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Politics and Taxes Legal Tax Angles: How to Save Taxes Without Going to Jail Readers, clients and even professional colleagues often complain that the income tax isn't "fair". My response for the past 30 years is that it isn't about fairness; it's about politics. The following are some very personal reflections and commentary about my perceptions of how politics and taxes are intertwined.Back in the early 1970s, I was working as the VP/Controller for a life insurance company. Like many corporate accountants, I did some accounting and tax preparation work for a few people on my own time. One of my clients was a personal friend and a successful insurance agent who constantly complained about having to pay higher and higher taxes, year after year. He kept badgering me to help him find some of those "loopholes" he was reading about in different publications. He would clip articles he read in different publications and send them to me to have me check to see if he could use that particular tax strategy. Eventually, I concluded that maybe I should be spending some of my time looking for the "loopholes", so I started collecting various kinds of tax information. Back then, there weren't nearly as many information sources as there are now, but I started to organize the ideas I could find. After a while, I came up with the idea of starting a newsletter to describe these tax saving ideas for small businesses. Despite being discouraged from doing this by a marketing expert (who really did know what he was talking about), I plunged into the newsletter business with a bi-monthly publication that I called, Tax Tricks and Techniques for the Self Employed. At first, I approached the subject from an accountant's, "Vulcan" (I'm an old Star Trek fan) type logic. But as I read and studied more about taxes and different "loopholes", I came to realize that there is no logic to our tax system other than the logic of politics.
I rarely have a new client who doesn't at some point complain about the many ways the tax system is so unfair. And it is unfair in many ways. It's unfair to married couples but it's even more unfair to those who are separated or those with spouses who are not residents or citizens of the US. It's unfair to those who don't have children. It's unfair to those who are employees, with respect to travel costs. But it's unfair to the self employed with respect to medical costs and retirement savings. So when a new client complains about this unfairness, that leads to a discussion of the political aspects of taxes. I've concluded that our tax system is absolutely the most discriminatory set of laws in the history of mankind. The politicians feed on the opportunity to grant favors to people through our tax system. It's not about fairness, or simplicity or even about economics. It's only about politics. The members of the House Ways and Means Committee and the Senate Finance Committee receive huge campaign contributions and are greatly sought after for favors by the other members of Congress. If you enjoyed this kind of economic and political advantage, would you willingly give it up? All of this talk about a "flat tax" seems to ignore the underlying reality that the tax system is a marvelous political tool to reward your political friends and punish your political enemies. The politicians don't have any desire to really change the tax system so that it will be simple and fair. Another somewhat preposterous aspect of the talk about a flat tax is that much of this talk assumes that the level of total government spending is a constant and that any new system of taxes must collect the same amount of revenue. What's the point of changing the tax system if we continue to let the politicians drain almost 50% of our gross domestic product into the political system? It's my view that there is no serious possibility of a flat tax until there is some massive and permanent reduction in the level of government spending. And from what I've been reading, it seems that the biggest two problems in the spending area are Social Security and Medicare. Both of these are virtually untouchable by the politicians. So if these entitlements aren't going to be seriously cut back, there isn't much room left in the rest of the budget to reduce the level of spending. It seems to me that talking about changing the tax collection system in order to change the spending process is a lot like trying to push toothpaste back into the tube or like trying to swim up a waterfall. But my biggest complaint about all the talk in favor of a flat income tax system is that these people apparently don't have a very good memory and they obviously don't understand the word "income". We cut the top personal income tax rate from 70% to 50% in 1981. Then, from 1986 to 1988, we cut the top rate from 50% to 33%. For a short while, we had a pretty simple rate structure with four tax rates. (1) Zero %. (2) 15%. (3) 28%. (4) 33%. Now we have seven brackets, if you include the zero tax rate. I believe the real problem of the income tax system is that it's the worst kind of tax base one could adopt - if one were being logical. But if you have political motivations, it's the most ideal type of tax system. As an accountant, I can tell you that it's easy to get a bunch of accountants into a heated argument about the meaning of the word, "income". Accountants are taught that income is affected by the method of accounting that is used to measure the change in value of assets and liabilities and the timing of those changes. In order to have a "true" measure of income, you need to determine the current value of every asset you own and the liquidation cost of every debt that you have. "Income" is essentially the difference between the net assets (assets minus debts) from the beginning of some time period to the end of the time period. But that definition is only about net income -- income minus what is spent or consumed. It works for a business most of the time, but it isn't really applicable to individuals. One person may have a generous income before expenses and may have minimal expenses. This person would have some income in excess of expenses to increase their net assets and would have income based on the definition above. Another person might have a smaller amount of income and more expenses. According to the business concept of income, they would not have any income. For tax purposes, gross income from salaries, minus a small amount for a personal exemption and minimum standard deduction may be the amount of income on which a tax is computed. For other taxpayers, taxable income may be gross income from salaries, business profits, interest, retirement benefits and numerous other items, minus a mind boggling variety of deductions. Some taxpayers could receive huge amounts of income from state and municipal bonds, dividends and long term capital gains and would owe little or no tax. There is hardly any way to define "income" without numerous inconsistencies and contradictions. The ones mentioned here only scratch the surface of the subject. What a nightmare! If you let the economists get into the argument, the level of noise and rancor increases enormously. Accountants and economists do not really, really agree with each other on a number of fundamental issues. What a marvelous opportunity for a greedy politician who wants to favor his friends and punish his political enemies. I don't believe there is any way to have a simple and fair income tax system because the problem is not the rate of the tax, or even whether the tax rate is a flat rate or a progressive series of higher rates. The real problem is the elusive nature of the word "income". It can mean whatever the politicians want it to mean. The present income tax system has been interpreted by the U.S. Supreme Count as giving the U.S. Congress, with the consent of the President, virtual carte blanc in selective taxation. The politicians can choose to impose different rates of tax on different taxpayers, depending on their marital status or on whether they have children. Corporations, estates and trusts have different tax rate schedules from individuals. Various deductions, exclusions and exemptions from the income tax are granted to one category of taxpayer but not to all taxpayers. Many deductions and exclusions are taken away from those who have a higher than average amount of income -- as defined by the tax law. Different tax rules apply to different industries. The discriminations and variations are endless. I've been accused of having a vested interest in the present system of taxation because I make my living helping people to save taxes. When I was a lot younger, a truly dramatic change in the tax system would have produced a serious change in my life and work. However, I could have easily gone back into the accounting business, into teaching, into financial planning, business appraisals and numerous other activities involving complex financial issues. Now that I'm a "senior citizen", I'm no longer dependent on working to pay the bills. I continue to work because I like what I do. Mostly, I try to teach people how to cope with an insanely complicated and unfair income tax system. I try to teach them how to pay less taxes without getting into trouble with the IRS. If by some unlikely event, the U.S. income tax is eliminated or even converted into a simple and flat tax that affects everyone equally, I will find many other ways to be productive as long as I am able to make a contribution. Until then I will continue to write, to teach and to provide consulting services to help as many people as possible to cope with an unfair and discriminatory system of taxation. Vernon Jacobs Copyright, 2003
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Books and Services by Vern Jacobs
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