, year after year, for making no additional investment at all!
The way these steps are achieved is through a deduction of 27-1/2 per cent (the figure was arrived at in 1926 as a compromise between a proposed arbitrary 25 per cent and an equally arbitrary 30 per cent) of the gross income from the well but not exceeding 50 per cent of its net income. If after all expenses, real and imaginary, a well owned by a corporation has a net income of $1 million, the depletion allowance can halve its ordinary liability to a corporation tax and it may maintain prices as though a full tax was paid. Through controlled production of some wells as against others, the tax rate can be reduced still further so that leading oil companies can and have paid as little as 4. 1 per cent tax on their net earnings. 44 Some pay no tax at all although earnings are large. Oil prices are "administered" by the companies; they are noncompetitive.
As Eisenstein sets forth this triple deduction, "For every $5 million deducted by the oil and gas industry in 1946 as percentage depletion, another $4 million was deducted as development costs. For every $3 million deducted as percentage depletion in 1947, another $2 million was deducted as developmerit costs. 45 The process continues, year after year, through the life of the well. Income often finally exceeds investment by many thousands of times.
A widowed charwoman with a child, taking the standard deduction which leaves her with $1,500 of taxable income pays taxes at a much higher rate, 14 to 16 per cent, than do many big oil companies and oil multimillionaires in the great land of the free and the home of the brave.
This depletion deduction "continues as long as production continues, though they may have recovered their investment many times over. The larger the profit, the larger the deduction. " 46
"For an individual in the top bracket, the expenses may be written off at 91 per cent while the income is taxable at 45. 5 per cent. For a corporation the expenses may be written off at 52 per cent while the income is taxable at 26 per cent. " 47 A company may work this percentage a good deal lower and even to nothing.
We have noted that the Supreme Court has called the depletion allowance "arbitrary"-- that is, as having no basis whatever in reason. Eisenstein examines in detail all the excuses given for permitting the depletion and in detail shows them all to be without a shadow of merit. Instead of reproducing any of his analysis here, I refer the interested reader to his book. The depletion allowance is a plain gouge of the public for the benefit
of a few ultra-greedy overreachers and is plainly the result of a continuing political conspiracy centered in the United States Congress.
What it costs the general public will be left until later.
Even more sweeping results are obtained by means of legally provided accelerated depreciation, long useful in real estate and under the Kennedy tax laws applicable up to 7 per cent annually for all new corporate investments. In brief, whatever a corporation invests in new plant out of its undistributed profits it may take, up to 7 per cent of the investment, and treat it as a deductible item. On an investment of $100 million this would amount to $7 million annually.
Because Stern traces, step by step, the process by which accelerated depreciation operates in the real estate field to eliminate taxes entirely the reader is referred to his book. 48
But the results in real estate alone, as related by Stern, are as follows:
In 1960, the following events occurred:
--Eight New York real estate corporations amassed a total of $18,766,200 in cash available for distribution to their shareholders. They paid not one penny of income tax.
--When this $18,766,200 was distributed, few of their shareholders paid even a penny of income tax on it.
--Despite this cash accumulation of nearly $19 million, these eight companies were able to report to Internal Revenue losses, for tax purposes, totaling $3,186,269.
--One of these companies alone, the Kratter Realty Corporation, had available cash of $5,160,372, distributed virtually all of this to its shareholders--and yet paid no tax. In fact, it reported a loss, for tax purposes, of $1,762,240. Few, if any of their shareholders paid any income tax on the more than $5 million distributed to them by the Kratter Corporation. 49
All of this was perfectly legal, with the blessing of Congress.
According to a survey by the Treasury Department, eleven new real estate corporations had net cash available for distribution in the amount of $26,672,804, of which only $936,425 or 3. 5 per cent was taxable. 50
The Great Game of Capital Gains
Capital gains are taxed, as we have noted, at a maximum of 25 per cent, although this rate is lowered corresponding to any lower actual tax bracket; but up to and including people in the highest tax brackets the rate is only 25 per cent. Thus, capital gains are a tax-favored way of obtaining additional income by the small number of people in the upper tax brackets.
Something to observe is that 69 per cent of capital gains go to 8. 7 per cent of taxpayers in the income group of $10,000 and up; 35 per cent go to the 0. 2 per cent of taxpayers in the income group of $50,000 and up. 51 The cut-rate capital gains tax, like many of these other taxes, is therefore obviously tailored to suit upper income groups only.
The total of capital gains reported to Internal Revenue for 1961, for example, was $8. 16 billion. Of this amount $465 million of gains were in the $1 million and upward income group; $1. 044 billion in the $200,000 to $1 million income group; $1. 63 billion in the $50,000-$200,000 income group; $1. 6 billion in the $20,000-$50,000 income group; and $1. 3 billion in the $10,000-$20,000 income group. Only $2 billion was in the less than $10,000 income group. 52 It is, plainly, people in the upper income classes who most use this way of garnering extra money.
What is involved in ordinary capital gains is capital assets--mainly stocks and real estate.
The theory behind the low-tax capital gain is that risk money for developing the economy is put to work. If the capital gains tax were applied for a limited period, say, to new enterprises, giving new employment, the theory might be defensible. But, as it is, it applies to any kind of capital asset, to seasoned securities or to very old real estate. Most capital gain ventures start nothing new.
There is some risk in buying any security, even AT&T. The risk here is that it may go down somewhat in price for a certain period; but there is absolutely no risk that the enterprise will go out of business. The theory on which the capital gains tax discount is based is that there is total risk; yet most capital gains are taken in connection with basically riskless properties. There would be some risk attached to buying the Empire State Building for $1; one might lose the dollar in the event a revolutionary government confiscated the property. But the amount of risk attached to paying a full going market price for the building is in practice only marginal. One might conceivably lose 10 per cent of one's money if one sold at an inopportune time. But one would not risk being wiped out.
In real estate, capital gains serve as the icing on a cake already rich with fictitious depreciation deductions. Depreciation is supposed to extend over the life of a property. Yet excessively depreciated properties continue to sell at much higher than original prices. When so much capital value is left after excessive depreciation has been taken, there must be something wrong with the depreciation schedule. What is wrong with it is that it is granted as an arbitrary and socially unwarranted tax gift to big operators. It is pure gravy.
Depreciation for tax purposes in real estate is taken at a much more rapid rate than is allowed even by mortgage-lending institutions.
First, a certain arbitrary life is set for a building, say, twenty-five years. But a bank will usually issue a mortgage for a much longer term. On such a new building in the first year a double depreciation--8 per cent--may be taken, but on an old building with a new owner a depreciation rate of one and a half may be taken in the first year. The depreciation taken in the first year and subsequently generally greatly exceeds the net income, leaving this taxless. The depreciation offsets income. For a person in high tax brackets it is, naturally, advantageous to have such tax-free income.
In a case cited of a new $5 million building the tax savings to an 81-percent bracket man amounted to nearly $1 million in five years.
The book value of this building, by reason of accelerated depreciation deductions of nearly $1. 7 million, was now $3. 3 million. The owner was offered $5 million for the building, the original cost. He decided to accept this offer. The tax deductions he had already taken had saved him 81 cents on the dollar and the tax rate he would get on his "book profit" would cost him only 25 cents on the dollar. The seller's net tax gain was $942,422. 78. 53
The new owner of the building could resume the depreciation cycle again on the basis of the $5 million cost and the old owner could go and start the process again with some other building. Real estate operators repeat this process endlessly. Many buildings in their lifetime have been depreciated many times their value. Best of all, the land remains.
Depreciation charges, deducted from before-tax profits, are an increasingly important way of concealing true earnings, as the Wall Street Journal notes (August 29, 1967; 18:3-4). "These funds don't show up as profits in corporate earnings reports, but are regarded by many investors as being nearly as good as profits . . . such funds can be put
into new facilities that eventually may bring bigger sales, earnings and dividends for stockholders.
"At no time during the 1948-57 period did depreciation funds amount to more than 80 cents for each dollar of after-tax earnings, Government records show," the Journal said. "In some of the earlier years, in fact, depreciation cash came to less than 40 cents per dollar of earnings. But in 1958--the year that the price-earnings ratio climbed so sharply--depreciation for the first time in the post-World War II era approximately equaled the after-tax earnings total. Through the Sixties, depreciation funds remained relatively high, so that for every dollar of corporate earnings there was nearly another dollar of cash for expansion programs or other such programs. "
Depreciation, in brief, amounts to a second line of profit, not acknowledged as such and now approximately equaling the acknowledged profit.
While this tax-deductible depreciation feature is not present with the purchase of stocks, the leverage of a loan at interest, as in the case of the real estate mortgage, is often present. For at least half the purchase price of the stock may be financed with a broker's loan at the standard rate of annual interest. The percentage of profit in relation to the input of investment becomes very great.
If 1,000 shares of stock are purchased at $50 a share, with a bank supplying half the money, the investor's share is $25,000. The interest he pays on the $25,000 of bank money is itself deductible. If the stock in six months doubles in value and is sold, the price realized is $100,000. As the bank loan is paid off and the initial investment is recovered there remains a profit of $50,000 or 200 per cent. On this there will be paid a capital gains tax of $12,500, leaving the profit after taxes at 150 per cent (or 300 per cent at a yearly rate).
It isn't usual that a stock doubles in value in six months, but many have done so. A post-tax profit of 150 per cent in as much as five years will amount to 30 per cent tax- free per year, which is not in itself a poor return. Compared with 5 per cent from a bank or a high-grade bond, which is taxable, it is an excellent return, making chumps out of most ordinarily thrifty citizens.
Whether the owner is using only his own money or is borrowing some, he is obtaining a tremendous tax advantage over the ordinary citizen.
Individual Tax Bills
A completely different sort of tax privilege, far less widely known and not even suspected by most persons, is gained by having one's Congress pass a special bill giving one special tax exemptions. Many such special bills are enacted, all reading as though they applied in general.
Actually, when they are incorporated after secret committee sessions into the tax laws the experts in the Treasury Department have no inkling of what they may mean. In order to ascertain their meaning they must wait until a certain return comes in, citing the relevant section of the law as authority for some unusual step being taken. Then it is seen, in a flash, that the return fits the law as neatly as a missing piece fits into a jigsaw puzzle.
One such case among many described by both Eisenstein and Stern concerned Louis B. Mayer, the movie mogul. The experts in the Treasury Department were mystified upon first reading Section 1240 of the Internal Revenue Code of 1954, written in the customary opaque tax language. They had not the remotest idea of what it meant.
What it said was:
Amounts received from the assignment or release by an employee, after more than 20 years' employment, of all his rights to receive, after termination of his employment and for a period of not less than 5 years (or for a period ending with his death), a percentage of future profits or receipts of his employer shall be considered an amount received from the sale or exchange of a capital asset held for more than 6 months if (1) Such rights were included in the terms of the employmerit of such employee for not less than 12 years, (2) Such rights were included in the terms of the employment of such employee before the date of enactment of this title, and (3) the total of the amounts received for such assignment or release is received in one taxable yeaer and after the termination of such employment.
Stern supplies a translation into English of this paragraph in its generality. But what it meant specifically was the following: Louis B. Mayer, and only Louis B. Mayer, may receive all future profits in the company to which he will be entitled after retirement in one lump sum and this lump sum will be taxed at 25 per cent as a capital gain even if it is not in any sense a capital gain.
Had Mr. Mayer received these profits after retirement as they were generated he would have had to pay maximum taxes on them each year. The special bill for his benefit-- Section 1240--gave him $2 million of pin money. 54
How did it come to be enacted? His attorney was Ellsworth C. Alvord, who appeared before the Senate Finance Committee not as Mr. Mayer's lawyer but as a spokesman for the United States Chamber of Commerce. And the section was so drawn as to be of no use to anyone else, although since then other measures have been passed that enable certain large lump-sum settlements of pension or income rights to be treated as capital gains.
A ludicrous sidelight of this and other tax sections is that the states sometimes copy the federal tax laws, as California copied the tax law of 1954. But much of what they copy has no possible applicability to any tax situation that may arise because some sections are specially tailored to a single situation. Sub-section 2 of Section 1240, which reads "such rights were included in the terms of the employment of such employee before the date of enactment of this title" made it applicable only to Mr. Mayer, who alone had such particular terms before the passage of the bill. Unless one can show one had a contract containing such provisions before the passage of the bill one cannot cite the section on one's tax return.
It should never be thought that the leaders of Congress do not know what they are doing.
Many such special sections exist in the tax laws. of benefit only to a single individual or estate (one-shotters) or of continual benefit to certain industries; and Stern discusses a number of them. To obtain such special tax sections for oneself one must, obviously, have a "friend at court," somebody who has the king's ear.
Many companies get such special tax laws, of benefit only to them; and otherwise illegal gains from mergers of various corporations or banks are covered either by one- shot or multiple-shot laws. Sometimes one company is able to squeeze itself into provisions especially tailored for another, but not often. 55
Low Estate Taxes
Not much will be said here about estate taxes other than to point out that entirely illusory rates are posted here as elsewhere. Many very rich men's estates pay little or no tax. The public supposition that the big estates are being dismantled by estate taxes, often repeated in newspapers, is entirely false.
According to the rate schedule in the law, estates exceeding $60,000 are now taxed from 3 per cent for the first $50,000 to 77 per cent for amounts over $10 million. Offhand, one might suppose that a man who left $100 million net would pay a tax of
$67,566,150. But no taxes like this are ever paid and, as we noted earlier, John D. Rockefeller Sr. and Jr. and Henry Ford I paid low estate taxes.
Some persons, below the top levels of wealth, do indeed pay full estate taxes. But this is because they have either through personal peculiarity or unusual moral standards refused to seek and follow the advice of an experienced tax lawyer. Usually it is a personal peculiarity that leads them in this direction, according to what lawyers say. They are unable to understand the steps outlined for them to take or fear they are in danger of losing something.
An anecdote of record about the late Somerset Maugham, the well-known and affluent writer, will illustrate the point. It was explained to Maugham that if he took certain steps to divest himself of nominal control over his assets for the benefit of his children, with whom he was not on good terms as such are generally understood, his estate under English law would almost entirely escape taxes.
"I won't do it," Maugham said as the situation was explained, "because I am too aware of what happened to King Lear. "
It is mainly, among the law-cognizant, persons with a strong feeling of alienation who do not avail themselves of the many profitable loopholes in the estate-tax law. Henry Ford, it appears, was one such, and only the last-minute recourse to the Ford Foundation saved control of the company for his family. Ford was obviously either a tenaciously grasping person, indifferent to his family, or simply could not understand the ins and outs of the law, which one assumes were thoroughly explained to him by able lawyers. We know he did not want the government to get his money.
Ford, of course, did not have the advantage of the marital deduction, which was passed the year after his death. Had it been in existence a half of about a billion dollars would have been, right off, tax free. As matters now stand, one half of the taxable value of all estates where there is a surviving spouse is tax exempt.
A $100 million net estate, instead of paying $67,566,150 under the posted rates, therefore seemingly pays only $32,566,150. This is quite a bit but it isn't anything like the posted 70 per cent; it is 32. 5 per cent.
Even this 32. 5 per cent is illusory under the various leveraging amendments to the estate-tax law and, to make a long story short, we may simply show in this table what the real against the posted rates are: 56
Gross Estate
(approximate)
$500,000-$1 million
$1-$2 million
$2-$3 million
$3-$5 million
$5-$10 million
$10-$20 million
$20 million and higher
Scheduled
Rates
(Per Cent)
29-33
33-38
38-42
42-49
49-61
61-69
69-77
Actual Average
Tax (1958)
(Per Cent)
15. 3
18. 2
19. 3
21. 2
23. 2
24. 4
15. 7
Percentage
of Discount
50 50 50+ 50+
50-60 60+
80+
One may obtain the actual rate for any year by averaging the actual payments in each bracket as reported by the Treasury Department. From year to year the actual rates vary slightly.
So, when one reads in a newspaper about high estate taxes one is reading something untrue. The maximum actual estate tax by percentage is about the same as the income tax on an individual $10,000-$20,000 income.
Similar low actual rates prevail on large incomes as shown by the Chase Manhattan Bank in 1960 in its bimonthly news letter, as follows:
Adjusted Gross
Income
Under $3,000
$ 10,000-$ 14,999
$ 20,000-$ 24,999
$50,000-$ 99,999
$200,000-$499,999
$1,000,000 and up
Scheduled Rates
(Per Cent)
20
25
36
55
80
87
Percentage
Actual Rates of
But a man with a family will not ordinarily pay anything even like the actual rates on a $100 million estate. For, being sensible and knowing that he must some day die, he has long before death begun transferring assets to his wife and children. Let us suppose he has two children.
He can transfer $100,000 a year to each of them at a gift-tax cost of $15,525 each or 15. 5 per cent, with the sums held in trust. In thirty years $9 million will have been transferred. He can make his own law firm trustees.
He can transfer an equal amount, at once or gradually, to his family-controlled foundation, entirely tax free up to 30 per cent of annual income.
He can increase his transfers at slightly higher gift-tax rates. Whatever he transfers brings the actual estate tax lower.
But he can do even better than this. He can transfer to members of his family, at extremely low gift-tax rates, properties of grossly understated value whose true value he alone knows. Such, let us say, would be mineral-bearing but unexploited lands, since privately surveyed and "proven. " If such land had been acquired at $100,000 it could be transferred for purely nominal taxes, and this big asset would be in the hands of his heirs long before his death. Times of downswings in the market, as during the Depression, are a good time to make corporate gifts. Overdepreciated real estate or foreign property, with a low book value but a high actual value, is another good thing to transfer by gift. The heirs can sell it at full value without paying any capital gains tax.
At no stage need he lose practical control over any of his properties, leaving aside his moral authority over his family. Many of those who do not avail themselves of these provisions apparently feel they have no moral authority over their heirs or believe their heirs will take these properties and leave them in the lurch, as Mr. Maugham publicly feared. While such a possibility, may exist in some families, even it can be guarded against by a knowledgeable tax lawyer.
The value of wives here is again outstanding, as in the case of the marital deduction in the upper brackets.
It might be asked what value it is to a man that half his estate escapes any taxes if his wife gets that money. But the first advantage is that she halves the tax. He must be interested in this feature because he could avoid all taxes by simply leaving all the money to the public in some form. As he usually doesn't do this, one must conclude that he is interested in preserving the fortune for some reason.
What he leaves to his wife can be left in a life trust, he naming the ultimate beneficiary but giving her the right to change this. By doing this he has clearly reduced the taxable amount by one half. His children ultimately take from the mother's estate, so at least two-thirds of the fortune is preserved. But much better than this can be done by means
(Per Cent)
Discount
19 5
20 20
23 35+	
38 33+
42 48
38 57. 5
of lifetime distributions in the form of trusts and by taking advantage of other provisions in the fine print of the law.
And through the use of trusts, assets can be kept intact for at least three generations. The dead man can assert his will for at least 100 years. If the final recipients, having full control over the property, now replace it in trust according to family doctrine, the holdings can be preserved in trust for another three generations. If it is a series of multiple trusts that have been established, the tax rates can be very, very low.
While the Constitution forbids the entailment of property as in England it is nevertheless practically possible to practice serial entailment, as Cleveland Amory reports many of the old Boston families have done. Serial entailment is achieved if the third-generation recipient, loyal to family teaching, replaces the property in trusts.
Estates, in fact, are not broken up by the tax laws; they grow larger through the generations, assuring the presence of an hereditary propertied class. This fact has many implications, one of which is that latecomers in the game of grabbing property face a shrunken hunting ground.
The whole point is this: Plenty of escape hatches exist in the estate-tax law for those who wish to avail themselves of them. Some, like Henry Ford, do not, and prefer to clutch nearly every last dime they own until the undertaker forces open their hands. For the heirs of such, the tax outlook is rather bleak, although by no means so hopeless as often reported. There is always the foundation escape hatch, and the foundation, all else failing, can give remunerative employment to members of the family, who become philanthropols or, somewhat paradoxically, philanthropist-politicians.
In summary, it should be noticed that the rich, who contrary to Ernest Hemingway are different in other respects than that they simply have more money, live in a specially favored tax preserve which could not have taken form without considerable elitist prompting. Congress alone would not have had the Kafka-esque imagination to devise this labyrinth of fiscal illusion. The public itself did not demand these tax laws.
All deductions and exemptions available to rank-and-file taxpayers in trifling amounts, as we have seen, have far greater weight when applied to the receivers of big incomes from property and its manipulation. Deductions for wives, children, general dependents, education, medicine and social investment have an in-pocket value up to the maximum of the tax rates for the rich. Beyond this are all the special tax dispensations provided especially for big property holders: accelerated depreciation, depletion allowances, expense accounts, low-tax capital gains, specially tailored exemptions, mortgage and interest leverages, tax-exempt bonds, multiple trust funds, light estate taxes, family partnerships, low-tax lump sum settlements of a large variety of fictitious capital gains, etc.
It is very evident that, as government expense has gone up attendant upon fighting corporately profitable wars, the rich have decided to play very little part in defraying it.
Results such as those depicted could have been attained only as the consequence of much elitist work, thought and conniving. Can anyone believe the results are accidental? Or that they are remotely equitable?
Taxpayer Terrorization
While the tax rates gouge the general populace, the Internal Revenue Service in recent years, by all accounts, has been conducting a highhanded reign of terror against small delinquent taxpayers, often confused by the crazy-quilt tax forms. "Tax disputes more than any other have given many harassed citizens a glimpse of the other face of Uncle Sam when he scowls," writes Washington political columnist Jack Anderson. The face
of Uncle Sam that many citizens now see closely resembles the skinflint depicted by hostile foreign cartoonists.
While making advantageous settlements with delinquent large taxpayers, says Anderson, "the government was relentlessly pursuing a host of small tax debtors, poor but loyal Americans, many of whom were in debt for reasons beyond their control. Uncle Sam garnisheed their wages, seized their property, confiscated their bank accounts, and deprived them of their jobs, stripping them of almost everything they possessed except the mere clothes on their backs. . . . More than one hard-pressed taxpayer has found himself in trouble because of a trivial or unintentional error in an old return, the failure of an employer to withhold the correct tax, or a personal tragedy that cleaned him out of the money he set aside for Uncle Sam. The files at Internal Revenue are stuffed with complaints from taxpayers who say they have been hounded, bullied, and browbeaten by collectors whose methods would put a loan shark to shame. Many a widow's last mite has been snatched from her. Men have been stripped of their livelihood and, along with it, their only means of paying the government. "
A committee of twenty-two tax lawyers and accountants appointed by Chairman Wilbur Mills of the House Ways and Means Committee found many acts of "overzealousness" by tax agents that infringed "the vital rights and dignities of individuals. " 57
If a taxpayer subjected to arbitrary Internal Revenue rulings is affluent enough to be able to hire a lawyer he on the average, in appeals, has 85 per cent of the tax assessments sharply reduced or eliminated.
"Only a small percentage of individuals whose deductions are disallowed, whether right or wrong, do use existing systems to challenge IRS auditors," writes William Surface. "Why not? 'The small taxpayer's first and usually last impulse is to quit,' says Senator Warren Magnuson of Washington. 'Just throw in the towel, pay the deficiency, no matter how unjust he believes it is, rather than face the tiers of faceless bureaucracy. The small taxpayer is faced with staggering disadvantages in his dealings with the Federal Government in comparison with large, corporate taxpayers. '"
The bigger taxpayers proceed otherwise. About 10 per cent of those assessed additional taxes request an "informal conference" with the auditor's supervisor, and about half of those who do this win some concession. In 1965 a total of 26,301 corporations and individuals who were assessed additional taxes, or 1 per cent, appealed their cases to the Appellate Division, an autonomous body. No less than 85 per cent of the cases so appealed each year have their cases settled for about $200 million a year less than what IRS originally assessed. Beyond this there is the Tax Court, where an average of 8,500 appeals from IRS rulings are heard each year. "Four out of five cases that reach Tax Court are settled without trial for only 31 per cent of the amount that Internal Revenue had initially demanded. " 58
On this showing, IRS is clearly overzealous in many cases, and most people readily knuckle under in fear of being suddenly confronted, apparently, by an unbenign Uncle Sam. Anderson, Surface and various congressmen blame it on petty bureaucrats in IRS, with which judgment I emphatically disagree. IRS people are civil service employees, all of them small people. They only follow instructions from higher up. They act only in response to orders passed down along a chain of command from the White House and the Secretary of the Treasury. When they get very tough and arbitrary it is because they feel their jobs are in jeopardy if they do not make a good showing.
It is true that underlings in all large organizations, governmental and corporate, often tend to be overzealous in carrying out very mild orders, thus giving the organization
eventually a bad name. Mild orders from on high tend to gain strength as they are passed down, and at their point of final execution are often brutal.
At times, with the approval of higher-ups, the Internal Revenue Service acts illegally. The Commissioner of Internal Revenue has admitted that for seven years, from July, 1958, to July, 1965, agents had made "improper" or questionable" use of electronic eavesdropping devices on 281 occasions. The information was elicited by the Senate judiciary Committee. One senator charged that electronic devices were used "during routine investigations of ordinary taxpayers"; the charge was denied. Planting of such devices by means of trespass, the Supreme Court ruled in 1961, is unconstitutional (illegal), violates the prohibition against unreasonable search and seizure, invalidating evidence so obtained. 59
Whereas the Bourbons, drunk with power, proceeded forcibly against the peasants en masse to collect unfair taxes, in modern states, including the United States, the full force of sovereignty is brought to bear against single individuals. Intimidated in advance by any sort of authority, the ordinary citizen here is in no position, even under constitutional government, to invoke his rights. He does what many intimidated innocent people do in the courts: He pleads guilty to a lesser charge.
General Remarks
What has been put down so far represents only part of the story of shoving the tax burden onto the patriotic labor force by the finpols and corp-pols with the consent of the pubpols, who in turn thoughtfully misapply (OverKill) at least 30 per cent of the tax money they do take in. This percentage of profitable misappropriation, largely on the excuse of "defense," more recently of "welfare," is put very conservatively; a thorough direct examination of what is obtained by the expenditures would probably show a larger percentage.
A careful comparison of the fiscal situations in the United States and eighteenth- century France, which was under candid autocratic rule, shows that the American populace is being short-changed far more efficiently than was the French populace under Bourbon rule. Indeed, the American process is more effective because most of the people are not even aware they are being trimmed under the twin banners of anti- Communism and anti-Poverty; most rank and file citizens would be the first to deny it vehemently while bursting into strains of Yankee Doodle. The French were fully aware of the process because many of their taxes were collected by force, often after pitched battles between the peasants and the troops. The American process of making the labor force shoulder most of the tax burden takes place in much subtler ways, behind the formidable barriers of deceptive language, high-flown ideology, simple arithmetic and the full panoply of sovereignty arrayed against isolated individuals.
In this atmosphere the withholding tax, levying on earned income before received, was nothing short of a pubpolic political inspiration.
The General Results
What is not paid by the higher-ups must be paid by the rank-and-file. The government, despite all the tax loopholes, is never deprived of whatever revenue it says it needs, even for waging fierce undeclared wars of its own bureaucratic making. What revenue the government decides not to take from the influential finpols it must take from the poor and needy over which the pubpols weep and wail like the Walrus and the Carpenter did over the happy trusting oysters they had eaten.
Stern has reported various shrinkages in the tax base and the attendant cost to the Treasury (which cost must be made up by the patriotic rank and file). 60
Here these various shrinkages and costs are presented somewhat differently: first, those shrinkages and costs of advantage solely to the wealthy; secondly, those shrinkages and costs participated in and preponderantly of advantage to the wealthy; and, thirdly, those shrinkages and costs generally of advantage only to rank-and-filers.
Lump-Sum Tax Evasions of the Wealthy Only
Shrinkage of Cost to
dollars)
Lump-Sum Tax Evasions in Which the Wealthy
Participate with the Less Wealthy Middle Classes
Shrinkage of Cost to
Tax Base Treasury
(billion dollars) (billion
Extra exemptions for the aged and
blind (most of these deductions per
centagewise and in totality must go
to those few with substantial income
--the higher the income the greater
the deduction)
Nontaxable income from social secur-
ity, unemployment and veterans'
benefits, etc. (except for unemploy
ment benefits, the wealthy partici-
pate to some extent)
$ 3. 2
11. 9
$ . 9
3. 6
2. 0 11. 9
5. 0 $23. 4
Cost to
Tax Base Treasury
(billion dollars) (billion dollars)
Depletion deductions
intangible oil and gas
drilling deductions
Excessive expense account
Deductions
Real estate depreciation
Dividend credits
Capital gains deductions
Estate tax evasions
Interest on tax-free bonds
Undistributed corporate profit* 25. 6 (1965)	12. 8 (est. )
Totals $49. 8 $22. 1
*Stern does not include this significant item.
The wealthier class of taxpayers, in brief, fails to pay $22. 1 billion of taxes which it might properly pay. Nor is this all, because it participates in tax loopholes available to others.
Rent equivalent (deducted mortgage
interest, etc. ) on owned homes
(greatest advantage to wealthy as
residents and as real estate opera-
tors) 6. 5
Itemized deductions (most profitably
used by wealthy) 43. 0
Income-splitting for married people
(of most percentage and dollar
value for wealthy persons)
Totals $64. 6
Lump-Sum Tax Dodges in Which the Wealthy
Probably Have Little Participation
Shrinkage of
$ 3. 7
$ 1. 5 . 5 . 3
. 2
6. 0 12. 5 2. 0
. 5 2. 4 2.
As salaries are taxed at standard graduated rates, it is only natural for corporate officials to prefer compensation in some untaxed or low-taxed form.
But the potential gain of outstanding options, as yet unexercised, is tremendous. For U. S. Steel executives it was recently $136 million, for Ford Motor executives $109 million and for Alcoa officials $164 million. 39
There are various arguments on behalf of the option system, all of which fall apart under analysis. 40
One is that the options attract and hold high-powered executives. But one firm gave more than half its optional stock to nine executives averaging more than sixty years of age and thirty-five years of service.
Watson of IBM at the time of his option purchase already held more than $40 million of the stock, which he had largely inherited. Would he have left the company without the option allotment? Was the option necessary to make him feel a proprietary interest?
Actually, the option scheme was only a method of passing to him a large bundle of additional no-tax or low-tax money.
Another argument is that the options enable companies to compete for executive talent. But as more and more companies come to have option plans no competitive advantage actually accrues.
A third argument is that executives with a big option stock interest will make the company boom. But, as Stern shows, even as a company's position is deteriorating, its stock often rises sharply in price under buying in speculation on a recovery, enabling officials to cash in on options. In a comparison between the performance of companies with and without option plans, more companies without option plans did well than companies with option plans. 41
Still another argument is that the option plan enables officials to become stockholders and thus have a strong personal interest in the company. But many officials sell out their option stock as quickly as they can and in fact hold no continuing ownership in the company. They are simply profit-hungry.
It is further contended that the options make company officials work harder to make a good showing. But there have been cases, as with Alcoa, where the stock has moved down in price and the option price has thereupon been moved down. The option plan has often worked profitably for insiders whether the stock goes down or the company deteriorates.
Again, it has been charged that company officials, in order to kite the price of the stock in the market and thus make possible an option "killing," have reduced necessary company outlays in order to show misleadingly high and entirely temporary profits.
Objections to the option schemes, particularly to their tax shelter, far outweigh any alleged public advantages, as one can see by reading Mr. Stern's analysis. The option schemes are simply a method of passing tax-free or low-tax money into favored hands and are often voted into effect by their own direct beneficiaries. But they always dilute the equity, reduce it, of nonparticipating stockholders. When an option plan is introduced into a company the book value of all nonparticipating stock is shaved or clipped, much as gold and silver coins used to be clipped by money dealers before governments introduced the milled edge.
In some cases minority groups of stockholders have successfully gone to court to have option plans of big companies either set aside or modified. This has been done in American Tobacco, Bethlehem Steel and General Motors, among others. A General Motors option plan in one instance was set aside by court order on grounds of fraud. 42 But most small stockholders cannot afford to go to court and many big stockholders go along with the option plan on the ground that if officials were not able to chisel in this way they would find some other arcane and possibly more subversive way of nibbling into the property.
As, in theory, a purely money-oriented person, a top big-corporation official is by definition pretty much of a tiger. The stockholder wants him to be a fierce hunting tiger vis-a`-vis the world in general but a tame tiger toward his masters. Yet a tiger, as many
cases in corporate history show, has a strong tendency to direct himself toward the fattest and nearest carcass, the company itself. The option scheme partly deflects this purely theoretical tiger by giving him at least a piece now and then of this rich carcass which he is supposed to guard and enhance.
Well paid, the top company official is supposed to be a faithful servant, dedicating himself to his master. But history knows of many cases of well-paid servants who for their own profit undercut their master's interest. Companies in the corporate jungle have been looted by psalm-singing, God-fearing paid officials.
Options, among other things, are held to be cheaper for corporations, although not for stockholders, than straight bonuses. On this point one must disagree with Mr. Stern, who believes that the corporation pays some tax. Whatever a corporation pays out in cash bonus is so much paid out of net return or added on to price; it is not merely an additional cost of operation reducing a true taxable income. On a stock option the corporation has no out-of-pocket expense at all. But while not costly to the corporation, the stock option is costly over the long term to the nonparticipating stockholders.
Something to notice about the stock option is that it is one of the valuable perquisites of company control. Earlier it was noted that control of a company may be exercised with from 5 to 100 per cent ownership. Whatever the percentage of ownership, control is control. The bigger the ownership stake, of course, the more is the retention of control assured. But a 5 per cent control is as effective as 100 per cent.
Among the advantages of controlling a company are these: (1) Dividend payout rates may be determined, and for large stockholders the smaller the payout rate and the larger the tax-free reinvestment rate the richer they become by evading taxes on dividends. (2) Cut-rate stock-option plans may be adopted, with the controllers participating and, indeed, increasing their degree of control by diluting the equity of nonparticipants. (3) In making outside investments with company money, properties personally acquired for song can be unloaded on the big company at a high price, thereby making concentrated personal profit but spreading the inflated price among many other persons. (4) Personally beneficial expense-account features can be arranged such as renting a tax- deductible permanent luxury suite in some tropical hotel which, when not used for allowable business purposes, may be used for extracurricular pleasures. (5) Relatives to whose support one might be expected to contribute may be placed on the payroll, often at a substantial figure, thus allowing others and the public to pay for their support. And this is only the beginning.
Control, of and by itself, is valuable because it is a means of directing tax-favored revenues toward oneself.
Depletion and Depreciation Allowances
We have not yet touched upon some of the more spectacular congressionally sanctioned large-scale special tax dispensations.
One of these is the oil depletion allowance. And at the outset it must be made clear that this depletion allowance applies to far more than oil. While it began with oil it now includes all the products of the earth except, as Congress finally stipulated, "soil, sod, dirt, turf, water, mosses, minerals from sea water, the air or similar inexhaustible sources. " But it does include farm crops, trees, grass, coal, sand and gravel, oyster shells and clam shells, clay and, in fact, every mineral and naturally occurring chemical or fiber on land.
The percentage depletion, according to the Supreme Court, is an "arbitrary" allowance that "bears little relationship to the capital investment" and is available "though no money was actually invested. " 43
But as more than 80 per cent of depletion benefits accrue to the oil and natural gas industries, the discussion can be confined to them.
Dating back to 1919 but with many tax-evading embellishments added since then, the depletion scheme works as follows:
1. The original investment by a company or individual in drilling a well--and under modern discovery methods three out of five wells drilled are producers--is wholly written off as an expense, thereby reducing an individual's or corporation's tax on other operations toward zero. Investment in oil drilling, in other words, offsets other taxable income. If an ordinary man had this privilege, then every dollar he deposited in a savings account would be tax deductible. The law permits, in short, a lucrative long- term investment to be treated as a current business expense.
2. As this was an investment in the well there is to be considered another outlay, or development cost, for the oil that is in the well. This cost is purely imaginary, as the only outlay was in drilling the well, but it is nevertheless fully deductible.
3. There remains a continuing, recurrent deduction, year after year, for making no additional investment at all!
The way these steps are achieved is through a deduction of 27-1/2 per cent (the figure was arrived at in 1926 as a compromise between a proposed arbitrary 25 per cent and an equally arbitrary 30 per cent) of the gross income from the well but not exceeding 50 per cent of its net income. If after all expenses, real and imaginary, a well owned by a corporation has a net income of $1 million, the depletion allowance can halve its ordinary liability to a corporation tax and it may maintain prices as though a full tax was paid. Through controlled production of some wells as against others, the tax rate can be reduced still further so that leading oil companies can and have paid as little as 4. 1 per cent tax on their net earnings. 44 Some pay no tax at all although earnings are large. Oil prices are "administered" by the companies; they are noncompetitive.
As Eisenstein sets forth this triple deduction, "For every $5 million deducted by the oil and gas industry in 1946 as percentage depletion, another $4 million was deducted as development costs. For every $3 million deducted as percentage depletion in 1947, another $2 million was deducted as developmerit costs. 45 The process continues, year after year, through the life of the well. Income often finally exceeds investment by many thousands of times.
A widowed charwoman with a child, taking the standard deduction which leaves her with $1,500 of taxable income pays taxes at a much higher rate, 14 to 16 per cent, than do many big oil companies and oil multimillionaires in the great land of the free and the home of the brave.
This depletion deduction "continues as long as production continues, though they may have recovered their investment many times over. The larger the profit, the larger the deduction. " 46
"For an individual in the top bracket, the expenses may be written off at 91 per cent while the income is taxable at 45. 5 per cent. For a corporation the expenses may be written off at 52 per cent while the income is taxable at 26 per cent. " 47 A company may work this percentage a good deal lower and even to nothing.
We have noted that the Supreme Court has called the depletion allowance "arbitrary"-- that is, as having no basis whatever in reason. Eisenstein examines in detail all the excuses given for permitting the depletion and in detail shows them all to be without a shadow of merit. Instead of reproducing any of his analysis here, I refer the interested reader to his book. The depletion allowance is a plain gouge of the public for the benefit
of a few ultra-greedy overreachers and is plainly the result of a continuing political conspiracy centered in the United States Congress.
What it costs the general public will be left until later.
Even more sweeping results are obtained by means of legally provided accelerated depreciation, long useful in real estate and under the Kennedy tax laws applicable up to 7 per cent annually for all new corporate investments. In brief, whatever a corporation invests in new plant out of its undistributed profits it may take, up to 7 per cent of the investment, and treat it as a deductible item. On an investment of $100 million this would amount to $7 million annually.
Because Stern traces, step by step, the process by which accelerated depreciation operates in the real estate field to eliminate taxes entirely the reader is referred to his book. 48
But the results in real estate alone, as related by Stern, are as follows:
In 1960, the following events occurred:
--Eight New York real estate corporations amassed a total of $18,766,200 in cash available for distribution to their shareholders. They paid not one penny of income tax.
--When this $18,766,200 was distributed, few of their shareholders paid even a penny of income tax on it.
--Despite this cash accumulation of nearly $19 million, these eight companies were able to report to Internal Revenue losses, for tax purposes, totaling $3,186,269.
--One of these companies alone, the Kratter Realty Corporation, had available cash of $5,160,372, distributed virtually all of this to its shareholders--and yet paid no tax. In fact, it reported a loss, for tax purposes, of $1,762,240. Few, if any of their shareholders paid any income tax on the more than $5 million distributed to them by the Kratter Corporation. 49
All of this was perfectly legal, with the blessing of Congress.
According to a survey by the Treasury Department, eleven new real estate corporations had net cash available for distribution in the amount of $26,672,804, of which only $936,425 or 3. 5 per cent was taxable. 50
The Great Game of Capital Gains
Capital gains are taxed, as we have noted, at a maximum of 25 per cent, although this rate is lowered corresponding to any lower actual tax bracket; but up to and including people in the highest tax brackets the rate is only 25 per cent. Thus, capital gains are a tax-favored way of obtaining additional income by the small number of people in the upper tax brackets.
Something to observe is that 69 per cent of capital gains go to 8. 7 per cent of taxpayers in the income group of $10,000 and up; 35 per cent go to the 0. 2 per cent of taxpayers in the income group of $50,000 and up. 51 The cut-rate capital gains tax, like many of these other taxes, is therefore obviously tailored to suit upper income groups only.
The total of capital gains reported to Internal Revenue for 1961, for example, was $8. 16 billion. Of this amount $465 million of gains were in the $1 million and upward income group; $1. 044 billion in the $200,000 to $1 million income group; $1. 63 billion in the $50,000-$200,000 income group; $1. 6 billion in the $20,000-$50,000 income group; and $1. 3 billion in the $10,000-$20,000 income group. Only $2 billion was in the less than $10,000 income group. 52 It is, plainly, people in the upper income classes who most use this way of garnering extra money.
What is involved in ordinary capital gains is capital assets--mainly stocks and real estate.
The theory behind the low-tax capital gain is that risk money for developing the economy is put to work. If the capital gains tax were applied for a limited period, say, to new enterprises, giving new employment, the theory might be defensible. But, as it is, it applies to any kind of capital asset, to seasoned securities or to very old real estate. Most capital gain ventures start nothing new.
There is some risk in buying any security, even AT&T. The risk here is that it may go down somewhat in price for a certain period; but there is absolutely no risk that the enterprise will go out of business. The theory on which the capital gains tax discount is based is that there is total risk; yet most capital gains are taken in connection with basically riskless properties. There would be some risk attached to buying the Empire State Building for $1; one might lose the dollar in the event a revolutionary government confiscated the property. But the amount of risk attached to paying a full going market price for the building is in practice only marginal. One might conceivably lose 10 per cent of one's money if one sold at an inopportune time. But one would not risk being wiped out.
In real estate, capital gains serve as the icing on a cake already rich with fictitious depreciation deductions. Depreciation is supposed to extend over the life of a property. Yet excessively depreciated properties continue to sell at much higher than original prices. When so much capital value is left after excessive depreciation has been taken, there must be something wrong with the depreciation schedule. What is wrong with it is that it is granted as an arbitrary and socially unwarranted tax gift to big operators. It is pure gravy.
Depreciation for tax purposes in real estate is taken at a much more rapid rate than is allowed even by mortgage-lending institutions.
First, a certain arbitrary life is set for a building, say, twenty-five years. But a bank will usually issue a mortgage for a much longer term. On such a new building in the first year a double depreciation--8 per cent--may be taken, but on an old building with a new owner a depreciation rate of one and a half may be taken in the first year. The depreciation taken in the first year and subsequently generally greatly exceeds the net income, leaving this taxless. The depreciation offsets income. For a person in high tax brackets it is, naturally, advantageous to have such tax-free income.
In a case cited of a new $5 million building the tax savings to an 81-percent bracket man amounted to nearly $1 million in five years.
The book value of this building, by reason of accelerated depreciation deductions of nearly $1. 7 million, was now $3. 3 million. The owner was offered $5 million for the building, the original cost. He decided to accept this offer. The tax deductions he had already taken had saved him 81 cents on the dollar and the tax rate he would get on his "book profit" would cost him only 25 cents on the dollar. The seller's net tax gain was $942,422. 78. 53
The new owner of the building could resume the depreciation cycle again on the basis of the $5 million cost and the old owner could go and start the process again with some other building. Real estate operators repeat this process endlessly. Many buildings in their lifetime have been depreciated many times their value. Best of all, the land remains.
Depreciation charges, deducted from before-tax profits, are an increasingly important way of concealing true earnings, as the Wall Street Journal notes (August 29, 1967; 18:3-4). "These funds don't show up as profits in corporate earnings reports, but are regarded by many investors as being nearly as good as profits . . . such funds can be put
into new facilities that eventually may bring bigger sales, earnings and dividends for stockholders.
"At no time during the 1948-57 period did depreciation funds amount to more than 80 cents for each dollar of after-tax earnings, Government records show," the Journal said. "In some of the earlier years, in fact, depreciation cash came to less than 40 cents per dollar of earnings. But in 1958--the year that the price-earnings ratio climbed so sharply--depreciation for the first time in the post-World War II era approximately equaled the after-tax earnings total. Through the Sixties, depreciation funds remained relatively high, so that for every dollar of corporate earnings there was nearly another dollar of cash for expansion programs or other such programs. "
Depreciation, in brief, amounts to a second line of profit, not acknowledged as such and now approximately equaling the acknowledged profit.
While this tax-deductible depreciation feature is not present with the purchase of stocks, the leverage of a loan at interest, as in the case of the real estate mortgage, is often present. For at least half the purchase price of the stock may be financed with a broker's loan at the standard rate of annual interest. The percentage of profit in relation to the input of investment becomes very great.
If 1,000 shares of stock are purchased at $50 a share, with a bank supplying half the money, the investor's share is $25,000. The interest he pays on the $25,000 of bank money is itself deductible. If the stock in six months doubles in value and is sold, the price realized is $100,000. As the bank loan is paid off and the initial investment is recovered there remains a profit of $50,000 or 200 per cent. On this there will be paid a capital gains tax of $12,500, leaving the profit after taxes at 150 per cent (or 300 per cent at a yearly rate).
It isn't usual that a stock doubles in value in six months, but many have done so. A post-tax profit of 150 per cent in as much as five years will amount to 30 per cent tax- free per year, which is not in itself a poor return. Compared with 5 per cent from a bank or a high-grade bond, which is taxable, it is an excellent return, making chumps out of most ordinarily thrifty citizens.
Whether the owner is using only his own money or is borrowing some, he is obtaining a tremendous tax advantage over the ordinary citizen.
Individual Tax Bills
A completely different sort of tax privilege, far less widely known and not even suspected by most persons, is gained by having one's Congress pass a special bill giving one special tax exemptions. Many such special bills are enacted, all reading as though they applied in general.
Actually, when they are incorporated after secret committee sessions into the tax laws the experts in the Treasury Department have no inkling of what they may mean. In order to ascertain their meaning they must wait until a certain return comes in, citing the relevant section of the law as authority for some unusual step being taken. Then it is seen, in a flash, that the return fits the law as neatly as a missing piece fits into a jigsaw puzzle.
One such case among many described by both Eisenstein and Stern concerned Louis B. Mayer, the movie mogul. The experts in the Treasury Department were mystified upon first reading Section 1240 of the Internal Revenue Code of 1954, written in the customary opaque tax language. They had not the remotest idea of what it meant.
What it said was:
Amounts received from the assignment or release by an employee, after more than 20 years' employment, of all his rights to receive, after termination of his employment and for a period of not less than 5 years (or for a period ending with his death), a percentage of future profits or receipts of his employer shall be considered an amount received from the sale or exchange of a capital asset held for more than 6 months if (1) Such rights were included in the terms of the employmerit of such employee for not less than 12 years, (2) Such rights were included in the terms of the employment of such employee before the date of enactment of this title, and (3) the total of the amounts received for such assignment or release is received in one taxable yeaer and after the termination of such employment.
Stern supplies a translation into English of this paragraph in its generality. But what it meant specifically was the following: Louis B. Mayer, and only Louis B. Mayer, may receive all future profits in the company to which he will be entitled after retirement in one lump sum and this lump sum will be taxed at 25 per cent as a capital gain even if it is not in any sense a capital gain.
Had Mr. Mayer received these profits after retirement as they were generated he would have had to pay maximum taxes on them each year. The special bill for his benefit-- Section 1240--gave him $2 million of pin money. 54
How did it come to be enacted? His attorney was Ellsworth C. Alvord, who appeared before the Senate Finance Committee not as Mr. Mayer's lawyer but as a spokesman for the United States Chamber of Commerce. And the section was so drawn as to be of no use to anyone else, although since then other measures have been passed that enable certain large lump-sum settlements of pension or income rights to be treated as capital gains.
A ludicrous sidelight of this and other tax sections is that the states sometimes copy the federal tax laws, as California copied the tax law of 1954. But much of what they copy has no possible applicability to any tax situation that may arise because some sections are specially tailored to a single situation. Sub-section 2 of Section 1240, which reads "such rights were included in the terms of the employment of such employee before the date of enactment of this title" made it applicable only to Mr. Mayer, who alone had such particular terms before the passage of the bill. Unless one can show one had a contract containing such provisions before the passage of the bill one cannot cite the section on one's tax return.
It should never be thought that the leaders of Congress do not know what they are doing.
Many such special sections exist in the tax laws. of benefit only to a single individual or estate (one-shotters) or of continual benefit to certain industries; and Stern discusses a number of them. To obtain such special tax sections for oneself one must, obviously, have a "friend at court," somebody who has the king's ear.
Many companies get such special tax laws, of benefit only to them; and otherwise illegal gains from mergers of various corporations or banks are covered either by one- shot or multiple-shot laws. Sometimes one company is able to squeeze itself into provisions especially tailored for another, but not often. 55
Low Estate Taxes
Not much will be said here about estate taxes other than to point out that entirely illusory rates are posted here as elsewhere. Many very rich men's estates pay little or no tax. The public supposition that the big estates are being dismantled by estate taxes, often repeated in newspapers, is entirely false.
According to the rate schedule in the law, estates exceeding $60,000 are now taxed from 3 per cent for the first $50,000 to 77 per cent for amounts over $10 million. Offhand, one might suppose that a man who left $100 million net would pay a tax of
$67,566,150. But no taxes like this are ever paid and, as we noted earlier, John D. Rockefeller Sr. and Jr. and Henry Ford I paid low estate taxes.
Some persons, below the top levels of wealth, do indeed pay full estate taxes. But this is because they have either through personal peculiarity or unusual moral standards refused to seek and follow the advice of an experienced tax lawyer. Usually it is a personal peculiarity that leads them in this direction, according to what lawyers say. They are unable to understand the steps outlined for them to take or fear they are in danger of losing something.
An anecdote of record about the late Somerset Maugham, the well-known and affluent writer, will illustrate the point. It was explained to Maugham that if he took certain steps to divest himself of nominal control over his assets for the benefit of his children, with whom he was not on good terms as such are generally understood, his estate under English law would almost entirely escape taxes.
"I won't do it," Maugham said as the situation was explained, "because I am too aware of what happened to King Lear. "
It is mainly, among the law-cognizant, persons with a strong feeling of alienation who do not avail themselves of the many profitable loopholes in the estate-tax law. Henry Ford, it appears, was one such, and only the last-minute recourse to the Ford Foundation saved control of the company for his family. Ford was obviously either a tenaciously grasping person, indifferent to his family, or simply could not understand the ins and outs of the law, which one assumes were thoroughly explained to him by able lawyers. We know he did not want the government to get his money.
Ford, of course, did not have the advantage of the marital deduction, which was passed the year after his death. Had it been in existence a half of about a billion dollars would have been, right off, tax free. As matters now stand, one half of the taxable value of all estates where there is a surviving spouse is tax exempt.
A $100 million net estate, instead of paying $67,566,150 under the posted rates, therefore seemingly pays only $32,566,150. This is quite a bit but it isn't anything like the posted 70 per cent; it is 32. 5 per cent.
Even this 32. 5 per cent is illusory under the various leveraging amendments to the estate-tax law and, to make a long story short, we may simply show in this table what the real against the posted rates are: 56
Gross Estate
(approximate)
$500,000-$1 million
$1-$2 million
$2-$3 million
$3-$5 million
$5-$10 million
$10-$20 million
$20 million and higher
Scheduled
Rates
(Per Cent)
29-33
33-38
38-42
42-49
49-61
61-69
69-77
Actual Average
Tax (1958)
(Per Cent)
15. 3
18. 2
19. 3
21. 2
23. 2
24. 4
15. 7
Percentage
of Discount
50 50 50+ 50+
50-60 60+
80+
One may obtain the actual rate for any year by averaging the actual payments in each bracket as reported by the Treasury Department. From year to year the actual rates vary slightly.
So, when one reads in a newspaper about high estate taxes one is reading something untrue. The maximum actual estate tax by percentage is about the same as the income tax on an individual $10,000-$20,000 income.
Similar low actual rates prevail on large incomes as shown by the Chase Manhattan Bank in 1960 in its bimonthly news letter, as follows:
Adjusted Gross
Income
Under $3,000
$ 10,000-$ 14,999
$ 20,000-$ 24,999
$50,000-$ 99,999
$200,000-$499,999
$1,000,000 and up
Scheduled Rates
(Per Cent)
20
25
36
55
80
87
Percentage
Actual Rates of
But a man with a family will not ordinarily pay anything even like the actual rates on a $100 million estate. For, being sensible and knowing that he must some day die, he has long before death begun transferring assets to his wife and children. Let us suppose he has two children.
He can transfer $100,000 a year to each of them at a gift-tax cost of $15,525 each or 15. 5 per cent, with the sums held in trust. In thirty years $9 million will have been transferred. He can make his own law firm trustees.
He can transfer an equal amount, at once or gradually, to his family-controlled foundation, entirely tax free up to 30 per cent of annual income.
He can increase his transfers at slightly higher gift-tax rates. Whatever he transfers brings the actual estate tax lower.
But he can do even better than this. He can transfer to members of his family, at extremely low gift-tax rates, properties of grossly understated value whose true value he alone knows. Such, let us say, would be mineral-bearing but unexploited lands, since privately surveyed and "proven. " If such land had been acquired at $100,000 it could be transferred for purely nominal taxes, and this big asset would be in the hands of his heirs long before his death. Times of downswings in the market, as during the Depression, are a good time to make corporate gifts. Overdepreciated real estate or foreign property, with a low book value but a high actual value, is another good thing to transfer by gift. The heirs can sell it at full value without paying any capital gains tax.
At no stage need he lose practical control over any of his properties, leaving aside his moral authority over his family. Many of those who do not avail themselves of these provisions apparently feel they have no moral authority over their heirs or believe their heirs will take these properties and leave them in the lurch, as Mr. Maugham publicly feared. While such a possibility, may exist in some families, even it can be guarded against by a knowledgeable tax lawyer.
The value of wives here is again outstanding, as in the case of the marital deduction in the upper brackets.
It might be asked what value it is to a man that half his estate escapes any taxes if his wife gets that money. But the first advantage is that she halves the tax. He must be interested in this feature because he could avoid all taxes by simply leaving all the money to the public in some form. As he usually doesn't do this, one must conclude that he is interested in preserving the fortune for some reason.
What he leaves to his wife can be left in a life trust, he naming the ultimate beneficiary but giving her the right to change this. By doing this he has clearly reduced the taxable amount by one half. His children ultimately take from the mother's estate, so at least two-thirds of the fortune is preserved. But much better than this can be done by means
(Per Cent)
Discount
19 5
20 20
23 35+	
38 33+
42 48
38 57. 5
of lifetime distributions in the form of trusts and by taking advantage of other provisions in the fine print of the law.
And through the use of trusts, assets can be kept intact for at least three generations. The dead man can assert his will for at least 100 years. If the final recipients, having full control over the property, now replace it in trust according to family doctrine, the holdings can be preserved in trust for another three generations. If it is a series of multiple trusts that have been established, the tax rates can be very, very low.
While the Constitution forbids the entailment of property as in England it is nevertheless practically possible to practice serial entailment, as Cleveland Amory reports many of the old Boston families have done. Serial entailment is achieved if the third-generation recipient, loyal to family teaching, replaces the property in trusts.
Estates, in fact, are not broken up by the tax laws; they grow larger through the generations, assuring the presence of an hereditary propertied class. This fact has many implications, one of which is that latecomers in the game of grabbing property face a shrunken hunting ground.
The whole point is this: Plenty of escape hatches exist in the estate-tax law for those who wish to avail themselves of them. Some, like Henry Ford, do not, and prefer to clutch nearly every last dime they own until the undertaker forces open their hands. For the heirs of such, the tax outlook is rather bleak, although by no means so hopeless as often reported. There is always the foundation escape hatch, and the foundation, all else failing, can give remunerative employment to members of the family, who become philanthropols or, somewhat paradoxically, philanthropist-politicians.
In summary, it should be noticed that the rich, who contrary to Ernest Hemingway are different in other respects than that they simply have more money, live in a specially favored tax preserve which could not have taken form without considerable elitist prompting. Congress alone would not have had the Kafka-esque imagination to devise this labyrinth of fiscal illusion. The public itself did not demand these tax laws.
All deductions and exemptions available to rank-and-file taxpayers in trifling amounts, as we have seen, have far greater weight when applied to the receivers of big incomes from property and its manipulation. Deductions for wives, children, general dependents, education, medicine and social investment have an in-pocket value up to the maximum of the tax rates for the rich. Beyond this are all the special tax dispensations provided especially for big property holders: accelerated depreciation, depletion allowances, expense accounts, low-tax capital gains, specially tailored exemptions, mortgage and interest leverages, tax-exempt bonds, multiple trust funds, light estate taxes, family partnerships, low-tax lump sum settlements of a large variety of fictitious capital gains, etc.
It is very evident that, as government expense has gone up attendant upon fighting corporately profitable wars, the rich have decided to play very little part in defraying it.
Results such as those depicted could have been attained only as the consequence of much elitist work, thought and conniving. Can anyone believe the results are accidental? Or that they are remotely equitable?
Taxpayer Terrorization
While the tax rates gouge the general populace, the Internal Revenue Service in recent years, by all accounts, has been conducting a highhanded reign of terror against small delinquent taxpayers, often confused by the crazy-quilt tax forms. "Tax disputes more than any other have given many harassed citizens a glimpse of the other face of Uncle Sam when he scowls," writes Washington political columnist Jack Anderson. The face
of Uncle Sam that many citizens now see closely resembles the skinflint depicted by hostile foreign cartoonists.
While making advantageous settlements with delinquent large taxpayers, says Anderson, "the government was relentlessly pursuing a host of small tax debtors, poor but loyal Americans, many of whom were in debt for reasons beyond their control. Uncle Sam garnisheed their wages, seized their property, confiscated their bank accounts, and deprived them of their jobs, stripping them of almost everything they possessed except the mere clothes on their backs. . . . More than one hard-pressed taxpayer has found himself in trouble because of a trivial or unintentional error in an old return, the failure of an employer to withhold the correct tax, or a personal tragedy that cleaned him out of the money he set aside for Uncle Sam. The files at Internal Revenue are stuffed with complaints from taxpayers who say they have been hounded, bullied, and browbeaten by collectors whose methods would put a loan shark to shame. Many a widow's last mite has been snatched from her. Men have been stripped of their livelihood and, along with it, their only means of paying the government. "
A committee of twenty-two tax lawyers and accountants appointed by Chairman Wilbur Mills of the House Ways and Means Committee found many acts of "overzealousness" by tax agents that infringed "the vital rights and dignities of individuals. " 57
If a taxpayer subjected to arbitrary Internal Revenue rulings is affluent enough to be able to hire a lawyer he on the average, in appeals, has 85 per cent of the tax assessments sharply reduced or eliminated.
"Only a small percentage of individuals whose deductions are disallowed, whether right or wrong, do use existing systems to challenge IRS auditors," writes William Surface. "Why not? 'The small taxpayer's first and usually last impulse is to quit,' says Senator Warren Magnuson of Washington. 'Just throw in the towel, pay the deficiency, no matter how unjust he believes it is, rather than face the tiers of faceless bureaucracy. The small taxpayer is faced with staggering disadvantages in his dealings with the Federal Government in comparison with large, corporate taxpayers. '"
The bigger taxpayers proceed otherwise. About 10 per cent of those assessed additional taxes request an "informal conference" with the auditor's supervisor, and about half of those who do this win some concession. In 1965 a total of 26,301 corporations and individuals who were assessed additional taxes, or 1 per cent, appealed their cases to the Appellate Division, an autonomous body. No less than 85 per cent of the cases so appealed each year have their cases settled for about $200 million a year less than what IRS originally assessed. Beyond this there is the Tax Court, where an average of 8,500 appeals from IRS rulings are heard each year. "Four out of five cases that reach Tax Court are settled without trial for only 31 per cent of the amount that Internal Revenue had initially demanded. " 58
On this showing, IRS is clearly overzealous in many cases, and most people readily knuckle under in fear of being suddenly confronted, apparently, by an unbenign Uncle Sam. Anderson, Surface and various congressmen blame it on petty bureaucrats in IRS, with which judgment I emphatically disagree. IRS people are civil service employees, all of them small people. They only follow instructions from higher up. They act only in response to orders passed down along a chain of command from the White House and the Secretary of the Treasury. When they get very tough and arbitrary it is because they feel their jobs are in jeopardy if they do not make a good showing.
It is true that underlings in all large organizations, governmental and corporate, often tend to be overzealous in carrying out very mild orders, thus giving the organization
eventually a bad name. Mild orders from on high tend to gain strength as they are passed down, and at their point of final execution are often brutal.
At times, with the approval of higher-ups, the Internal Revenue Service acts illegally. The Commissioner of Internal Revenue has admitted that for seven years, from July, 1958, to July, 1965, agents had made "improper" or questionable" use of electronic eavesdropping devices on 281 occasions. The information was elicited by the Senate judiciary Committee. One senator charged that electronic devices were used "during routine investigations of ordinary taxpayers"; the charge was denied. Planting of such devices by means of trespass, the Supreme Court ruled in 1961, is unconstitutional (illegal), violates the prohibition against unreasonable search and seizure, invalidating evidence so obtained. 59
Whereas the Bourbons, drunk with power, proceeded forcibly against the peasants en masse to collect unfair taxes, in modern states, including the United States, the full force of sovereignty is brought to bear against single individuals. Intimidated in advance by any sort of authority, the ordinary citizen here is in no position, even under constitutional government, to invoke his rights. He does what many intimidated innocent people do in the courts: He pleads guilty to a lesser charge.
General Remarks
What has been put down so far represents only part of the story of shoving the tax burden onto the patriotic labor force by the finpols and corp-pols with the consent of the pubpols, who in turn thoughtfully misapply (OverKill) at least 30 per cent of the tax money they do take in. This percentage of profitable misappropriation, largely on the excuse of "defense," more recently of "welfare," is put very conservatively; a thorough direct examination of what is obtained by the expenditures would probably show a larger percentage.
A careful comparison of the fiscal situations in the United States and eighteenth- century France, which was under candid autocratic rule, shows that the American populace is being short-changed far more efficiently than was the French populace under Bourbon rule. Indeed, the American process is more effective because most of the people are not even aware they are being trimmed under the twin banners of anti- Communism and anti-Poverty; most rank and file citizens would be the first to deny it vehemently while bursting into strains of Yankee Doodle. The French were fully aware of the process because many of their taxes were collected by force, often after pitched battles between the peasants and the troops. The American process of making the labor force shoulder most of the tax burden takes place in much subtler ways, behind the formidable barriers of deceptive language, high-flown ideology, simple arithmetic and the full panoply of sovereignty arrayed against isolated individuals.
In this atmosphere the withholding tax, levying on earned income before received, was nothing short of a pubpolic political inspiration.
The General Results
What is not paid by the higher-ups must be paid by the rank-and-file. The government, despite all the tax loopholes, is never deprived of whatever revenue it says it needs, even for waging fierce undeclared wars of its own bureaucratic making. What revenue the government decides not to take from the influential finpols it must take from the poor and needy over which the pubpols weep and wail like the Walrus and the Carpenter did over the happy trusting oysters they had eaten.
Stern has reported various shrinkages in the tax base and the attendant cost to the Treasury (which cost must be made up by the patriotic rank and file). 60
Here these various shrinkages and costs are presented somewhat differently: first, those shrinkages and costs of advantage solely to the wealthy; secondly, those shrinkages and costs participated in and preponderantly of advantage to the wealthy; and, thirdly, those shrinkages and costs generally of advantage only to rank-and-filers.
Lump-Sum Tax Evasions of the Wealthy Only
Shrinkage of Cost to
dollars)
Lump-Sum Tax Evasions in Which the Wealthy
Participate with the Less Wealthy Middle Classes
Shrinkage of Cost to
Tax Base Treasury
(billion dollars) (billion
Extra exemptions for the aged and
blind (most of these deductions per
centagewise and in totality must go
to those few with substantial income
--the higher the income the greater
the deduction)
Nontaxable income from social secur-
ity, unemployment and veterans'
benefits, etc. (except for unemploy
ment benefits, the wealthy partici-
pate to some extent)
$ 3. 2
11. 9
$ . 9
3. 6
2. 0 11. 9
5. 0 $23. 4
Cost to
Tax Base Treasury
(billion dollars) (billion dollars)
Depletion deductions
intangible oil and gas
drilling deductions
Excessive expense account
Deductions
Real estate depreciation
Dividend credits
Capital gains deductions
Estate tax evasions
Interest on tax-free bonds
Undistributed corporate profit* 25. 6 (1965)	12. 8 (est. )
Totals $49. 8 $22. 1
*Stern does not include this significant item.
The wealthier class of taxpayers, in brief, fails to pay $22. 1 billion of taxes which it might properly pay. Nor is this all, because it participates in tax loopholes available to others.
Rent equivalent (deducted mortgage
interest, etc. ) on owned homes
(greatest advantage to wealthy as
residents and as real estate opera-
tors) 6. 5
Itemized deductions (most profitably
used by wealthy) 43. 0
Income-splitting for married people
(of most percentage and dollar
value for wealthy persons)
Totals $64. 6
Lump-Sum Tax Dodges in Which the Wealthy
Probably Have Little Participation
Shrinkage of
$ 3. 7
$ 1. 5 . 5 . 3
. 2
6. 0 12. 5 2. 0
. 5 2. 4 2.
