David Cay Johnston

By David Cay Johnston
The writer is a Reuters columnist. The opinions expressed are his own.

Each year New York State lets real estate investors evade at least $200 million of taxes. In peak years the figure likely rises to $700 million, if known tax cheating in another state is any indication. Some of the investors who cheat New York State also cheat New York City out of at least $40 million annually.

Back in the 1990s Jerry Curnutt figured out how to finger such cheats when he was the top partnership specialist at the Internal Revenue Service. Curnutt’s computer sifted through tax returns until he learned how to separate thieves from honest taxpayers. The tax-evasion estimates of $200 million and $40 million are his.

Six New York state tax auditors took classes Curnutt taught in June 2000 and gave stellar evaluations. California’s top tax auditor praised Curnutt’s course as “effective, relevant and most importantly, appreciated and understood by our auditors.”

Why has nothing been done for more than 11 years to make the cheats in New York pay what the law requires?

New York state and city are strapped for cash, slashing services for the poor, disabled and elderly. With penalties of up to 50 percent plus interest at penalty rates, the state is easily due more than $5 billion from years still open to collection, I calculate.

Every state has similar issues, but New York matters most as the epicenter of highly leveraged real estate investment pools.

Curnutt found that real estate investment partnerships with depreciated properties often misreport gains when they sell. That such cheating is widespread screams about tax law enforcement looking the other way when those at the top steal. In contrast, New York State has a well-deserved reputation for going after people whose mistakes cost the state as little as three dollars.

GO AWAY, THEY SAY

Yet in letter after letter since 2001, New York state tax officials told Curnutt to go away, smugly insisting there were no untaxed millions.

As head of audits for New York State, Thomas Heinz wrote Curnutt in 2003 that the state was “not interested in pursuing you or any other consultant on the matter” of systematic cheating by real estate partnership investors. Months later Heinz wrote a second letter that made it clear he had not understood what Curnutt was proposing, while reiterating that there were no untaxed millions to be found.

A year ago Curnutt again was told to go away because there was no money going untaxed.

And yet in Pennsylvania, Curnutt’s research “resulted in the taxation of over $700 million in unreported income,” the Pennsylvania Revenue Department wrote in a letter to tax administrators across the country in reference to a single instance.

“Without his assistance, our staff would have spent numerous hours getting to the crux of the issues, in that especially complex case,” Pennsylvania tax authorities said.

Pennsylvania has relied on Curnutt since 2002, calculating that every dollar spent on his research and subsequent audits was worth $10 of tax.

So why are sightless sheriffs ignoring massive cheating by the most affluent among us?

The likely reason became clear nearly a decade ago when one Kentucky tax official told Curnutt that the governor’s office did not want his services because it would uncover tax cheating by influential citizens, meaning campaign donors.

It is time for New York’s three top state officials, all Democrats with higher ambitions, to do their duty, especially since the thieves are virtually certain to include some of their campaign contributors.

LAWMEN AND THEIR DUTY

Governor Andrew Cuomo, who harbors ambitions to be president, made his name as a state attorney general who appeared to get tough with Wall Street. Lieutenant Governor Bob Duffy rose from Rochester street cop to chief and would love to be governor. So would Attorney General Eric T. Schneiderman, elected in 2010 on a promise to be tough on white-collar crime.

Mayor Michael Bloomberg, an independent, has a similar duty to go after tax cheats even if these should turn out to include some of his friends.

New York law gives authorities leverage aplenty. The mere threat of public exposure through civil lawsuits would prompt many to write checks. For repeat offenders, the threat of indictment for tax evasion would produce checks even faster. Faced with the prospect of civil or criminal charges, many in positions of public trust would be ruined if their names got out.

The general partners — those in charge in the partnerships Curnutt investigated — took calculated steps to cheat and the most serious offenders should face indictment and, upon conviction, years of prison time. But many limited partners may have assumed their K-1 tax statements were reliable. Innocent victims owe taxes and interest, but not penalties. Those with multiple untaxed gains are not innocents.

As lawmen Cuomo, Duffy and Schneiderman all understand leverage. They have enough to lift billions into the state treasury where it belongs just by indicating in letters that failure to pay will result in disclosure of names. Will they?

Until Cuomo, Duffy, Schneiderman and Bloomberg enforce the law, their official inaction lends credence to billionaire Leona Helmsley’s remark, quoted by her housekeeper, that “we don’t pay taxes; only the little people pay taxes.”

This column will keep you posted on whether these officials act or not.

By David Cay Johnston
The views expressed are his own.

President Barack Obama this week started pitching his plan to cut U. S. taxes for everyone in 2012 and then in 2013 raise income tax rates for high earners, primarily those making more than $1 million, many of whom bear a lighter burden than a cop married to a nurse.

Two responses are certain.

There will be claims that economic ruin will follow once taxes go up. Never mind the proposed 2012 tax cuts are for virtually everyone. Never mind that the modest rate hikes would apply only to those who make more than 97 percent of their fellow Americans with most of the burden on those making more than $1 million. Never mind IRS data showing that tens of thousands of those whose increased taxes would increase their income tax rate by just 1.2 percentage points make more in a year than the median family earns in a lifetime.

Obama has also set a clever trap for anti-tax Republicans. Obama’s American Jobs Act would lower Social Security taxes for all workers and for all businesses in 2012. Republicans who vote against the bill would be voting against a tax cut. They would also be voting against a huge business tax break, letting business immediately write off all capital investments made in 2012.

The other, more pernicious attack will be on the best funded, most effective and most efficient government program around: Social Security.

The latest assault on Social Security comes from Governor Rick Perry of Texas, a Republican presidential hopeful who insists that social insurance for widows, orphans, the disabled and the old is a Ponzi scheme.

If Social Security is a Ponzi scheme then so are public education, businesses and the state government that has for decades employed Rick Perry.

ACCOLADE OR EPITHET
The education of the children born to today’s kindergarten students must come from future tax revenues. The profits Wal-Mart makes in 2091 depend on people not yet born making purchases. And if Perry is elected president, his salary and presidential pension will depend on new money coming in.

Every enterprise depends on future income, which is where any similarity between legitimate activities and Ponzi schemes ends, though Perry seems ignorant of this.

Perry boasts that he was an awful student. Instead of being dismissed as a know-nothing, however, he is a serious contender for the most important job in the world, in part because many Americans have been persuaded that the word “elite” is not an accolade but an epithet.

Egging on Perry are people whose elite education suggests they should know better, like Washington Post columnist Charles Krauthammer, who has an M.D. and a Pulitzer prize. One need not be elite, which means “the best,” to know that Ponzi schemes are criminal enterprises that depend on secrecy to defraud.

In contrast, Social Security is an open book. It publishes exhaustive financial reports, all of which have proven reliable. Social Security’s overhead, at less than one percent, is a much smaller share of its budget than any large corporation or that multi-billion dollar enterprise known as the State of Texas. And Social Security has collected more than $2 trillion in advance to help pay future benefits through 2037. That surplus makes it an anti-Ponzi scheme.

Social Security’s projected $5.3 trillion shortfall sounds huge, but it is spread over 75 years, making its impact insignificant. This minor problem would shrivel if we just went back to the levy under President Ronald Reagan, when 90 percent of wages and salaries were subject to the Social Security tax instead of the 83 percent today.
The shortfall would vanish if we reversed our policies that discourage higher education, export jobs, drive down wages and savage our manufacturing, research and development prowess.

CAT FOOD FOR DINNER
Most Americans are not old enough to recall when old ladies bought cat food on sale, not for a pet but for dinner. A half century ago more than a third of older Americans lived in poverty. Today fewer than 10 percent do because of Social Security.

More than a third of older Americans rely on Social Security for 90 percent of their income. The average benefit is just $14,124 per year, but many older Americans get only half that much, which Perry and Krauthammer tell us is more than we can afford.

Gentlemen, will that be Fancy Feast or Meow Mix for your fellow Americans who have not fared as well as you have fared?

Now let’s put the Obama plan, which has no chance of becoming law in the current Congress, in perspective. He would raise taxes on 534,000 of an estimated 166 million taxpayers in 2013 by an average of $39,182 each, the Tax Policy Center calculated. Their average income was $3 million in 2009, which is more than twice what the median income taxpayer earns in a lifetime of work.

Together these top earners made more money in 2009 than the 56.5 million taxpayers whose cash income was less than $25,000 and on average just $12,366.

To assert that we must not raise taxes at the top, but we must cut Social Security is to say this: America’s rich do not have enough and we must take from those with less to give the rich more.

Can we do better? Of course, but we won’t until we make it standard for politicians to develop their minds, and to understand taxes and public finance, enough so that we can call them elite.
(Editing by Howard Goller)

By David Cay Johnston
The views expressed are his own.

It’s time to prick the popular image of ballooning executive pay with some sharp new facts.

As a group, corporate officers — executives with broad authority to act on the company’s behalf, not just follow orders from the CEO or some other boss — are making less, not more, my analysis of newly available tax data shows.

This is in sharp contrast with the thoroughly documented excesses at the very top revealed through analysis of disclosures to shareholders. The new tax data includes CEOs, but the few score of wildly overpaid ones at the biggest companies become statistically insignificant within the universe of nearly a million corporate officers covered in the new tax data.

Many CEOs get paid far beyond what economic theory says is necessary to motivate them. Worse, a fair number enjoyed soaring pay while shareholders saw their wealth dwindle, as with John Snow when he ran the CSX Corp railroad company. When Snow left to become Treasury secretary his pay had grown 69 percent, while the price of CSX shares fell as much as 64 percent, just one of many disconnects between CEO pay and performance.

But among the nearly one million corporate officers in the United States, this new data, never available before, show that the overall story is one of shrinking pay.

TOP-LEVEL SQUEEZE
One implication of this is that executives at the very top are squeezing those just below them. This fits with anecdotal information many mid-level executives have provided me over the years. But it may also mean that many companies are not properly filling out their tax returns, neglecting to fill in Schedule E as required, understating officer pay, especially at nonpublic companies.

Corporate officers earned less total pay in 2008 than they did a decade earlier in 1998, even though there were more company officers at firms with more than $500,000 of revenue, the threshold for reporting by name to the IRS. In all but two years since 1998, total pay was higher than in 2008.

Average pay looks to be significantly smaller than way back in 1994.

Measured in 2008 dollars, the 990,077 corporate officers whose compensation was reported on tax returns made $466.8 billion in 2008, down slightly from $471.4 billion in 1998.

In 2008 their average compensation was $471,500, down about 13.5 percent from an estimated $545,100 in 1994.

These figures, which I distilled from traditional IRS statistical reports plus a valuable new IRS data set, run counter to the image of the bloated corporate pay packages that have been a staple of spring news reports for two decades. I feel a special duty to analyze the new data because I wrote many of the front-page New York Times reports that directors of some of the largest companies told me later made them realize that they were paying their CEOs far more than they thought. This new data provide a much broader picture not only of corporate pay, but also of profitability, than available before.

BORING TITLE, BUT…
The new data come from a document entitled “2008 Estimated Data Line Counts / Corporate Tax Returns.”

That boring title belies a wealth of information that stock analysts, tax lawyers, accountants, government revenue estimators and policy wonks of all kinds can extract from its 246 pages.

The IRS has long published similar reports on individual income tax returns. The new corporate report is one of several I have for which I have agitated over the years to provide a more rounded and thorough source of information about incomes, assets and tax burdens. (Partnerships next, please!)

The report consists of the various Form 1120s and their schedules, showing how many times each line was filled out. What makes the report valuable is a second set of the same pages showing the total amount of money entered on each line, pages fittingly tinted green.

Existing IRS corporate tax reports have for years shown us that fewer than 2,600 megafirms own 81 percent of all U.S. corporate assets. Another 21,000 firms control most of the rest, leaving just 5.6 percent of corporate assets that are divvied up among the more than 5.8 million remaining corporations.

The new data report, combined with the old, can be mined for trend lines about assets, liabilities, compensation, fringe benefits, profitability and other information needed to make smart investments and devise public policies that comport with reality, not rhetoric.

CALCULATED CLUES
The figures on 2008 average corporate officer pay were calculated from the new report. To estimate average corporate officer pay in 1994 I calculated that the number of officers grew in tandem with the number of corporations, a rough proxy for sure. I tried some other proxies and the results were in the same range.

The 2008 data show that while almost three million corporate officers show up on company tax returns, only 990,077 Social Security numbers do and of those only 838,551 show up as being paid. That may suggest some owners took no pay in the Great Recession year of 2008, but it also hints at how many officers serve multiple corporations.

The officer pay data show huge variations. Just 70 officers of 1,660 Real Estate Investment Trusts averaged $5.2 million in 2008, while 832 officers of 7,670 property and casualty insurers averaged $3.8 million. At the other end, more than 2.1 million officers of S Corporations averaged just $107,403, though many of them must be officers of multiple corporations.

The new data also show that in 2007, the last peak economic year, the total pay of corporate officers was almost one percent smaller than in 2000, the previous peak year. Compare this with the stock market, whose 2007 peak adjusted for inflation was about 17 percent lower than in 2000.

Since 1994, business receipts have grown about 50 percent faster than profits, tax data show. Since corporate officers are supposed to run companies efficiently, the narrowing margin on sales is an indicator of poorer performance and thus may partially explain why overall their pay is smaller than in the 1990s, a fact nobody knew until just now.

Many CEOs continue to enjoy pay out of sync with performance, but the more important story appears to lie in the diminishing compensation of the vast majority of corporate officers, the people you never hear about as a group.  (Editing by Howard Goller)

By David Cay Johnston
The views expressed are his own.

Every day we hear politicians and pundits say that government spending cannot lift the economy out of the worst slump since the 1930s, which is as sensible as saying that 2-1=3 or that water and flour make steak.

Those who said after President Barack Obama’s speech last week to Congress that government does not create wealth, does not create jobs and cannot stimulate the economy spoke nonsense. So do those who say that only private business creates wealth, as if any revenue going to taxes destroys wealth.

Adam Smith, who figured out market capitalism in his 1776 book “The Wealth of Nations,” could set them straight. We have plenty of equally competent economists who understand these issues today. They just do not get the attention that the news media lavish on high-profile politicians and pundits who speak with absolute certainty on matters about which their words show they know nothing.

So why are politicians and commentators who speak economic nonsense treated as sages? And why do so many journalists uncritically repeat their nonsense?

Sadly, the answer is that too few people in public life understand economics, numbers or algebra. Too few people learned, or remember, the crucial concept underlying matters of economics and finance known as accounting identities.

ACCOUNTING IDENTITIES
Accounting identities are statements that must be true no matter how you arrange the components. Thus 2+1=3 just as 3-1=2. Likewise, net worth equals assets minus liabilities just as assets equal liabilities plus net worth and profits equal revenue minus costs. But water plus flour does not equal steak.

In economics, Gross Domestic Product equals consumer spending plus government spending plus investment plus the net of exports and imports. Or in its simplest form: Spending = Output = Income.

Economics is like a circle, as Smith figured out 235 years ago. More spending by government creates jobs, whether at war plants making smart bombs, dredging ports so cargo moves efficiently or stimulating the gray matter between young ears to create productive adults. Bombs ultimately destroy value, while ports and education add value.

Now, refreshed on the bedrock economics of accounting identities, consider these statements by three prominent Republican lawmakers:

“We need to cut spending now in order to create jobs in America” — House Speaker John Boehner on the floor of the House of Representatives in July 2010. “If government spending would stimulate the economy, we’d be in the middle of a boom” — Senator Mitch McConnell in March 2011. “Government doesn’t create jobs, you do” — Representative Nan Hayworth, M.D., speaking in January to business leaders in her New York district.

None of the comments makes sense. The first violates the accounting identity that spending equals income. The second assumes that the stimulus was big enough to make up for the fall in private sector jobs, when it was less than half what accounting identity algebra showed was needed. The third is just plain nonsense.

JOBS ARE KEY
It is certainly true that jobs are key. People with jobs are taxpayers, while those without tend to become taxeaters. More wages mean more spending, which is income to others.

As John Maynard Keynes observed in 1932: “There is no possibility of balancing the budget except by increasing the national income, which is the same thing as increasing employment.”

None of this means that President Obama’s jobs package, which has no hope of becoming law, is the optimal approach. It relies, however, on sound principles.

On the other hand, creating jobs that cost more than they add in value destroys wealth. That is why a defense plant for which Senator McConnell wants to get a federal loan guarantee of $1.7 million per job makes no sense economically.

We also inhibit future wealth when we fire teachers, let roads fall apart so that truck traffic slows and repair bills rise, and ignore weakened dams whose collapse would destroy property and lives. Cutting research funds just sends researchers to China and India, along with future fortunes.

Investing in education, research and infrastructure all add to economic inputs and, in turn, increase economic outputs.

In general the market does a better job of allocating capital for investment than government does. But when the market fails, as with the unregulated insurance and bad loans that destroyed so much value in the last decade, then the only way to stop the vicious cycle of decline is for government to temporarily make up the difference through more spending. Saying otherwise is the economic equivalent of arguing that water and flour make steak.

By David Cay Johnston
The author is a Reuters columnist. The opinions expressed are his own.

Since at least July 1, 1943, the day income tax withholding from paychecks began to finance war and tamp down demand for consumer goods, American politicians have promised a simpler tax system.

But while politicians talked on for seven decades, the code grew ever more complex with favors for this group or that, favors that mostly benefited the rich.

One country actually has created a very simple income tax. That would be China, its income tax filing rules modeled on those of the U.S. Congress circa 1913-1942.

Until Sept. 1 Chinese workers who earned less than 2,000 yuan per month (about US$313) paid no income taxes. That is when the threshold for paying taxes was increased to 3,500 yuan (about US$548). The change removed 60 million Chinese workers from the income tax rolls and cut taxes for another 24 million.

“Under the new amendment, about 7.7 percent of wage earners will have to pay tax, down from the current 28 percent,” Wang Jianfan, deputy director of the tax policy department at the Ministry of Finance, said in announcing the changes, China Daily reported in June.

In Washington the Republican leadership has been decrying the fact that half of American households pay no income tax. Partly that is due to millions being too poor to owe income taxes, though they pay payroll, sales and other taxes. The other big factor is the $1,000 per child tax credit, sponsored by Republicans, which removed millions of middle class families from the income tax rolls.

While Americans spend billions on income tax advice and paperwork, in China there is no arduous tax preparation.

LESS THAN 1 PERCENT
Only those Chinese who make more than 120,000 yuan annually (US$18,800) even file a tax form, and that’s a small fraction of one percent of the population. In the United States married American couples must file a tax return once their income reaches $18,700, while the threshold to be in the top one percent of workers is $200,000, Social Security Administration data show.

It takes a couple of minutes to complete the Chinese form according to Lawrence Lipsher, an American accountant who has long worked in China.

Contrast this with the U.S. system with its complex rules. The vast majority of the working poor pay someone to fill out their tax returns so they can qualify for the Earned Income Tax Credit, a negative income tax that President Ronald Reagan called “the best anti-poverty, the best pro-family, the best job creation measure to come out of Congress.”

American taxpayers took $6.4 billion in tax deductions just for the costs of preparing their income tax in 2009, an economic drag not suffered in China.

The United States once had a very simple tax return, but that was almost a century ago when the modern income tax began. The 1913 income tax form consisted of three pages plus one page of instructions. Only those at the top paid income taxes, filling out that simple form, just as in China today.

The Chinese are in the early stages of developing an income tax. They have only the simplest enforcement mechanism. In America it is commonplace to attach explanatory statements to tax returns because people’s income situation does not always fit neatly onto a Form 1040 or all the schedules that Congress has ordered up as it has handed out tax favors galore.

FAVORS FOR THE RICH
These tax favors tend to be skewed up the income ladder. Less than half of homeowners, for example, make enough to get any savings from deducting mortgage interest. The share of people benefiting from tax breaks for retirement plans and healthcare rises with income, an upside subsidy system for the affluent. At the nonprofit, nonpartisan Tax Policy Center, Eric Toder, Len Burman, and Chris Geissler added up all of these tax breaks for 2007. The total came to $950 billion.

To give that number some perspective, for every dollar of individual income tax revenue the federal government collected that year Congress gave tax breaks worth 80 cents. While those tax breaks benefit some, they mean higher taxes for those who do not qualify and a lot of time doing paperwork.

If we dumped all the tax favors, all else being equal, we could make one of three choices. We could cut tax rates across the board. We could bring in enough money to make the perennial federal budget deficits the kind of minor concern they were before the Reagan era. Or we could exempt at least 72 percent of American workers from paying income tax, as China did until this month.

Imagine the talk in Washington if, as in China now, 92.3 percent of American workers were exempt from income tax. Imagine also how much simpler and pleasant life would be if, as with China today and America long ago, we had an income tax so simple you need not file a return unless you were highly paid and, even then, could file a return in a couple of minutes.

Then again, the Chinese are modeling their income tax system on ours. So as some in China speak of the possibility of greater democracy at some future time, one wonders whether their leaders might then model themselves after American politicians, who hand out ever more tax favors and then decry complexity and the tax rates required to make up for those favors.

Lipsher said his bet is that within a century “China will create a system as hellacious as America’s.”  (Editing by Howard Goller)