Perfectly Legal: The Covert Campaign to Rig Our Tax System to Benefit the Super Rich and Cheat Everybody Else.

• Author: Lederman, Leandra
• Position: Brief Article - Book Review

PERFECTLY LEGAL: THE COVERT CAMPAIGN TO RIG OUR TAX SYSTEM TO BENEFIT THE SUPER RICH--AND CHEAT EVERYBODY ELSE. By David Cay Johnston. New York: Penguin Group Inc. 2003. Pp. iii, 338. $25.95.

1. INTRODUCTION

   Books about tax administration tend to fall into one of two broad categories: those that paint the Internal Revenue Service ("IRS") as an agency peopled by corrupt, out-of-control bureaucrats who take pleasure in seeing innocent taxpayers suffer, (1) and those that tell readers how to structure their affairs to minimize the risk of incurring an IRS employee's wrath during a tax audit. (2) Perfectly Legal, the full title of which communicates David Cay Johnston's intent to focus on the tax system, does neither of those things. Instead, it is a book much like The Great American Tax Dodge, (3) which explained the many varieties of tax fraud; the difficulties the IRS faces in pursuing high-income individuals; the influence the affluent have on lawmaking; and Congress's success in tying the hands of the IRS.

   In its strongest chapters, Perfectly Legal examines the inner workings of the IRS and describes the agency in a very different way from that represented in the popular press. While other authors may decry the threat of overzealous IRS agents, Johnston laments the inability of IRS employees to pursue known acts of noncompliance because of resource limitations and political pressures. While other authors may complain about the complexity of the Internal Revenue Code, leaving readers with the impression that the IRS is responsible for its enactment, Johnston lays blame for this complexity squarely where it belongs--with Congress and executive branch policymakers. (4)

   Johnston's coverage of tax issues as an investigative reporter for the New York Times won him a Pulitzer Prize in 2001. Although many of Johnston's articles focus on complex issues of tax policy and administration--such as the restructuring of the IRS or efforts to repeal the estate tax--he, unlike most other journalists who attempt to tackle tax issues in the general press, is able to explain these difficult concepts in a thorough and engaging manner. Johnston's exposes, particularly those relating to the growth of the tax shelter industry in recent years, illustrate his formidable investigatory skills. While IRS officials may not be willing to admit as much, his articles apparently have brought to light a number of tax dodges that, if not for his reports, might still be hidden from government regulators. (5)

   As its prologue suggests, Perfectly Legal draws in part on stories Johnston published in the New York Times. (6) The prologue explains that Johnston's initial goal in covering taxes was "to launch a running investigation" of the tax system (p. 1). Many of the chapters of Perfectly Legal do not discuss tax issues, however. Instead, they criticize such things as an increase in income inequality over the past thirty or so years and a tendency Johnston finds on the part of large corporations to prioritize compensating their key executives while disregarding the needs of the rank-and-file workers. Johnston claims that, because "there is no free lunch," the super rich "leave part of their bill on your table" (p. 11). According to Johnston, politicians and their campaign contributors are behind this trend, though the connection is not always made explicit. (7) The tax system is but one piece of the dark picture Johnston's completed puzzle depicts.

   The chapters that do focus on taxation discuss issues that range from the specific and technical to larger issues of IRS enforcement. The theme that implicitly ties together Johnston's complaints about growing income inequality, the priorities of large corporations, decreasing progressivity in the federal tax system, and Congress's "handcuff[ing of] the tax police" (p. 150) is that low-income and middle-income individuals are fighting just to survive, while the well-to-do are doing better and better. In fact, much of Perfectly Legal is comprised of narratives about particular individuals, some of whom appear to represent, for Johnston, an entire class of people, such as the working poor, the middle class, or "the political donor class."

   Given the broad range of topics that Perfectly Legal covers, it is unfortunate that it is not divided into parts. Some chapters are clearly connected to chapters they precede or follow while others essentially stand alone. As the next Part of this Review suggests, the first half of Perfectly Legal is particularly disjointed; it addresses a variety of seemingly unconnected issues, ranging from demographic trends to public disclosure of executive compensation to specific tax loopholes. Following that description of the book in Part II, Part III of this Review provides further critique and Part IV suggests a line of inquiry for future analysis of tax administration.

2. THE BOOK'S STRUCTURE AND PRINCIPAL ARGUMENTS

   Perfectly Legal begins by introducing Jonathan Blattmachr, an attorney who specializes in finding loopholes that enable the wealthy to save taxes. The purpose the story serves in the book can be summarized in a statement Johnston attributes to Blattmachr: "The U.S. tax code is the most political law in the world" (p. 9). Chapter One also serves as an introduction to some of the topics discussed in later chapters, such as a number of tax compliance issues, including marketed tax shelters, corporate inversions, and difficulties in detecting certain types of tax evasion, as well as IRS reform resulting from Senate Finance Committee hearings in 1997 and 1998 (pp. 11-14). It also introduces Johnston's underlying theme that wealth concentration in the United States is partly due to a tax system that taxes the "super rich" more lightly than others (p. 11).

   Johnston connects that claim with the notion that the super rich can hire attorneys like Mr. Blattmachr to develop strategies under which money can change hands "without showing up in the official statistics on wealth and income" (p. 11). Not only that, but super-rich individuals have more opportunities to evade taxes because they generally are not wage earners and receive less income subject to information reporting; "their friends in Congress have slashed budgets for inspecting the tax returns of the rich and super rich"; and, if they own businesses, they can live subsidized lifestyles by charging some of their expenses to their businesses (p. 13). Johnston argues, "[s]ince at least 1983 it has been the explicit, but unstated, policy in Washington to let the richest Americans pay a smaller portion of their incomes in taxes and to defer more of their taxes ... while collecting more in taxes from those in the middle class" (p. 18).

   After the first chapter, Johnston turns to a discussion of demographic trends, focusing primarily on changes in the U.S. economy in the last thirty to thirty-five years. His principal point is that, once earnings are adjusted for inflation, the salaries of most Americans have remained relatively flat while "the incomes of those at the very top soared" (p. 29), resulting in increased income inequality. (8) Johnston also discusses a trend over the same thirty or so years towards lower top income tax brackets and increased government reliance on Social Security revenue, which, because of its wage-base cap and lack of zero bracket, disproportionately burdens low-income individuals (p. 41).

   Johnston connects growing income inequality with increased compensation for managers of large corporations. This created a demand for corporate tax shelters to keep profits high, "which helped shift the overall tax burden off capital and onto labor" (p. 41). Johnston blames Congress and other "lawmakers" for funneling benefits to "Corporate America" by allowing the demise of personal liability for the acts of other partners in a firm, (9) facilitating the "spread of 401(k) plans," (10) and "attacking" the IRS. (11) Johnston also includes a chapter on executive compensation, where he begins a discussion of stock compensation with a story about Robert Goizueta (pp. 45-47), Coca-Cola's one-time CEO. Here,

   Johnston's focus is on compensation arrangements that allow a small group of high-level executives to defer reporting a large portion of their compensation until future years (p. 47). According to Johnston, these "secret" arrangements are significant because they contribute to the "economic pain felt by millions of workers whose compensation was squeezed so that the top executives could take a larger share of the [corporation's] compensation budget" (p. 47). Johnston also argues that because a company cannot deduct deferred compensation, it raises the company's tax bill and is, therefore, "very expensive for shareholders, rank-and-file workers, and taxpayers" (p. 48).

   The theme of corporate excess and its tax cost continues with a chapter focusing on the valuation of company-provided personal air travel. Johnston points out that the valuation rules often have made it less expensive for an executive to fly on a company-owned plane and pay the associated income taxes than to fly on a commercial airliner in coach class (p. 62). In addition, the income tax cost to the executive has often been substantially less than even the direct cost to the company for use of the plane (p. 62). Johnston describes such executive "perks" as an example of a stealth tax cut for the wealthy and powerful, and another way in which corporations and the tax code can, in effect, subsidize executives' personal lifestyles. (12)

   After his indictment of big business, Johnston addresses a variety of specific tax issues. First, he discusses congressional efforts to repeal the estate tax. Johnston makes a convincing case that no family farms actually have been lost to the estate tax--the false premise that is the primary argument among politicians in favor of repeal--and that instead the beneficiaries of repeal (and the force behind...