Here, in other words, is the real milk of the interest
deduction
coconut.
Lundberg - The-Rich-and-the-Super-Rich-by-Ferdinand-Lundberg
Boyce, misled by the logic of the tax laws, in one day established ninety identical trusts to hold a mere $17,000 of stocks and bonds.
The $100 dividend exemption left them each tax exempt.
Appealed to the tax court, the plan was found "preposterous.
" "Straining reason and credulity," the learned court said, "it ought to be struck down forthwith.
" And, as Mr.
Stern remarks, "It was.
"
Another device for income splitting, thus obtaining lower taxes, is to establish many corporations in place of one. In one of many instances a finance business split into 137 corporations to avoid $433,000 of taxes annually, and a retail chain divided itself into 142 corporations to avoid $619,000 annually. 22 The surest way of keeping money today is to steer a proper course through the crazy-quilt tax laws.
Additional Tax Dodges
A man who is sixty-five or over, in the best of health, gets an additional deduction of $600 whether his income is $1,000, $10:000, $100,000 or $1 million, although most people over sixty-five have little income at all beyond meager Social Security. But if he is in chronic poor health, unable to work except spasmodically, and under sixty-five, even if he is sixty-four--no extra deduction. A blind person gets an extra exemption of $600, suggesting to the reader of tax instructions that he lives under a Congress with a heart. But if a person retains his sight and is stone deaf, without hands, has had a stroke or is paralyzed from the waist down he does not get this compassionate exemption.
Whenever such a disparity is pointed out to Congress it usually gladly, in the name of consistency and equity, spreads the inequity to include others. We may, therefore, soon see Congress giving an exemption to all disabled or physically handicapped people, thereby further narrowing the tax base.
The point here is not whether a person is handicapped but whether he has income. What value is an extra exemption to a blind, disabled or aged person who has no income" The only person such an exemption could benefit would be one with an income. And all such special exemptions are taken by persons with incomes--often very substantial incomes. They are props to financial strength, not supports of weakness.
Just how much good the exemptions for over age sixty-five do may be seen by considering the income statistics for 1962, the latest year available. Of 7. 4 million male income recipients over sixty-five years old, 18. 6 per cent got less than $1,000 gross; 34 per cent, from $1,000 to $2,000; 18. 4 per cent, from $2,000 to $3,000; and 9. 9, from $3,000 to 84,000--80. 9 per cent under $4,000 gross. Of 7,491,000 female recipients 56. 2 per cent got less than $1,000; 30 per cent, from $1,000 to $2,000; and 6. 7 per cent, from $2,000 to $3,000--92. 9 per cent under $3,000 gross. 23 Much of this income was from tax-free Social Security, which averaged $74. 33 per month in October, 1965.
In other words, exemptions for persons over sixty-five can be of significant advantage only to affluent persons, property owners, retired corporation executives on large pensions with big stock bonuses and upper professionals who have managed to save and invest. Like marital income splitting and deductions for children, it is of significant advantage only if one has a large, preferably unearned income.
For a man in the 70-per-cent tax bracket each such exemption is worth in cash 70 per cent. For a person with zero income it is worth zero. In order to benefit slightly from the extra exemptions for being over sixty-five and blind, a single person using the standard deduction must have in excess of $2,000 taxable income. If he receives $4,001, he will pay tax on $1,800 (standard deduction plus three exemptions) or $294. But, having saved $80 by being blind, he will then be in a minority income group of less than 20 per
cent of over-aged males! He will, despite the smallness: of his income, be in a small, highly privileged income group. If it is a woman with an income of $3,001, she will pay $146--but she will then, despite the smallness of her income, be in a restricted group of less than 8 per cent of overaged females!
The tax deductions for the aged, blind and retired are of significant benefit only if one belongs to a small group of persons with taxable incomes higher than 81. 8 per cent of the males and 92. 9 per cent of the females actually do have. The ones most benefited are the affluent aged, blind and retired.
These income statistics for the aged throw a curious light on the propaganda about the United States as a land of opportunity, the richest country in the world and the home of the individual-success system. Under this system, most people, economically, appear to be failures at the end of the road. And were it not for Social Security, the figures in each of the income brackets cited would, on the average, be about $900 less.
Some hidden hand, force or influence appears to cause most people, after a lifetime of effort, to show up very patently as losers. Could prices, taxes and overpersuasive advertising, as well as individual shortcomings, have anything to do with the result? With only 19. 1 per cent of over-age males having a gross income above $4,000 and 7. 1 per cent of retired females above $3,000, economic success does not appear to have crowned the efforts of most survivors in the most opulent land ever known to history.
In drawing the tax laws Congress is no more being sentimental than when it temporarily exempts the father of twelve from battle duty. Although individual congressmen no doubt have their personal points of view on all of this, collectively Congress in drawing the tax laws is absolutely indifferent to whether one is poor, married, has children or has personal disabilities. But it is not indifferent if one has property or a well-paid position. Then it is most enthusiastically on one's side.
Congress, as we have noted, likes students. It likes them so much that if one is able to gain a scholarship or fellowship he need pay no tax at all on it, an educational exemption, up to $300 a month for thirty-six months and even if the scholarship adds considerably to family income. Scholarships are awarded by many endowed colleges and special bodies, but many corporations now earmark scholarship funds given, for example, to the National Merit Scholarship Fund. Some funds are not earmarked, but the earmarked funds are for the children of emplovees (usually executives) of the company. The granting of the scholarship has the hidden effect of giving the father an untaxed pay raise and the corporation a pre-tax deduction, paid by consumers and small taxpayers. The father will not now have to pay his own taxed money for tuition. And in known cases students of lower standing in test examinations and lower academic standing have drawn earmarked scholarships while students of higher standing have drawn none, even as the public supposes the scholarships are awarded on the basis of strictly on-the-record merit.
For nonabilitv factors are taken into consideration in this quarter, too, as in the hiring of people of negative ethnicity. 24
Divide and Prevail
My object in going into this small stuff is to make this point: Congress is not really sentimental at all but is just busy dividing the taxpayers into separately manageable little bands of over-reachers, each of whom feels particularly and unwarrantably virtuous about some feature of his status--that he is married, has children, has a student in school, contributes to a church, has one out of many possible disabilities, is over sixty-five or was never arrested while robbing the Bank of England on a bicycle ridden on a high wire with a monkey on his back.
A congressman might deny this, might hold that the body is really sentimental, and point out that payments under Social Security and the Railroad Retirement Act are tax exempt entirely. But every recipient of Social Security and retirement provisions is not automatically entitled to special sympathy. A number of them are survivors from among many who have succumbed before them and as such, someone might argue, ought to pay a special tax--or at least be taxed equally with others. A long-employed utility- company executive, no risk competitor, who retires at age sixty-five with a pension of $40,000, a rather standard figure for his industry, plus owning accumulated stock, money in the bank and a large home, may draw the maximum Social Security payment, tax free, plus the special exemption for over age sixty-five. Upper-bracket officials of long service in their personally owned corporations as well as lower-bracket wage- earners are equally under Social Security and get the same tax exemption whether they need it or not.
When the average man retires, his income drops sharply. But when an executive or owner who has worked over the years for his own company retires, his income from stocks, bonds, pensions, annuities, etc. , does not decline. Yet he gets untaxed Social Security payments as well as the poorer man, showing again the equality of the law in all its majesty. .
Untaxed Income
While the average man, chuckling to himself, is stooping over picking up the sops a cynical Congress has laid out for him, his pocket is being emptied from behind. As he has elected to trade punches with the champion, let us see how he fares.
Ninety per cent of people, more or less, own no stock and receive no dividends. But people who own stock receive the first $100 of dividends tax free; a husband and wife each owning stock get $200 tax free. However, so-called dividends from mutual savings banks and building and loan associations, usually received by low-income people, do not qualify for this strange deduction.
Furthermore, dividends paid in stock or in "rights" to subscribe to stock pay no tax at all even though the company has taken money from earnings with which to increase invested capital. This feature of the laws explains the popularity of the stock dividend: It is tax free.
The stockholder is in a more favored tax position than even this shows because most companies do not pay out all their earnings in dividends. The dividend payout rate varies among companies from zero to 80 or 90 per cent but averages at about 44 per cent.
What this betokens is that accrued earnings, not paid out, are credited to the capital account and amount to so much untaxed money at work for the stockholder.
Let us imagine that someone owns 100 shares in a company that earns an average of $10 a share but pays out an average of $5 a share in dividends. The stockholder receives $500, deducts $100, and puts $400 into his gross taxable income. But the $500 not paid out is at work for him in the company, growing each year. It is tax-free unearned capital. But if a wage worker receives a $500 bonus at year-end and the employer deposits it in a bank for his account, the $500 must be reported as taxable income and will be taxed. Not to pay a tax on it would be a violation of law, and punishable.
Some companies, although they are big earners, pay no dividends at all. Known as "growth companies," they grow by leaps and bounds. If a man invests $10,000 in such a growth company and it grows at 10 per cent a year (rather modest for a growth company) the investment will be worth $16,105 at the end of five years and $20,600 in
a little more than seven years. On all this accrual he has paid no taxes, yet is becoming wealthier and wealthier.
If he decides to take his profit at $20,000 he will pay a maximum of 25 per cent (he might pay less) on $10,000, or $2,500. But he need not do this at all, need never sell and never pay a tax.
When he eventually dies, his heirs will not be liable at all for a capital gain tax even if the original investment of $10,000 has grown to $50 million. Nor need they even pay estate taxes if he has prudently placed it in trust funds for their benefit. While his heirs may receive from him stock worth $50 million, his estate tax may be zero so that all along there has been incurred no income tax, no capital gains tax and no estate tax.
But if he split the original investment of $10,000 among four trust funds, at his death four beneficiaries would have estates worth $12. 5 million each, on which there had never been paid income taxes, capital gains taxes, gift taxes or estate taxes. All would be completely legal.
This road to wealth is not only theoretically possible but is actually traveled in various degrees by many of the rich, as their final accountings show. They die stripped of assets.
The amount of untaxed undistributed profits of corporations each year is very large. In 1950 it was $16 billion. It was $16. 5 billion in 1955, lowered to $10. 8 billion in 1958, rose to $15. 9 billion in 1959. Since then it has ranged between $13. 2 billion to $16. 8 billion in 1963. 25 Since 1946 it has always been each year more than $10 billion. Like money in the bank, the beneficiaries pay no tax on any of it. It is this feature that enables major stockholders to become constantly richer, tax free.
Retained corporate profits, mostly reinvested, have exceeded dividends Since 1962 and in 1965 totaled $25. 6 billion against $18. 9 billion of dividends. They also exceeded dividends in every year from 1946 through 1959, with the exception of 1958, often by a very wide margin; in 1947 and 1948 they were more than double the dividend payout. 26
From 1945 through 1965 total corporate dividends paid out amounted to $226. 9 billion compared with $296. 2 billion of profits retained, as shown by the immediately preceding source. The actual payout rate has been a shade more than 44 per cent. Retained profits and increased earnings on them have been among the more solid reasons for the increase in market value of stocks.
Not to pay dividends is an accepted maxim of tax economists. In the words of one tax advice service, "paying dividends is clearly a tax waste. " 27
The retention and reinvestment of corporate profits is the royal road to tax avoidance and financial expansion, at home and abroad. Abroad it is the basis of what is known as American economic imperialism. It requires, of course, the maintenance of a vast "defensive" military establishment largely paid for by the less affluent lower taxpayers. The aggrandizing foreign investments, like the domestic investments, are largely made by corporations with tax-free money!
Under the Eisenhower Administration, as we have observed, the dividend tax credit passed in 1954 enabled big stockholders to make a killing while small stockholders gained very little, the usual pattern of the tax laws. With fewer than 1 per cent of all families holding more than 70 per cent of all stock by value, it is clear that very few could be advantaged by this law. As Mr. Stern shows, a man who had a tax bill of $2,020 and had received dividends of $500 would reduce his tax by $20 under the Eisenhower law. But for 306 top taxpayers, with an average dividend income of nearly a million dollars, we have noted the dividend credit meant an average $40,000 in cold cash for each. Quite a difference. 28
Tax-Exempt Medicine--for the Rich
As the wealthy person has more money available, he can always purchase more tax- deductible medical services than the average man. A married taxpaver is limited to a maximum $20,000 medical deduction, a great deal even for a rich man, and to the excess over 1 per cent of taxable income for drugs and medicines.
But if the taxpayer has an employer who pays his medical and hospital expenses, these are exempt from taxes, which is very handy for the company executives who often enjoy this "fringe benefit. " For the ordinary taxpayer any wages paid as "sick pay" are exempt up to $100 a week after a waiting period, but not many figure in such arrangements. Those persons retained by companies that make this a practice obviously enjoy a differential tax advantage over most taxpayers.
Corporation executives often enjoy free medical services, for themselves and their families, from fulltime company medical departments. This amounts to so much tax- free medicine, which is charged to consumers in price and to general taxpayers. High public officials, it must be noted, also often come in for such free medical services at various of the up-to-date governmental military hospitals. Former high officials also participate through the courtesy of incumbents, whom they publicly back when controversy rises.
If he has no organization he can charge for the medical services, the rich man does have up to $20,000 of medical attention each year as a tax-free deduction from spendable income, thus reducing his taxable income. In the 70-per-cent bracket this is worth $14,000, cash.
Most persons in the country never enjoy the services of a doctor until they are in extremis or a doctor must be called in to pronounce them dead. This is because they cannot afford a doctor and instead rely on the nearby pharmacist in all poorer neighborhoods referred to as "Doc. " Their prescriptions are whatever proprietary drugs he recommends. The pleasant-sounding medical deduction, then, is of no service to the many persons without money to spare for doctors and medicine.
Lucrative Charities
One may deduct up to 30 per cent of gross adjusted income for contributions to charities, and if contributions exceed 30 per cent in any one year they may be spread over five years. As most taxpayers manifestly cannot make contributions on such a scale, the provision is obviously of service only to the wealthy.
While the contributions may be made to existing bodies, most of the wealthy prudently decide to make them to their own charitable foundations, which are run as helpful adjuncts to their other affairs.
Oddly enough, one's financial power in society increases as one "gives" money to a personally owned foundation, proving that it is more profitable to "give" than to receive. If a certain man has a million-dollar taxable income (he has made all deductions), he is liable for $660,980 in taxes under the 1965 or nearly 70 per cent flat. But he can still make a charitable contribution for a deduction of $300,000. If he does, his tax will be only $450,980, a tax saving of $210,000. But as he has "given" $300,000 it looks as though he is deprived of $90,000 more than if he had paid straight tax.
But what he has "given" he has given to his own foundation, and he can invest this money in stocks of his own companies and thereby maintain profitable control. Again, the earning power of this $300,000 (at least $15,000 a year) is now tax free itself, greatly increasing its effectiveness. It will recoup his $90,000 out-of-pocket cost in at most six years and thereafter show a tax-free profit. He has more income to dispose of
now in "philanthropic" patronage than if he had retained his taxed earnings and invested or spent them, for the proceeds of such retained money would be taxed.
What does his foundation contribute to? It contributes, as actual cases show, to laboratories seeking cures for various diseases. Surely this is entirely worthy, and so it is. But what do the corporations make that he controls? They may make medicines that are sold at a profit for the cure of various diseases, and any discoveries made by the laboratories to which his taxfree foundations "give" money will be utilized by his medicine-making corporations in making further profits. But few such discoveries will be available to impecunious people. It usually takes money to buy medicines.
"Charity" under our tax laws can be highly profitable. It can be monetarily more profitable, indeed, than noncharity.
Big Killings via Interest
Interest received, except from tax-exempt bonds, is taxable, Every man who gets interest from a bank account, a mortgage or on a federal or corporate bond is liable for taxes on it.
Interest paid out, on the other hand, is 100 per cent deductible. The man who buys an automobile or household appliance on the installment plan may deduct the interest paid before computing his income tax, just like the man who deducts for the payment of $100,000 of interest a year on a margined stock-market account. For the latter, the interest is deductible as an expense of doing business, and in the 70-per-cent bracket is worth to him $70,000. His true interest outlay is only 30 per cent of the face amount.
All such big interest payments are of major advantage to the big operators in stocks, real estate and oil lands who borrow a great deal in order to contrive their killings, which are sometimes sure things--as in the case of the metropolitan realty operators who "mortgage out. "
Where interest paid as a deduction most obviously divides the population, placing another large number in the role of sucker and an apparent large number among the advantaged, is in the matter of home ownership. While tenants, in the form of rent, pay all costs, including mortgage interest and taxes of the owner, the home owner may deduct on his federal tax return interest he pays on his mortgage and his local real estate taxes. On a $30,000 house in which he has a $10,000 equity the home owner may pay 5 per cent perhaps on a $20,000 mortgage, or $1,000; his taxes may be $500; and he may reasonably figure 3 or 4 per cent for depreciation, repairs and maintenance, or $900- $1,200. His rent, then, exclusive of heating, is minimally $2,400. But if he is married and has a $10,000 taxable income he may first deduct the interest payment of $1,000 and then the real estate tax of $500. At the 22 per cent rate for that bracket the deduction is worth $330, bringing his actual rent down to $2,070 or $172. 50 per month. A tenant would have to pay considerably more per month plus some entrepreneurial profit to the owner; he would probably have to pay from $225 to $275 per month, possibly more.
While this seems to give home owners a bit of an edge over tenants (I have omitted items like cost of insurance), Congress is not especially fond of home owners either. It has much bigger game in mind. With home owners sitting contentedly chewing their little tidbit, knowing they are slightly better off taxwise than tenants, the interest deduction meanwhile has opened some large gaps in the tax laws through which profit- hungry elements churn like armored divisions through Stone Age club-wielders.
First, for the wealthy man with many houses and country estates, both the realty tax and interest deductions amount to windfalls. If a million dollars of such residential property is mortgaged up to half at 5 per cent, there is a total interest charge of $25,000. But in the 70-per-cent bracket only $7,500 of this represents an out-of-pocket payment.
Whatever the realty tax bill is, only 30 per cent of it represents an out-of-pocket payment. The same situation applies with respect to personally owned cooperative luxury apartments; the general taxpayers defray up to 70 per cent of the interest and realty tax outlay.
The interest and realty tax deductions, then, are extraordinarily valuable to holders of extensive properties.
But this is only the beginning of the story.
Metropolitan real estate operators, as we have observed, use interest as a ]ever with which to "mortgage out" and then obtain tax-free income.
Here, in other words, is the real milk of the interest deduction coconut. Whereas the average home owner is getting away with peanuts at the expense of tenants, both tenants and home owners in the end must make up out of other taxes they pay, mainly in the form of prices, what the big operators have been able to avoid paying on their profits.
Congress, although not loving home owners, is surely infatuated with big real estate and stock-margin operators. And why not? It is these chaps who have the money to kick in for campaign funds, always a matter of concern to the officeholder.
One may agree that the ordinary citizen is entitled to complain. He knows he is in some sort of squeeze. But, politically illiterate, he clearly does not realize its nature nor does he see that he won't get out of it by obtaining some petty advantage over the single the childless, the tenants and other fellow rank-and-file citizens. He cannot understand that it is the very type of person he likes as a legislator that is his undoing. For he prefers "con men" to seriously honest men.
Tax-Exempt Bonds
One of the biggest tax-exemption loopholes consists of state and municipal government and school bonds. Here, whether one draws $1,000 or $50 million of income, one pays absolutely no tax ever.
Very few people invest in such bonds and nearly all who do are very rich. Tax-exempt bonds are, clearly, a rich man's investment vehicle and are provided for this very purpose.
In the last available Treasury report issued about such bonds, the top 1/10 of 1 per cent of the population owned 45 per cent of all outstanding, the top 3/10 of 1 per cent owned 66 per cent and the top 1-1/2 per cent owned 87 per cent. 29 In short, no down-to-earth people own such bonds.
How many such bonds are outstanding? As of 1963 there were $85. 9 billion outstanding compared with only $17. 1 billion in 1945 . 30 One can see they are very popular with their buyers. At an average interest rate of 3 per cent, this amounts to $2. 577 billion of untaxed annual revenue falling into the hands of wealthy individuals and a few banks and insurance companies.
The ordinary man would not find such investments attractive, as he can get from 4 to 5 per cent on savings. The advantage enters through the leverage exerted by the tax-free feature as one ascends the formal income brackets.
As Mr. Stern has worked it out, for a person with a taxable income of $4,000 a 3 per cent tax-free bond is equal to a stock yielding 3. 75 per cent; for a person in the $20,000- $24,000 bracket to 4. 8 per cent; for a person in the $32,000-$36,000 bracket to 6 per cent; but to a person in the $88,000-$100,000 bracket it is equal to 10. 7 per cent on a stock.
On $140,000-$160,000 income it is equal to 15. 8 per cent on a stock, on $300,000- $400,000 income to 30 per cent on a stock and on everything above $400,000 it is equal to a blessed, flat, cold 33 per cent on a stock! Such a percentage return in a tax jungle is obviously worth reaching for.
As these bonds are secured by a lien on all the real estate taxes in their respective jurisdictions, they are absolutely without risk as to capital or payment of interest. In order to make as much taxable money, a high-income person would obviously have to invest in very risky enterprises that paid dividends of at least 33 per cent on invested capital. Not many established companies do this.
While some persons, like Delphine Dodge, put all their holdings into such securities, the average wealthy man puts only part of his fortune in them, thus reducing his total tax bill. A possible diversified portfolio and the taxes paid on it -might be as follows:
Investment Income
Tax
None
None
None
Total tax
None
Total tax
None
$100 million tax-free
bonds
$100 million oil
royalties
$100 million growth stocks
earning 15 per cent but
reinvesting all; no
dividend payout
Total Investment
$300 million
$3 million (cash)
$15 million (cash)
$15 million (accrued)
Total cash income
$18 million
Total accrued income
$15 million
Total real income
$33 million
But such a man's chauffeur, if single and receiving $6,000 a year, would have paid a tax of $1,130 a year at 1965 rates.
Not only is it possible, but it actually happens, that the house servants--chauffeurs, cooks, maids, gardeners--of some ultra-wealthy people pay income taxes and the employers pay none at all, year after year. For this, as one must understand, is a democracy where the lowly pay taxes but many of the rich do not.
In passing, very few Americans can afford to hire servants, and there are in fact few servants in the United States, which some naive souls take as proof of how "democratic" the country is. According to the 1960 census, there were only 159,679 private household workers "living in" in the entire country; they had a median wage of $1,178, were of a median age of 51. 6 years a only 26. 4 per cent of them were nonwhite. As some large estates harbor huge staffs of servants it is evident that this number distributes among a very small percentage. of rich families. Private household workers "living out" numbered at that time 1,600,125, had a median wage of $658, were of a median age of 44. 2 years and were 57. 3 per cent nonwhite. This latter group obviously makes up the part-time help of some of the urban middle class.
Even suburban families with two or three children in the $25,000 income-bracket find they cannot pay for a servant after taxes, educational and medical costs, car operation and ordinary running expenses. And even part-time servants in the United States are now a luxury confined to an extremely small group of people.
The Expense-Account Steal
A corporation that rewards its top executives opulently, so that after personal deductions each has $500,000 of taxable income a year, is cognizant that each Must pay, if married, an income tax of $320,980 or 60-plus per cent. According to one line of doctrine this "reduces incentive" to work like crazy for the dear old company; another doctrine feels it has little dampening effect on executive performance. 31
As the ascendant view, Congress concurring, is that incentives to make the United States ueber alles are reduced by high taxes on executive salaries, ways have had to be devised for putting additional but refreshingly tax-free money into the hands of discouraged upper corporate executives, among whom some of the big hereditary stockholders are included. The two major additional ways are (1) expense accounts and (2) cut-rate stock options. Many corporation executives derive most of their take-home pay from these two sources, insouciantly allowing the government to clip their direct- cash salaries up to 70 per cent.
In conducting a business, as anyone can see, an executive naturally incurs nonpersonal expenses for travel, hotel rooms, meals and tips away from home. If a good customer is casually present at mealtime the custom has also been long established of inviting him for a meal and perhaps a convivial drink or two.
But controversy over expense accounts does not relate to these facts of ordinary business life, which may be termed "proper expenses. " The controversy centers on "improper expenses," which are a much-criticized way of directing tax-free revenue into the hands of a corporation executive or representative, either giving him money he would not otherwise have had or relieving him of paying for luxurious recreation and diversion out of his own pocket and thereby reinforcing his personal finances while he has fun, fun, fun.
The controversy over expense accounts has succeeded in removing some of the more ludicrously blatant abuses, but in essentials the expense account remains a perfectly legal tax-evading racket. In the 1930's, for example, wealthy people formed special corporations to operate their yachts, racing stables and country estates; the operating cost was deducted as a business expense, thus reducing taxable income. One woman caused her personal holding company, which ran her country estate, to hire her husband at a generous salary to manage the place. His ample salary was a deductible expense before taxes! 32
In such cases standard corporate methods were applied to personal finances. And why not? If a corporation can do it, why not it profit-seeking individual? A spouse, from an accounting point of view, is clearly a deductible expense.
But, despite a narrowing of some expense-account latitude, the field is still rather wide open to free and fancy improvisation.
Almost institutional now are the business convention and regional sales meeting for industry and company go-getters. Here the tab for the milling throng is picked tip by the company or companies as a deductible expense. Everything is "on the house"--meals, cigars, wine and liquor, music, entertainment and fancy-free girls. The amount of business transacted at such affairs would be hard to detect with an electron microscope. Anthropologists have compared them with primitive saturnalian festivals, a lusty change of pace from the austere rigors of higher business life.
At one such hilariously confused affair the comely profit-oriented wife of a conventioneer, having heard to her innocent astonishment from some of the call girls in the powder room about the high fees they were getting, got herself on the payroll as a part-time nymph without informing her husband. She was duly installed in a hotel room
and a blind date was arranged for a certain hour. As she melodiously called "Come in" to the knock on the door at the appointed time, in walked her own husband.
Those sheltered readers who may consider this story farfetched and untrue are not aware of what has long been known to close observers of High Society: Some socialite women function as professional prostitutes--a fact finally recognized by the New York Times (August 14, 1967; 24:1) in its allusion during a survey of contemporary prostitution "to the socially prominent woman who grants her favors for up to $500 in a suite in one of New York's best hotels. "
From a pecuniary point of view there are distinct advantages to plying this trade at this social level. At $500 per seance, and with only one such choice seance per week, such a practitioner would gross $26,000 per year tax free. For the politicians have yet devised no way of levying a tax on this traffic or bringing it into the range of reportable income. The quest for tax-exempt income naturally turns the thoughts of some pecuniary- minded women in this direction.
Proper business expenses would be those defrayed by a salesman in traveling about to call on customers, or an executive on a plant-inspection tour. But such outlays on expense accounts are minor.
The larger expenses are incurred in providing elaborate entertainment for actual or potential customers, unnecessary entertainment for colleagues and business peers when the sole business topic is ordinary shop talk, and in providing executives with a wide range of recreational expenses. It is a succession of Roman holidays financed by the public.
As to lavishly entertaining customers, if it is done by individuals for their own account, the cost is tax deductible up to 70 per cent, which makes the government (i. e. , the general public pay for it up to 70 per cent. If the bill is paid by a corporation, all of it is deductible as it cost of doing business, paid for in prices.
Under the entertainment feature, corporations make lavish gifts to customers, particularly at Christmas time. A very minor gift is a case of whiskey, and corporation liquor purchases have been estimated at more than $1 billion annually. 33 Corporate gifts in general, involving Cadillacs and jewels, are estimated to exceed 82 billion. 34 The public bears such costs in price directly. Here is a big patronage sewer.
The Internal Revenue Bureau has fought many of the weirdest claims for deductions but has often lost in the tax courts to corporate-minded judges. The owner of a large dairy and his wife were allowed to deduct the $16,443 cost of a six-month African safari as an "ordinary and necessary" business expense because the showing of movies of their trip resulted in presumably beneficial advertising for the dairy. A well-known actress was allowed to deduct the cost of expensive gifts to her agent, dialogue director and dress designer. As she was in the upper brackets, the cost of the gifts was borne almost entirely by the government; she would, had she not made the gifts, have had to pay out most of this money to the government--that is, the general public. As it was, she garnered for herself some personal good will with it. 35
President John F. Kennedy proposed some mild curtailments in expense-account deductions but was largely over-ruled by Congress. Under his scheme the government would have picked up an estimated additional $250 million in taxes and would no longer have allowed deductions at public expense for theater and sports tickets, night clubs and the maintenance of yachts, hunting lodges and Caribbean hideaways.
Congress allowed such expenditures to remain tax deductible but stipulated that the maintenance of facilities like yachts, hunting lodges and tropical resorts would be disallowed unless they were used more than half the time for business purposes, not a
difficult provision to comply with. Making it a bit more annoying, Congress now required itemizing of expenses; previously itemizing was not necessary. But itemized lists are not difficult to supply.
Furthermore, country club dues could continue to be deducted only if more than half of club use was for business purposes (not difficult to show as business associates and customers are about all the average business member knows. ). The heavy dues and expenses of membership in the big metropolitan clubs, when in showdowns claimed as business clubs, are all deductible.
Under the new law, for business entertaining to be deductible, there must be some "possibility of conducting business affairs" and there may not be present "substantial distractions. " This appears to rule out theater parties, sports events and nightclubs though it does allow entertaining in luxury restaurants and at-home dinner parties. But there may be participation even in the presence of distracting events "directly preceding or following a substantial and bona fide business discussion," which opens the door wide again to sports events, bullfights, theaters, nightclubs and the like. As in the shell game, now you see it, now you don't.
"Some skeptics," says Stern, "foresee this major exception resulting in the strategic scheduling of 'substantial and bona fide business discussions' at such select times as the eve of the Rose Bowl game, or the Kentucky Derby--or even the heavyweight title fight. "
As one threads one's way back and forth through the yes-and-no fine print it becomes evident that anything goes for which the shadow of a claim can be made, including all- expense trips to Caribbean resorts, gifts of Cadillacs and objets d'art to key customers and the placing at the disposal of executives of fully serviced, chauffeured cars for business and personal use.
Said one businessman, a member of a coterie of business acquaintances whose companies picked up their lunch bills serially: "I haven't paid for my lunch in thirty-one years. " Credit cards are largely paid for by corporations; hence their wide use.
The basic intent of the improperly used expense account is to pay most of the recreational-entertainment bill of executives and some of the recreational bill of customers, and to siphon directly tax-free money into the pockets of upper sales personnel who are given expense accounts, no questions asked, of up to $700 to $900 per week. 36 They pay no tax on such largesse.
There is really no point in picking one's way through what is paid via the expense account and what is not paid: Basically, the whole recreational bill is put on the shoulders of the public, thereby relieving the beneficiaries of this considerable out-of- pocket expense.
Expense money may serve in lieu of salary and has the advantage of being nontaxable. In one case an unmarried president of a small eastern corporation was paid a salary of $25,000 on which he paid $8,300 taxes. He wanted no more because his company paid his apartment rent, club dues and expenses (meals and drinks), entertainment expenses and an occasional trip abroad "to study business methods overseas and improve his firm's competitive position. " He thus had the equivalent of a $98,000 salary on which income taxes would have been $62,600, nearly eight times what he actually paid! 37
Where a man has a stipulated expense account it is, of course, understood that he does not have to spend it all. Some of it is "keeping money," tax free. After all, who knows the difference?
One of the subjects faced by Congress in slightly revising the expense-account provisions was the business-mixed-with-pleasure trips of corporate husbands and wives. These latter are an indispensable feature of many business affairs and are fully tax deductible. When the ordinary citizen takes his wife out for a trip or entertainment he foots the bill fully; but for a man on the expense-account circuit she is fully deductible, a pleasant feature of corporate matrimony.
Whereas before Kennedy on a business-mixed-with-pleasure trip the whole cost was deductible, even if a brief conference in Europe or the Caribbean were followed by a prolonged vacation, under the new law when a trip lasts more than a week and where the pleasure component is greater than 25 per cent, only a partial deduction of transportation costs will be allowed unless it can be shown that the pleasure component was the prelude or the aftermath to portentous discussions. Then, apparently, the sky is the limit. While the percentage stipulated seems very precise it cannot, in fact, be applied.
What if a business executive and his wife (he can't do without her presence) journey to Rome where there is a business conference of half a day about a possible oil deal of $250 million? Now the man and his wife tour the Mediterranean for three to six weeks. Does one now measure the pleasure component by time, by intensity or by magnitude of outlay? If it is the latter, then it is a flea-bite in relation to the magnitude of the possible deal; if it is by time, then close to 99 per cent of the component has been pleasure. If the whole trip cost $12,000, how can this be reasonably questioned as an adjunct to a possible $250-million deal? The fact is, of course, that big deals can be, and have been, arranged with the expenditure of just 10 cents for a phone call. A large deal does not necessarily require expense outlays commensurate to its size, does not need to be arranged in a palace in the presence of dancing girls, whirling dervishes and musical clowns at a Lucullan feast. These are thrown in because they are diverting--and are at public expense.
Clarence B. Randall, former chairman of the Inland Steel Company, is a sharp critic of the expense-account racket, which he rightly sees as adding nothing of value to the economy and as conveying a damaging image abroad of the American businessman's way of life. 38 But he is a minority of one in the business community, as far as the record shows.
The New York pleasure-belt, extending roughly from 34th to 59th Streets and First to Eighth Avenues, is largely supported by expense-account deductions--that is, by the general public. This was made evident when leading restaurateurs and theatrical producers, supported by their congressmen, protested to Congress that they would go out of business if the Kennedy proposals became law. A host of expensive shops would also presumably go under.
Although all these establishments are regarded as play areas of the rich, not many rich people would patronize them if they had to pay for them with their own money. For a wealthy man, often in mortal fear of being considered a sucker, is more apt to overrate than to underrate the value of a dollar. If he spends, he prefers that it is other people's money.
This whole area, where the mere serving of a meal may be a ceremony rivaling the High Mass of the Catholic Church, is underwritten by the general public in the price paid for goods and in lost tax money made up by the lower brackets.
New York City is the Mecca of the nation's big retail establishments, which send buyers there by the hundreds. These buyers, man and wife, are ordinarily royally entertained, providing many a tale for telling at the home-town country club. If, however, no entertaining whatever were done, tax deductible or not, would the nation's
total of business suffer? Would the buyers refuse to buy and the customers at home go unappeased?
While it is true that all this may make business more pleasant and exciting, it would make everything more pleasant and exciting if such tax-supported antics were available to everyone. If two scholars have lunch and incidentally discuss the number of commas in Chaucer's writings, should not the lunch be tax deductible? If a physician or lawyer takes acquaintances to dinner, should the cost not be tax deductible on the ground that they might some day become patients or clients? What if two philosophers meet to discuss the cosmos? This is obviously a large matter, larger than a merger of all companies into one. Should they not be tax exempt for life? Does not the government really owe them billions in view of the magnitude of their task? Why should not the ordinary office worker's lunch be tax deductible? Is not the lunch an "ordinary and necessary" expense ancillary to carrying on business?
Should not, by the same line of reasoning, everybody's outlays for anything--food, housing, clothing, chewing gum, tobacco, entertainment--be tax deductible? Is not clothing an "ordinary and necessary" expense for attending to one's job? Could one show up for work clad only in a pair of slippers?
If business expenses, proper and improper, are all deductible, why should not all personal expenses be similarly deductible under the principle of equality under the law?
The Stock-Option Racket
A far more lucrative way of deriving income and evading taxes is by means of executive stock options, which have become increasingly used since World War II.
The essence of the stock-option scheme is that it allows its designated beneficiaries, few in number, to purchase stock at steeply reduced rates. Some price is arbitrarily set at which a favored group of executives, often including large hereditary owners, may buy stock after a certain date. The benefiting executives are supposed to scheme harder in order to enhance the underlying value of the company, thus giving themselves profits. Naturally, if the economy were sinking, no matter how hard they schemed the value of the company would not increase; it increases only as the company participates in an expanding economy, which has nothing to do with the efforts of the executives (with some exceptions).
The way it works is as follows:
Certain high-salaried executives are told that they may within three years buy a block of stock in the company, if they wish, at $5O a share. It is now selling at $45. After three years, let us say, the stock has risen to $125. As they each decide to buy the allotted number of shares, usually running into many thousands, they pay $50 for a stock worth in the market $125, or $75 per share instant profit. If they now sell this stock they pay a maximum 25 per cent tax on the gain or they may retain the stock and pay no tax at all.
But what if the stock fails to advance or declines? This is too bad and in that case the options, with nothing lost, are not exercised and expire. But in many cases of record, when this has happened, the board of directors simply voted that the option price be reduced, from perhaps $45 to $20. This made it possible to buy the stock at a discount of $25, and the purchase of sufficient additional shares might be allowed to permit as great a profit as if the stock had advanced to $125 under the original option.
The option plan clearly allows its preferred beneficiaries to buy stock at a discount and hold on to it, paying no tax, or to sell it and pay a relatively low tax on the increment. An executive need not, indeed, put any of his own money into the deal at all because
most issues listed on the Stock Exchange are good for a bank loan at 50 per cent of their market value at any time. If the option price is at least 50 per cent of the market price, a bank will put up all of it, gladly, and the executive need then, after holding the shares a few months, simply sell them to lift off the low-tax capital gain. Smooth, smooth, smooth. . . .
But stock options always dilute the equity of stockholders, large and small. In the case of large stockholders, these sometimes participate in the option plans themselves, thus experiencing no dilution of equity; but in some cases large stockholders concur without participating, apparently feeling it is worth it to them to get this tax-favored extra compensation into the hands of aggressive higher executives.
If a group of executives elect to keep their stock, as did the leading executives of General Motors over the years, they may in time become independently wealthy. Alfred E. Sloan and others of the well-known executives in Du Pont-controlled General Motors from the 1920's to the 1950's were big stock-option men.
There is no risk involved in exercising these options. It is all as difficult as shooting fish in a barrel. And much of the gain involved stems from the reduced or nonexistent tax. If these acquisitions of value were taxed at the same rate as the corporate salary, it would be virtually impossible for big corporation executives to become tycoons on their own account, as a few have become. It is the tax-exempt feature, paid for all the way by the public, that enables them to emerge as financial kingpins, ,vithout performance of any commensurate service.
Specific cases under these general observations fully support everything that has been said.
Another device for income splitting, thus obtaining lower taxes, is to establish many corporations in place of one. In one of many instances a finance business split into 137 corporations to avoid $433,000 of taxes annually, and a retail chain divided itself into 142 corporations to avoid $619,000 annually. 22 The surest way of keeping money today is to steer a proper course through the crazy-quilt tax laws.
Additional Tax Dodges
A man who is sixty-five or over, in the best of health, gets an additional deduction of $600 whether his income is $1,000, $10:000, $100,000 or $1 million, although most people over sixty-five have little income at all beyond meager Social Security. But if he is in chronic poor health, unable to work except spasmodically, and under sixty-five, even if he is sixty-four--no extra deduction. A blind person gets an extra exemption of $600, suggesting to the reader of tax instructions that he lives under a Congress with a heart. But if a person retains his sight and is stone deaf, without hands, has had a stroke or is paralyzed from the waist down he does not get this compassionate exemption.
Whenever such a disparity is pointed out to Congress it usually gladly, in the name of consistency and equity, spreads the inequity to include others. We may, therefore, soon see Congress giving an exemption to all disabled or physically handicapped people, thereby further narrowing the tax base.
The point here is not whether a person is handicapped but whether he has income. What value is an extra exemption to a blind, disabled or aged person who has no income" The only person such an exemption could benefit would be one with an income. And all such special exemptions are taken by persons with incomes--often very substantial incomes. They are props to financial strength, not supports of weakness.
Just how much good the exemptions for over age sixty-five do may be seen by considering the income statistics for 1962, the latest year available. Of 7. 4 million male income recipients over sixty-five years old, 18. 6 per cent got less than $1,000 gross; 34 per cent, from $1,000 to $2,000; 18. 4 per cent, from $2,000 to $3,000; and 9. 9, from $3,000 to 84,000--80. 9 per cent under $4,000 gross. Of 7,491,000 female recipients 56. 2 per cent got less than $1,000; 30 per cent, from $1,000 to $2,000; and 6. 7 per cent, from $2,000 to $3,000--92. 9 per cent under $3,000 gross. 23 Much of this income was from tax-free Social Security, which averaged $74. 33 per month in October, 1965.
In other words, exemptions for persons over sixty-five can be of significant advantage only to affluent persons, property owners, retired corporation executives on large pensions with big stock bonuses and upper professionals who have managed to save and invest. Like marital income splitting and deductions for children, it is of significant advantage only if one has a large, preferably unearned income.
For a man in the 70-per-cent tax bracket each such exemption is worth in cash 70 per cent. For a person with zero income it is worth zero. In order to benefit slightly from the extra exemptions for being over sixty-five and blind, a single person using the standard deduction must have in excess of $2,000 taxable income. If he receives $4,001, he will pay tax on $1,800 (standard deduction plus three exemptions) or $294. But, having saved $80 by being blind, he will then be in a minority income group of less than 20 per
cent of over-aged males! He will, despite the smallness: of his income, be in a small, highly privileged income group. If it is a woman with an income of $3,001, she will pay $146--but she will then, despite the smallness of her income, be in a restricted group of less than 8 per cent of overaged females!
The tax deductions for the aged, blind and retired are of significant benefit only if one belongs to a small group of persons with taxable incomes higher than 81. 8 per cent of the males and 92. 9 per cent of the females actually do have. The ones most benefited are the affluent aged, blind and retired.
These income statistics for the aged throw a curious light on the propaganda about the United States as a land of opportunity, the richest country in the world and the home of the individual-success system. Under this system, most people, economically, appear to be failures at the end of the road. And were it not for Social Security, the figures in each of the income brackets cited would, on the average, be about $900 less.
Some hidden hand, force or influence appears to cause most people, after a lifetime of effort, to show up very patently as losers. Could prices, taxes and overpersuasive advertising, as well as individual shortcomings, have anything to do with the result? With only 19. 1 per cent of over-age males having a gross income above $4,000 and 7. 1 per cent of retired females above $3,000, economic success does not appear to have crowned the efforts of most survivors in the most opulent land ever known to history.
In drawing the tax laws Congress is no more being sentimental than when it temporarily exempts the father of twelve from battle duty. Although individual congressmen no doubt have their personal points of view on all of this, collectively Congress in drawing the tax laws is absolutely indifferent to whether one is poor, married, has children or has personal disabilities. But it is not indifferent if one has property or a well-paid position. Then it is most enthusiastically on one's side.
Congress, as we have noted, likes students. It likes them so much that if one is able to gain a scholarship or fellowship he need pay no tax at all on it, an educational exemption, up to $300 a month for thirty-six months and even if the scholarship adds considerably to family income. Scholarships are awarded by many endowed colleges and special bodies, but many corporations now earmark scholarship funds given, for example, to the National Merit Scholarship Fund. Some funds are not earmarked, but the earmarked funds are for the children of emplovees (usually executives) of the company. The granting of the scholarship has the hidden effect of giving the father an untaxed pay raise and the corporation a pre-tax deduction, paid by consumers and small taxpayers. The father will not now have to pay his own taxed money for tuition. And in known cases students of lower standing in test examinations and lower academic standing have drawn earmarked scholarships while students of higher standing have drawn none, even as the public supposes the scholarships are awarded on the basis of strictly on-the-record merit.
For nonabilitv factors are taken into consideration in this quarter, too, as in the hiring of people of negative ethnicity. 24
Divide and Prevail
My object in going into this small stuff is to make this point: Congress is not really sentimental at all but is just busy dividing the taxpayers into separately manageable little bands of over-reachers, each of whom feels particularly and unwarrantably virtuous about some feature of his status--that he is married, has children, has a student in school, contributes to a church, has one out of many possible disabilities, is over sixty-five or was never arrested while robbing the Bank of England on a bicycle ridden on a high wire with a monkey on his back.
A congressman might deny this, might hold that the body is really sentimental, and point out that payments under Social Security and the Railroad Retirement Act are tax exempt entirely. But every recipient of Social Security and retirement provisions is not automatically entitled to special sympathy. A number of them are survivors from among many who have succumbed before them and as such, someone might argue, ought to pay a special tax--or at least be taxed equally with others. A long-employed utility- company executive, no risk competitor, who retires at age sixty-five with a pension of $40,000, a rather standard figure for his industry, plus owning accumulated stock, money in the bank and a large home, may draw the maximum Social Security payment, tax free, plus the special exemption for over age sixty-five. Upper-bracket officials of long service in their personally owned corporations as well as lower-bracket wage- earners are equally under Social Security and get the same tax exemption whether they need it or not.
When the average man retires, his income drops sharply. But when an executive or owner who has worked over the years for his own company retires, his income from stocks, bonds, pensions, annuities, etc. , does not decline. Yet he gets untaxed Social Security payments as well as the poorer man, showing again the equality of the law in all its majesty. .
Untaxed Income
While the average man, chuckling to himself, is stooping over picking up the sops a cynical Congress has laid out for him, his pocket is being emptied from behind. As he has elected to trade punches with the champion, let us see how he fares.
Ninety per cent of people, more or less, own no stock and receive no dividends. But people who own stock receive the first $100 of dividends tax free; a husband and wife each owning stock get $200 tax free. However, so-called dividends from mutual savings banks and building and loan associations, usually received by low-income people, do not qualify for this strange deduction.
Furthermore, dividends paid in stock or in "rights" to subscribe to stock pay no tax at all even though the company has taken money from earnings with which to increase invested capital. This feature of the laws explains the popularity of the stock dividend: It is tax free.
The stockholder is in a more favored tax position than even this shows because most companies do not pay out all their earnings in dividends. The dividend payout rate varies among companies from zero to 80 or 90 per cent but averages at about 44 per cent.
What this betokens is that accrued earnings, not paid out, are credited to the capital account and amount to so much untaxed money at work for the stockholder.
Let us imagine that someone owns 100 shares in a company that earns an average of $10 a share but pays out an average of $5 a share in dividends. The stockholder receives $500, deducts $100, and puts $400 into his gross taxable income. But the $500 not paid out is at work for him in the company, growing each year. It is tax-free unearned capital. But if a wage worker receives a $500 bonus at year-end and the employer deposits it in a bank for his account, the $500 must be reported as taxable income and will be taxed. Not to pay a tax on it would be a violation of law, and punishable.
Some companies, although they are big earners, pay no dividends at all. Known as "growth companies," they grow by leaps and bounds. If a man invests $10,000 in such a growth company and it grows at 10 per cent a year (rather modest for a growth company) the investment will be worth $16,105 at the end of five years and $20,600 in
a little more than seven years. On all this accrual he has paid no taxes, yet is becoming wealthier and wealthier.
If he decides to take his profit at $20,000 he will pay a maximum of 25 per cent (he might pay less) on $10,000, or $2,500. But he need not do this at all, need never sell and never pay a tax.
When he eventually dies, his heirs will not be liable at all for a capital gain tax even if the original investment of $10,000 has grown to $50 million. Nor need they even pay estate taxes if he has prudently placed it in trust funds for their benefit. While his heirs may receive from him stock worth $50 million, his estate tax may be zero so that all along there has been incurred no income tax, no capital gains tax and no estate tax.
But if he split the original investment of $10,000 among four trust funds, at his death four beneficiaries would have estates worth $12. 5 million each, on which there had never been paid income taxes, capital gains taxes, gift taxes or estate taxes. All would be completely legal.
This road to wealth is not only theoretically possible but is actually traveled in various degrees by many of the rich, as their final accountings show. They die stripped of assets.
The amount of untaxed undistributed profits of corporations each year is very large. In 1950 it was $16 billion. It was $16. 5 billion in 1955, lowered to $10. 8 billion in 1958, rose to $15. 9 billion in 1959. Since then it has ranged between $13. 2 billion to $16. 8 billion in 1963. 25 Since 1946 it has always been each year more than $10 billion. Like money in the bank, the beneficiaries pay no tax on any of it. It is this feature that enables major stockholders to become constantly richer, tax free.
Retained corporate profits, mostly reinvested, have exceeded dividends Since 1962 and in 1965 totaled $25. 6 billion against $18. 9 billion of dividends. They also exceeded dividends in every year from 1946 through 1959, with the exception of 1958, often by a very wide margin; in 1947 and 1948 they were more than double the dividend payout. 26
From 1945 through 1965 total corporate dividends paid out amounted to $226. 9 billion compared with $296. 2 billion of profits retained, as shown by the immediately preceding source. The actual payout rate has been a shade more than 44 per cent. Retained profits and increased earnings on them have been among the more solid reasons for the increase in market value of stocks.
Not to pay dividends is an accepted maxim of tax economists. In the words of one tax advice service, "paying dividends is clearly a tax waste. " 27
The retention and reinvestment of corporate profits is the royal road to tax avoidance and financial expansion, at home and abroad. Abroad it is the basis of what is known as American economic imperialism. It requires, of course, the maintenance of a vast "defensive" military establishment largely paid for by the less affluent lower taxpayers. The aggrandizing foreign investments, like the domestic investments, are largely made by corporations with tax-free money!
Under the Eisenhower Administration, as we have observed, the dividend tax credit passed in 1954 enabled big stockholders to make a killing while small stockholders gained very little, the usual pattern of the tax laws. With fewer than 1 per cent of all families holding more than 70 per cent of all stock by value, it is clear that very few could be advantaged by this law. As Mr. Stern shows, a man who had a tax bill of $2,020 and had received dividends of $500 would reduce his tax by $20 under the Eisenhower law. But for 306 top taxpayers, with an average dividend income of nearly a million dollars, we have noted the dividend credit meant an average $40,000 in cold cash for each. Quite a difference. 28
Tax-Exempt Medicine--for the Rich
As the wealthy person has more money available, he can always purchase more tax- deductible medical services than the average man. A married taxpaver is limited to a maximum $20,000 medical deduction, a great deal even for a rich man, and to the excess over 1 per cent of taxable income for drugs and medicines.
But if the taxpayer has an employer who pays his medical and hospital expenses, these are exempt from taxes, which is very handy for the company executives who often enjoy this "fringe benefit. " For the ordinary taxpayer any wages paid as "sick pay" are exempt up to $100 a week after a waiting period, but not many figure in such arrangements. Those persons retained by companies that make this a practice obviously enjoy a differential tax advantage over most taxpayers.
Corporation executives often enjoy free medical services, for themselves and their families, from fulltime company medical departments. This amounts to so much tax- free medicine, which is charged to consumers in price and to general taxpayers. High public officials, it must be noted, also often come in for such free medical services at various of the up-to-date governmental military hospitals. Former high officials also participate through the courtesy of incumbents, whom they publicly back when controversy rises.
If he has no organization he can charge for the medical services, the rich man does have up to $20,000 of medical attention each year as a tax-free deduction from spendable income, thus reducing his taxable income. In the 70-per-cent bracket this is worth $14,000, cash.
Most persons in the country never enjoy the services of a doctor until they are in extremis or a doctor must be called in to pronounce them dead. This is because they cannot afford a doctor and instead rely on the nearby pharmacist in all poorer neighborhoods referred to as "Doc. " Their prescriptions are whatever proprietary drugs he recommends. The pleasant-sounding medical deduction, then, is of no service to the many persons without money to spare for doctors and medicine.
Lucrative Charities
One may deduct up to 30 per cent of gross adjusted income for contributions to charities, and if contributions exceed 30 per cent in any one year they may be spread over five years. As most taxpayers manifestly cannot make contributions on such a scale, the provision is obviously of service only to the wealthy.
While the contributions may be made to existing bodies, most of the wealthy prudently decide to make them to their own charitable foundations, which are run as helpful adjuncts to their other affairs.
Oddly enough, one's financial power in society increases as one "gives" money to a personally owned foundation, proving that it is more profitable to "give" than to receive. If a certain man has a million-dollar taxable income (he has made all deductions), he is liable for $660,980 in taxes under the 1965 or nearly 70 per cent flat. But he can still make a charitable contribution for a deduction of $300,000. If he does, his tax will be only $450,980, a tax saving of $210,000. But as he has "given" $300,000 it looks as though he is deprived of $90,000 more than if he had paid straight tax.
But what he has "given" he has given to his own foundation, and he can invest this money in stocks of his own companies and thereby maintain profitable control. Again, the earning power of this $300,000 (at least $15,000 a year) is now tax free itself, greatly increasing its effectiveness. It will recoup his $90,000 out-of-pocket cost in at most six years and thereafter show a tax-free profit. He has more income to dispose of
now in "philanthropic" patronage than if he had retained his taxed earnings and invested or spent them, for the proceeds of such retained money would be taxed.
What does his foundation contribute to? It contributes, as actual cases show, to laboratories seeking cures for various diseases. Surely this is entirely worthy, and so it is. But what do the corporations make that he controls? They may make medicines that are sold at a profit for the cure of various diseases, and any discoveries made by the laboratories to which his taxfree foundations "give" money will be utilized by his medicine-making corporations in making further profits. But few such discoveries will be available to impecunious people. It usually takes money to buy medicines.
"Charity" under our tax laws can be highly profitable. It can be monetarily more profitable, indeed, than noncharity.
Big Killings via Interest
Interest received, except from tax-exempt bonds, is taxable, Every man who gets interest from a bank account, a mortgage or on a federal or corporate bond is liable for taxes on it.
Interest paid out, on the other hand, is 100 per cent deductible. The man who buys an automobile or household appliance on the installment plan may deduct the interest paid before computing his income tax, just like the man who deducts for the payment of $100,000 of interest a year on a margined stock-market account. For the latter, the interest is deductible as an expense of doing business, and in the 70-per-cent bracket is worth to him $70,000. His true interest outlay is only 30 per cent of the face amount.
All such big interest payments are of major advantage to the big operators in stocks, real estate and oil lands who borrow a great deal in order to contrive their killings, which are sometimes sure things--as in the case of the metropolitan realty operators who "mortgage out. "
Where interest paid as a deduction most obviously divides the population, placing another large number in the role of sucker and an apparent large number among the advantaged, is in the matter of home ownership. While tenants, in the form of rent, pay all costs, including mortgage interest and taxes of the owner, the home owner may deduct on his federal tax return interest he pays on his mortgage and his local real estate taxes. On a $30,000 house in which he has a $10,000 equity the home owner may pay 5 per cent perhaps on a $20,000 mortgage, or $1,000; his taxes may be $500; and he may reasonably figure 3 or 4 per cent for depreciation, repairs and maintenance, or $900- $1,200. His rent, then, exclusive of heating, is minimally $2,400. But if he is married and has a $10,000 taxable income he may first deduct the interest payment of $1,000 and then the real estate tax of $500. At the 22 per cent rate for that bracket the deduction is worth $330, bringing his actual rent down to $2,070 or $172. 50 per month. A tenant would have to pay considerably more per month plus some entrepreneurial profit to the owner; he would probably have to pay from $225 to $275 per month, possibly more.
While this seems to give home owners a bit of an edge over tenants (I have omitted items like cost of insurance), Congress is not especially fond of home owners either. It has much bigger game in mind. With home owners sitting contentedly chewing their little tidbit, knowing they are slightly better off taxwise than tenants, the interest deduction meanwhile has opened some large gaps in the tax laws through which profit- hungry elements churn like armored divisions through Stone Age club-wielders.
First, for the wealthy man with many houses and country estates, both the realty tax and interest deductions amount to windfalls. If a million dollars of such residential property is mortgaged up to half at 5 per cent, there is a total interest charge of $25,000. But in the 70-per-cent bracket only $7,500 of this represents an out-of-pocket payment.
Whatever the realty tax bill is, only 30 per cent of it represents an out-of-pocket payment. The same situation applies with respect to personally owned cooperative luxury apartments; the general taxpayers defray up to 70 per cent of the interest and realty tax outlay.
The interest and realty tax deductions, then, are extraordinarily valuable to holders of extensive properties.
But this is only the beginning of the story.
Metropolitan real estate operators, as we have observed, use interest as a ]ever with which to "mortgage out" and then obtain tax-free income.
Here, in other words, is the real milk of the interest deduction coconut. Whereas the average home owner is getting away with peanuts at the expense of tenants, both tenants and home owners in the end must make up out of other taxes they pay, mainly in the form of prices, what the big operators have been able to avoid paying on their profits.
Congress, although not loving home owners, is surely infatuated with big real estate and stock-margin operators. And why not? It is these chaps who have the money to kick in for campaign funds, always a matter of concern to the officeholder.
One may agree that the ordinary citizen is entitled to complain. He knows he is in some sort of squeeze. But, politically illiterate, he clearly does not realize its nature nor does he see that he won't get out of it by obtaining some petty advantage over the single the childless, the tenants and other fellow rank-and-file citizens. He cannot understand that it is the very type of person he likes as a legislator that is his undoing. For he prefers "con men" to seriously honest men.
Tax-Exempt Bonds
One of the biggest tax-exemption loopholes consists of state and municipal government and school bonds. Here, whether one draws $1,000 or $50 million of income, one pays absolutely no tax ever.
Very few people invest in such bonds and nearly all who do are very rich. Tax-exempt bonds are, clearly, a rich man's investment vehicle and are provided for this very purpose.
In the last available Treasury report issued about such bonds, the top 1/10 of 1 per cent of the population owned 45 per cent of all outstanding, the top 3/10 of 1 per cent owned 66 per cent and the top 1-1/2 per cent owned 87 per cent. 29 In short, no down-to-earth people own such bonds.
How many such bonds are outstanding? As of 1963 there were $85. 9 billion outstanding compared with only $17. 1 billion in 1945 . 30 One can see they are very popular with their buyers. At an average interest rate of 3 per cent, this amounts to $2. 577 billion of untaxed annual revenue falling into the hands of wealthy individuals and a few banks and insurance companies.
The ordinary man would not find such investments attractive, as he can get from 4 to 5 per cent on savings. The advantage enters through the leverage exerted by the tax-free feature as one ascends the formal income brackets.
As Mr. Stern has worked it out, for a person with a taxable income of $4,000 a 3 per cent tax-free bond is equal to a stock yielding 3. 75 per cent; for a person in the $20,000- $24,000 bracket to 4. 8 per cent; for a person in the $32,000-$36,000 bracket to 6 per cent; but to a person in the $88,000-$100,000 bracket it is equal to 10. 7 per cent on a stock.
On $140,000-$160,000 income it is equal to 15. 8 per cent on a stock, on $300,000- $400,000 income to 30 per cent on a stock and on everything above $400,000 it is equal to a blessed, flat, cold 33 per cent on a stock! Such a percentage return in a tax jungle is obviously worth reaching for.
As these bonds are secured by a lien on all the real estate taxes in their respective jurisdictions, they are absolutely without risk as to capital or payment of interest. In order to make as much taxable money, a high-income person would obviously have to invest in very risky enterprises that paid dividends of at least 33 per cent on invested capital. Not many established companies do this.
While some persons, like Delphine Dodge, put all their holdings into such securities, the average wealthy man puts only part of his fortune in them, thus reducing his total tax bill. A possible diversified portfolio and the taxes paid on it -might be as follows:
Investment Income
Tax
None
None
None
Total tax
None
Total tax
None
$100 million tax-free
bonds
$100 million oil
royalties
$100 million growth stocks
earning 15 per cent but
reinvesting all; no
dividend payout
Total Investment
$300 million
$3 million (cash)
$15 million (cash)
$15 million (accrued)
Total cash income
$18 million
Total accrued income
$15 million
Total real income
$33 million
But such a man's chauffeur, if single and receiving $6,000 a year, would have paid a tax of $1,130 a year at 1965 rates.
Not only is it possible, but it actually happens, that the house servants--chauffeurs, cooks, maids, gardeners--of some ultra-wealthy people pay income taxes and the employers pay none at all, year after year. For this, as one must understand, is a democracy where the lowly pay taxes but many of the rich do not.
In passing, very few Americans can afford to hire servants, and there are in fact few servants in the United States, which some naive souls take as proof of how "democratic" the country is. According to the 1960 census, there were only 159,679 private household workers "living in" in the entire country; they had a median wage of $1,178, were of a median age of 51. 6 years a only 26. 4 per cent of them were nonwhite. As some large estates harbor huge staffs of servants it is evident that this number distributes among a very small percentage. of rich families. Private household workers "living out" numbered at that time 1,600,125, had a median wage of $658, were of a median age of 44. 2 years and were 57. 3 per cent nonwhite. This latter group obviously makes up the part-time help of some of the urban middle class.
Even suburban families with two or three children in the $25,000 income-bracket find they cannot pay for a servant after taxes, educational and medical costs, car operation and ordinary running expenses. And even part-time servants in the United States are now a luxury confined to an extremely small group of people.
The Expense-Account Steal
A corporation that rewards its top executives opulently, so that after personal deductions each has $500,000 of taxable income a year, is cognizant that each Must pay, if married, an income tax of $320,980 or 60-plus per cent. According to one line of doctrine this "reduces incentive" to work like crazy for the dear old company; another doctrine feels it has little dampening effect on executive performance. 31
As the ascendant view, Congress concurring, is that incentives to make the United States ueber alles are reduced by high taxes on executive salaries, ways have had to be devised for putting additional but refreshingly tax-free money into the hands of discouraged upper corporate executives, among whom some of the big hereditary stockholders are included. The two major additional ways are (1) expense accounts and (2) cut-rate stock options. Many corporation executives derive most of their take-home pay from these two sources, insouciantly allowing the government to clip their direct- cash salaries up to 70 per cent.
In conducting a business, as anyone can see, an executive naturally incurs nonpersonal expenses for travel, hotel rooms, meals and tips away from home. If a good customer is casually present at mealtime the custom has also been long established of inviting him for a meal and perhaps a convivial drink or two.
But controversy over expense accounts does not relate to these facts of ordinary business life, which may be termed "proper expenses. " The controversy centers on "improper expenses," which are a much-criticized way of directing tax-free revenue into the hands of a corporation executive or representative, either giving him money he would not otherwise have had or relieving him of paying for luxurious recreation and diversion out of his own pocket and thereby reinforcing his personal finances while he has fun, fun, fun.
The controversy over expense accounts has succeeded in removing some of the more ludicrously blatant abuses, but in essentials the expense account remains a perfectly legal tax-evading racket. In the 1930's, for example, wealthy people formed special corporations to operate their yachts, racing stables and country estates; the operating cost was deducted as a business expense, thus reducing taxable income. One woman caused her personal holding company, which ran her country estate, to hire her husband at a generous salary to manage the place. His ample salary was a deductible expense before taxes! 32
In such cases standard corporate methods were applied to personal finances. And why not? If a corporation can do it, why not it profit-seeking individual? A spouse, from an accounting point of view, is clearly a deductible expense.
But, despite a narrowing of some expense-account latitude, the field is still rather wide open to free and fancy improvisation.
Almost institutional now are the business convention and regional sales meeting for industry and company go-getters. Here the tab for the milling throng is picked tip by the company or companies as a deductible expense. Everything is "on the house"--meals, cigars, wine and liquor, music, entertainment and fancy-free girls. The amount of business transacted at such affairs would be hard to detect with an electron microscope. Anthropologists have compared them with primitive saturnalian festivals, a lusty change of pace from the austere rigors of higher business life.
At one such hilariously confused affair the comely profit-oriented wife of a conventioneer, having heard to her innocent astonishment from some of the call girls in the powder room about the high fees they were getting, got herself on the payroll as a part-time nymph without informing her husband. She was duly installed in a hotel room
and a blind date was arranged for a certain hour. As she melodiously called "Come in" to the knock on the door at the appointed time, in walked her own husband.
Those sheltered readers who may consider this story farfetched and untrue are not aware of what has long been known to close observers of High Society: Some socialite women function as professional prostitutes--a fact finally recognized by the New York Times (August 14, 1967; 24:1) in its allusion during a survey of contemporary prostitution "to the socially prominent woman who grants her favors for up to $500 in a suite in one of New York's best hotels. "
From a pecuniary point of view there are distinct advantages to plying this trade at this social level. At $500 per seance, and with only one such choice seance per week, such a practitioner would gross $26,000 per year tax free. For the politicians have yet devised no way of levying a tax on this traffic or bringing it into the range of reportable income. The quest for tax-exempt income naturally turns the thoughts of some pecuniary- minded women in this direction.
Proper business expenses would be those defrayed by a salesman in traveling about to call on customers, or an executive on a plant-inspection tour. But such outlays on expense accounts are minor.
The larger expenses are incurred in providing elaborate entertainment for actual or potential customers, unnecessary entertainment for colleagues and business peers when the sole business topic is ordinary shop talk, and in providing executives with a wide range of recreational expenses. It is a succession of Roman holidays financed by the public.
As to lavishly entertaining customers, if it is done by individuals for their own account, the cost is tax deductible up to 70 per cent, which makes the government (i. e. , the general public pay for it up to 70 per cent. If the bill is paid by a corporation, all of it is deductible as it cost of doing business, paid for in prices.
Under the entertainment feature, corporations make lavish gifts to customers, particularly at Christmas time. A very minor gift is a case of whiskey, and corporation liquor purchases have been estimated at more than $1 billion annually. 33 Corporate gifts in general, involving Cadillacs and jewels, are estimated to exceed 82 billion. 34 The public bears such costs in price directly. Here is a big patronage sewer.
The Internal Revenue Bureau has fought many of the weirdest claims for deductions but has often lost in the tax courts to corporate-minded judges. The owner of a large dairy and his wife were allowed to deduct the $16,443 cost of a six-month African safari as an "ordinary and necessary" business expense because the showing of movies of their trip resulted in presumably beneficial advertising for the dairy. A well-known actress was allowed to deduct the cost of expensive gifts to her agent, dialogue director and dress designer. As she was in the upper brackets, the cost of the gifts was borne almost entirely by the government; she would, had she not made the gifts, have had to pay out most of this money to the government--that is, the general public. As it was, she garnered for herself some personal good will with it. 35
President John F. Kennedy proposed some mild curtailments in expense-account deductions but was largely over-ruled by Congress. Under his scheme the government would have picked up an estimated additional $250 million in taxes and would no longer have allowed deductions at public expense for theater and sports tickets, night clubs and the maintenance of yachts, hunting lodges and Caribbean hideaways.
Congress allowed such expenditures to remain tax deductible but stipulated that the maintenance of facilities like yachts, hunting lodges and tropical resorts would be disallowed unless they were used more than half the time for business purposes, not a
difficult provision to comply with. Making it a bit more annoying, Congress now required itemizing of expenses; previously itemizing was not necessary. But itemized lists are not difficult to supply.
Furthermore, country club dues could continue to be deducted only if more than half of club use was for business purposes (not difficult to show as business associates and customers are about all the average business member knows. ). The heavy dues and expenses of membership in the big metropolitan clubs, when in showdowns claimed as business clubs, are all deductible.
Under the new law, for business entertaining to be deductible, there must be some "possibility of conducting business affairs" and there may not be present "substantial distractions. " This appears to rule out theater parties, sports events and nightclubs though it does allow entertaining in luxury restaurants and at-home dinner parties. But there may be participation even in the presence of distracting events "directly preceding or following a substantial and bona fide business discussion," which opens the door wide again to sports events, bullfights, theaters, nightclubs and the like. As in the shell game, now you see it, now you don't.
"Some skeptics," says Stern, "foresee this major exception resulting in the strategic scheduling of 'substantial and bona fide business discussions' at such select times as the eve of the Rose Bowl game, or the Kentucky Derby--or even the heavyweight title fight. "
As one threads one's way back and forth through the yes-and-no fine print it becomes evident that anything goes for which the shadow of a claim can be made, including all- expense trips to Caribbean resorts, gifts of Cadillacs and objets d'art to key customers and the placing at the disposal of executives of fully serviced, chauffeured cars for business and personal use.
Said one businessman, a member of a coterie of business acquaintances whose companies picked up their lunch bills serially: "I haven't paid for my lunch in thirty-one years. " Credit cards are largely paid for by corporations; hence their wide use.
The basic intent of the improperly used expense account is to pay most of the recreational-entertainment bill of executives and some of the recreational bill of customers, and to siphon directly tax-free money into the pockets of upper sales personnel who are given expense accounts, no questions asked, of up to $700 to $900 per week. 36 They pay no tax on such largesse.
There is really no point in picking one's way through what is paid via the expense account and what is not paid: Basically, the whole recreational bill is put on the shoulders of the public, thereby relieving the beneficiaries of this considerable out-of- pocket expense.
Expense money may serve in lieu of salary and has the advantage of being nontaxable. In one case an unmarried president of a small eastern corporation was paid a salary of $25,000 on which he paid $8,300 taxes. He wanted no more because his company paid his apartment rent, club dues and expenses (meals and drinks), entertainment expenses and an occasional trip abroad "to study business methods overseas and improve his firm's competitive position. " He thus had the equivalent of a $98,000 salary on which income taxes would have been $62,600, nearly eight times what he actually paid! 37
Where a man has a stipulated expense account it is, of course, understood that he does not have to spend it all. Some of it is "keeping money," tax free. After all, who knows the difference?
One of the subjects faced by Congress in slightly revising the expense-account provisions was the business-mixed-with-pleasure trips of corporate husbands and wives. These latter are an indispensable feature of many business affairs and are fully tax deductible. When the ordinary citizen takes his wife out for a trip or entertainment he foots the bill fully; but for a man on the expense-account circuit she is fully deductible, a pleasant feature of corporate matrimony.
Whereas before Kennedy on a business-mixed-with-pleasure trip the whole cost was deductible, even if a brief conference in Europe or the Caribbean were followed by a prolonged vacation, under the new law when a trip lasts more than a week and where the pleasure component is greater than 25 per cent, only a partial deduction of transportation costs will be allowed unless it can be shown that the pleasure component was the prelude or the aftermath to portentous discussions. Then, apparently, the sky is the limit. While the percentage stipulated seems very precise it cannot, in fact, be applied.
What if a business executive and his wife (he can't do without her presence) journey to Rome where there is a business conference of half a day about a possible oil deal of $250 million? Now the man and his wife tour the Mediterranean for three to six weeks. Does one now measure the pleasure component by time, by intensity or by magnitude of outlay? If it is the latter, then it is a flea-bite in relation to the magnitude of the possible deal; if it is by time, then close to 99 per cent of the component has been pleasure. If the whole trip cost $12,000, how can this be reasonably questioned as an adjunct to a possible $250-million deal? The fact is, of course, that big deals can be, and have been, arranged with the expenditure of just 10 cents for a phone call. A large deal does not necessarily require expense outlays commensurate to its size, does not need to be arranged in a palace in the presence of dancing girls, whirling dervishes and musical clowns at a Lucullan feast. These are thrown in because they are diverting--and are at public expense.
Clarence B. Randall, former chairman of the Inland Steel Company, is a sharp critic of the expense-account racket, which he rightly sees as adding nothing of value to the economy and as conveying a damaging image abroad of the American businessman's way of life. 38 But he is a minority of one in the business community, as far as the record shows.
The New York pleasure-belt, extending roughly from 34th to 59th Streets and First to Eighth Avenues, is largely supported by expense-account deductions--that is, by the general public. This was made evident when leading restaurateurs and theatrical producers, supported by their congressmen, protested to Congress that they would go out of business if the Kennedy proposals became law. A host of expensive shops would also presumably go under.
Although all these establishments are regarded as play areas of the rich, not many rich people would patronize them if they had to pay for them with their own money. For a wealthy man, often in mortal fear of being considered a sucker, is more apt to overrate than to underrate the value of a dollar. If he spends, he prefers that it is other people's money.
This whole area, where the mere serving of a meal may be a ceremony rivaling the High Mass of the Catholic Church, is underwritten by the general public in the price paid for goods and in lost tax money made up by the lower brackets.
New York City is the Mecca of the nation's big retail establishments, which send buyers there by the hundreds. These buyers, man and wife, are ordinarily royally entertained, providing many a tale for telling at the home-town country club. If, however, no entertaining whatever were done, tax deductible or not, would the nation's
total of business suffer? Would the buyers refuse to buy and the customers at home go unappeased?
While it is true that all this may make business more pleasant and exciting, it would make everything more pleasant and exciting if such tax-supported antics were available to everyone. If two scholars have lunch and incidentally discuss the number of commas in Chaucer's writings, should not the lunch be tax deductible? If a physician or lawyer takes acquaintances to dinner, should the cost not be tax deductible on the ground that they might some day become patients or clients? What if two philosophers meet to discuss the cosmos? This is obviously a large matter, larger than a merger of all companies into one. Should they not be tax exempt for life? Does not the government really owe them billions in view of the magnitude of their task? Why should not the ordinary office worker's lunch be tax deductible? Is not the lunch an "ordinary and necessary" expense ancillary to carrying on business?
Should not, by the same line of reasoning, everybody's outlays for anything--food, housing, clothing, chewing gum, tobacco, entertainment--be tax deductible? Is not clothing an "ordinary and necessary" expense for attending to one's job? Could one show up for work clad only in a pair of slippers?
If business expenses, proper and improper, are all deductible, why should not all personal expenses be similarly deductible under the principle of equality under the law?
The Stock-Option Racket
A far more lucrative way of deriving income and evading taxes is by means of executive stock options, which have become increasingly used since World War II.
The essence of the stock-option scheme is that it allows its designated beneficiaries, few in number, to purchase stock at steeply reduced rates. Some price is arbitrarily set at which a favored group of executives, often including large hereditary owners, may buy stock after a certain date. The benefiting executives are supposed to scheme harder in order to enhance the underlying value of the company, thus giving themselves profits. Naturally, if the economy were sinking, no matter how hard they schemed the value of the company would not increase; it increases only as the company participates in an expanding economy, which has nothing to do with the efforts of the executives (with some exceptions).
The way it works is as follows:
Certain high-salaried executives are told that they may within three years buy a block of stock in the company, if they wish, at $5O a share. It is now selling at $45. After three years, let us say, the stock has risen to $125. As they each decide to buy the allotted number of shares, usually running into many thousands, they pay $50 for a stock worth in the market $125, or $75 per share instant profit. If they now sell this stock they pay a maximum 25 per cent tax on the gain or they may retain the stock and pay no tax at all.
But what if the stock fails to advance or declines? This is too bad and in that case the options, with nothing lost, are not exercised and expire. But in many cases of record, when this has happened, the board of directors simply voted that the option price be reduced, from perhaps $45 to $20. This made it possible to buy the stock at a discount of $25, and the purchase of sufficient additional shares might be allowed to permit as great a profit as if the stock had advanced to $125 under the original option.
The option plan clearly allows its preferred beneficiaries to buy stock at a discount and hold on to it, paying no tax, or to sell it and pay a relatively low tax on the increment. An executive need not, indeed, put any of his own money into the deal at all because
most issues listed on the Stock Exchange are good for a bank loan at 50 per cent of their market value at any time. If the option price is at least 50 per cent of the market price, a bank will put up all of it, gladly, and the executive need then, after holding the shares a few months, simply sell them to lift off the low-tax capital gain. Smooth, smooth, smooth. . . .
But stock options always dilute the equity of stockholders, large and small. In the case of large stockholders, these sometimes participate in the option plans themselves, thus experiencing no dilution of equity; but in some cases large stockholders concur without participating, apparently feeling it is worth it to them to get this tax-favored extra compensation into the hands of aggressive higher executives.
If a group of executives elect to keep their stock, as did the leading executives of General Motors over the years, they may in time become independently wealthy. Alfred E. Sloan and others of the well-known executives in Du Pont-controlled General Motors from the 1920's to the 1950's were big stock-option men.
There is no risk involved in exercising these options. It is all as difficult as shooting fish in a barrel. And much of the gain involved stems from the reduced or nonexistent tax. If these acquisitions of value were taxed at the same rate as the corporate salary, it would be virtually impossible for big corporation executives to become tycoons on their own account, as a few have become. It is the tax-exempt feature, paid for all the way by the public, that enables them to emerge as financial kingpins, ,vithout performance of any commensurate service.
Specific cases under these general observations fully support everything that has been said.
