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Published on: October 3, 2012
Campaign Sounds of Silence

In early September, AI publisher Charles Davidson spoke with Jack Blum—chairman of Tax Justice Network USA and one of the world’s premier experts on tax evasion, money laundering, banking and real estate scams, and corporate fraud—about the failure of both presidential campaigns to face up to America’s serious budget and taxation problems. 

CD: Let’s turn our attention to the upcoming American election in terms of the issues you’re known for.

JB: I’m very concerned about the poor quality of the debate, and the failure of both parties and both presidential candidates to discuss the real issues underlying budget, revenue and taxation. Both candidates are talking about tax cuts, about the huge deficits and the long-term problems they cause. They identify as the real problems the so-called entitlements programs—Social Security and Medicare—and completely omit the breakdown on the revenue side of the picture. I’m not talking about increasing tax rates; I’m talking about the Swiss-cheese, loophole-ridden system we have in place that allows people who are pretty clever to write off just about anything, while the rest of us who are stuck with withholding at the source don’t get to write off anything at all. We’re told, “Well, if you’re good we’ll give you a 1 percent tax cut, but then we’ll take away all the government benefits because there’s nothing left in the till.” That dishonest debate needs to stop.

How can they get away with it?

To answer that, you have to go back almost thirty years, to the establishment of the American Council on Capital Formation. It was the first of a number of well-funded “think tanks.” It pushed for capital gains tax rates, which, supposedly, would create jobs. Their funding, and the drumbeat it and others created, led people to believe that lowering taxation on capital would improve employment. There is no empirical evidence to support this proposition, but they’ve repeated it over and over again to the point where it has become accepted in the public dialogue.

As for the deficit and the entitlements issue, there have been commissions that discussed “entitlements” as the problem. But it was a few wealthy individuals who put up tremendous amounts of money to convince people that the real problems in America are Social Security and Medicare, and that unless these programs—which are essential to the social safety net—are curtailed, the country will go broke. Note that there are no “commissions” reporting on corporate subsidies of all types on all levels.

The truth is, the country is going broke for a totally different reason: a set of invisible tax arrangements that really require public discussion. It doesn’t take genius to figure out what they are. If you look at Mitt Romney’s tax return and wonder how he got his rates so low, well, Mitt Romney knows better than anyone else how the loophole system works. If he doesn’t know, he should be talking to his adviser, Bradford Malt, who set up offshore his arrangements—arrangements that facilitated putting together piles of money that remain untaxed. He has never talked about those arrangements, but instead talks about closing certain other loopholes, for example my mortgage interest deduction, or charitable deductions. How he can ignore the loopholes he uses borders on the fantastic.

Similarly, Obama has not discussed dealing with the corporate tax evasion and avoidance that operates on a grand scale. It boggles the mind that the most successful corporations in the United States essentially pay no tax. These are the income-shifters, the companies that are moving jobs and profits offshore to tax havens. These are companies that organize exotic tax-shifting systems like the double dutch, in which profits are attributed to someplace like Bermuda where they don’t even have an office. But we haven’t heard a word from Romney or Obama about shutting any of this down.

Mitt Romney has said the most successful corporations are the ones that don’t pay tax. What he is saying that successful corporations need tax breaks to be profitable. Why should the rest of us support those companies? If the Romney theory holds, these corporations would create more jobs. In fact, the record shows it leads to bloated executive salaries and fewer jobs.

There are whole areas where the ignorance of both Congress and the public is just plain startling. I’ll start with the refusal of Congress to look carefully at what’s happening. If I were a member of the Finance Committee, I’d insist that the tax returns of the twenty largest publicly listed corporations be made public. And I’d have hearings in which they’d be gone over line by line to figure out how they got to zero tax rates, and what the loopholes were and what they were costing, and what the benefits were. These people in Congress haven’t asked any of these questions. They don’t know and they don’t want to know. If they knew they would have to admit responsibility for the mess. After all, knowledge means responsibility.

There are entire industries that are subsidized by the government in ways that verge on the astonishing. One example is commercial real estate. If I want to get rid of one building and buy another one, the sale turns out not to be a taxable event if I do a “like kind exchange.” Why shouldn’t the sale be a taxable event? In addition, the definition of like kind exchange turns out to be very flexible, and claims that it has occurred are rarely challenged by the IRS.

If you’re clever, then, you can build a real estate empire, take money out of it in the form of loans and never pay a dime in tax. What does that do? It enriches a select group of people and creates insane real estate bubbles. The tax subsidies are really adding to the amount of available commercial real estate, and at the same time they severely distort the market.

The same distortions occur because of strange depreciation rules. We should allow depreciation over the useful like of a product used in business. But Congress has come up with tax breaks including direct write-off of investment as an expense; accelerated depreciation; and support for moving depreciation from the company that bought the goods to someone who needs a tax break. Workaday tax lawyers spend their time planning complex ways to maximize depreciation benefits. The joke in the aircraft business is that the deal cannot be signed until the documentation equals the weight of the airplane. Most of those documents are related to depreciation and tax benefits. Clever leases that give them the depreciation is how General Electric built an entire finance division that makes great profits and never pays Federal income tax.

Layers of corporations and partnerships are routinely used to move depreciation and mortgage interest deductions to unrelated profitable businesses. This is done by highly skilled lawyers and seldom challenged by the IRS.

In addition to those areas, which are screamingly obvious and totally unexplored by Congress, there are other things that used to be in the Internal Revenue Code but have since disappeared. One of them was the provision that taxed retained earnings. If they exceeded what was going to be reinvested in the business, they would be taxed on a current basis. You wouldn’t be allowed to pile up earnings inside the corporation without paying tax. We now have a system of deferral for foreign earnings. We allow unbelievable amounts of cash in reserves.

The reserves have been allowed to grow without current taxation on the theory that the company with the reserves may want to make a big acquisition. So a few large corporations have a great pile-up of cash, which they’ve systematically refused to distribute in the form of dividends, and use to pay out bloated compensation to a handful of CEOs and high level executives. That is a terrible strategic mistake if you want the government to have a revenue base and if corporations are to contribute to the economy. The idea should be: both build the business and actually do stuff, or pay it out to shareholders who will invest it with someone who will. Alternatively, the government will take away profits and redistribute it. That would be a real investment incentive.

There are other things that have occurred during the course of the campaign debate that are pretty disturbing and dishonest. Neither party has brought up the estate tax. That tax is very important for social reasons, particularly the long-term societal health of the country. We don’t need our own version of nobility—people who can for multiple generations have money flow to them from above with no taxation and no leveling out. The original idea was that over time the accumulated wealth of a few individuals would be reduced, and that eventually, three or four generations later the inheritors would be just like anybody else and have to hustle to make a living. We’ve now reduced it to the point where you can put a pile of money into a legacy trust and keep it on ice in perpetuity. There used to be a limit of life plus 21 years for trusts, but now that’s gone. States and Federal government are in competition to help along this process of estate planning, with a complete exemption for the mega-rich. While everybody talks about how raising taxes on the rich won’t bring in enough money to put a dent in the deficits, no one is suggesting an estate tax as we’ve had it before. There are no estimates of lost estate tax dollars informing the discussion.

What’s wrong with talking about estate taxes? Why isn’t that a subject for discussion? Why are we talking instead about taking money away from Social Security and Medicare because of our debt problem, and averting our eyes from the way we help the rich keep their families rich in perpetuity?

Another issue that is key to solving the country’s revenue problems is the IRS. The IRS is underfunded, understaffed, and at the moment incapable of enforcing the tax laws when it comes to the sophisticated, high-end tax planning and tax cheating that’s in progress. Right now the IRS does a great job of going after people who work for a living. The people whose 1099s are sent in, who don’t file, are easily found and it’s a gotcha for a Revenue Agent. That is also true for charitable contributions, stock market trading by individuals who have brokers and old-fashioned brokerage accounts—if you forget to report you’ll get a notice from the IRS be dunned for the money with a penalty. On the other hand, the mega-rich can set up perfectly legal and maybe even reported offshore arrangements that don’t have any collateral reporting to the IRS. When there is collateral reporting, the integrity of the individual tax return improves to about 90 percent.

CD: Could this have anything to do with why candidate Romney has not released more than one year of his tax returns?

JB: It’s almost certain this has something to do with it. This ability to conceal assets, and to plan when to take a profit or a loss by layering corporations one on top of the other is something that individuals can’t do. When the very rich do it, it’s invisible. This brings me to a massive problem. A lot of the political discussion looks at IRS statistics and finds that taxing the very rich more would only bring in a little bit of money. But the IRS statistics don’t show what they don’t know.

If the tax return is linked to offshore accounts whose activities you can’t identify and whose underlying assets you can’t possibly know, the numbers are largely irrelevant. If the United States is incompetent in tracking the very rich in their offshore world, think about the rest of the world’s governments and how capable they are.

If you ask the Greek government leaders how well they do in tracking down money in offshore havens, you’ll get a blank look. There’s no capacity there.

CD: You mentioned earlier that you met with former Prime Minister Papandreou, and we’d be interested to hear how that came about and what you said to him.

JB: It came about through an economic adviser to Papandreou who’s a friend of mine, and the meeting was extraordinarily good. The problem that he confronted was that the resources to follow up simply didn’t exist. The tax collection apparatus was simply not designed to go after the sophisticated kind of problem that I was describing. As time has gone on, that capacity is slowly being brought online. The Greek government has been seizing the assets of the very rich, based on conclusions that there is offshore unreported income. But it has taken them essentially three years to put together. Again, I’m sure it’s because they don’t have an enforcement system that really works.

An area that is completely opaque and that must be opened up is the hedge fund game. In the United States we’ve talked a lot about the financialization of the American economy. Hedge funds are set up and operated through offshore entities. The people who run them, and the people they’re trading with, are all in the United States. But all of this is done as if it weren’t happening here. There’s virtually no reporting of any of that activity, nor is there any taxation. It’s mind-bending as to why the government doesn’t intervene when a firm is located in Greenwich, Connecticut, its clients are in Manhattan or Palo Alto, trading on American exchanges and doing business with American institutions, and yet claiming the activity is offshore. But we very carefully don’t ask. That, too, should be part of the tax debate. The IRS should receive 1099s for everyone working at a hedge fund and everyone investing in a hedge fund.

The whole idea of carried interest, which has been a big way that allows people like Mitt Romney to avoid paying tax, is absurd beyond discussion. There’s no excuse for it, and everyone agrees the people who use it are getting income for services rendered. How did this come about in the first place, and how has Congress failed to change it?

There are some obvious signs of how corrupt and rotten the system is. I’d invite people to take a trip with me along the Intracoastal Waterway that runs along the coast of Florida from Ft. Lauderdale upward. You’ll see one 200-foot yacht after another, and the array of flags affixed to the yachts is very diverse. The Marshall islands, the Caymans, Panama, Liberia. These boats all belong to Americans; how do they come to be registered in offshore jurisdictions? Because of various things I’ve been privy to, I’ve seen documentation of how one person handled this kind of yacht business, and he also handled offshore aircraft using the same techniques. The device is pretty simple. Set up a corporation that owns the yacht. The corporation is owned by a foreign trust, which owns a lot of other assets that make tons of money. Because of the way the reporting goes to the IRS, you can offset expenses against income. So the yacht and the private airplane, the house on the island and who knows what else, all get charged as expenses against this other foreign income. For the rest of us poor citizens, that’s just what we do with our after-tax income. That kind of arrangement is beyond scandalous and should also be part of the debate. Why aren’t we talking about it?

CD: Well, then, should we talk about tax reform, Jack? What can we do about all this?

JB: First, make tax returns and tax settlements public for corporations above a certain size and for individuals who have settlements of, say, more than $2 million. I don’t particularly care about the little guys, but when an individual is hit by the IRS and cuts a deal involving millions of dollars, it should be a matter of public record. Likewise, it should be public for corporations. There should be a public filing of tax returns that go along with the SEC statements. Both the shareholders and the public deserve to see how different what’s reported to the IRS is from what’s reported to the SEC and shareholders. I think that in itself would create a political force to change the system. Without that kind of information, there will never be a public discussion.

CD: What about the tax code itself? We’re up to about 70,000 pages of code and regulation now. What should we do? Is there any hope for reform?

JB: The hope begins with changing the tax expenditures. Every time you create some special loophole or deal for a particular industry, you then have to try to write regulations that define and limit what you’ve done so others can’t use it. But no matter how good the regulations writers are, clever tax lawyers figure out how to pyramid these tax exemptions—which then leads to more pages of regulations, which leads to better money for the lawyers and no effective result for collection. I think the solution is to properly fund and staff the IRS to a high level that it hasn’t been before. Anybody who has been inside will tell you that there’s no real auditing of large corporations. There’s a challenge here or there on large issues, but for the most part they’re compromised, and there’s kind of a kabuki dance involved in the negotiation. In the end the IRS can say it was triumphant in collecting such an amount, and the company can say that it paid less than it would have otherwise. We have to get beyond that.

We also have to stop accepting at face value form over substance, which has been the enemy of tax law as long as I’ve known anything about it. For instance, as we learned from Mitt Romney’s tax return, companies that serve as blocker corporations. Why should it be respected, if the net effect is just to walk around the code and have no other purpose. No office, no employees. Why should we care that it exists? But the tax code and the IRS cheers on such form over substance. That has to stop.

CD: Can you give us another example of this, Jack—form over substance?

JB: It’s mostly corporations layered one on top of the other. Look at major defense contractors’ 10K filings with the SEC, and find that they have a hundred offshore unnamed corporations, and there’s no explanation of what they do. They just tell the SEC they’re “immaterial.”

CD: So we’re talking about a sort of Enron situation here, where the offshore corporations were hiding all sorts of cheating and wrongdoing, I see.

Our readers would be interested to learn more about your background, Jack, and your involvement historically in these issues. Some of the most spectacular involvement has been recent, such as the Lichtenstein affair and UBS, and further back you worked with John Kerry in exposing the BCCI scandal.

JB: I’ve been working on different forms of financial crime, fraud and chicanery both tax and otherwise for 45 years. One of the first scandals I worked on as an investigator for the U.S. Senate was the collapse of the Penn Central railroad, which many people have forgotten about, in which various and sundry offshore corporations were used to conceal losses. It was almost a playbook for Enron 35 years later. This sort of stuff has been going on a long time, and I’ve been blessed—or cursed—to have followed a lot of the kinds of scandals we’ve been talking about. Typically, they don’t just involve taxes, but also other kinds of criminal activity. It’s a strange aspect of our system that federal law enforcement is based on sections of the U.S. code. So the IRS investigates tax fraud, customs investigates customs crimes, and so it goes. Frequently, a major scandal involves fifty different kinds of crimes, and few people get to view the whole panoply of what’s going on. Thieves and crooks will take advantage of any opportunity to hide what they’re doing, whether to defraud the company, the investors, the governments involved. The system also allows for payouts and bribes and looting of national treasuries.

So, for instance, I’ve looked at the offshore tax credit situation with the oil industry, this with the Senate Foreign Relations committee in the 1970s. I looked at BCCI, a criminal bank that had no capital, was unsupervised, and engaged in almost every form of criminal activity imaginable—including assisting people in looting their countries, money laundering and arms trafficking. And then I looked at the incapacity of the international system to respond to a bank that billed itself as “multilateral” and “third world.” Who was supposed to enforce the law?

CD: The bust-up of BCCI was in what year?

JB: They were finally closed down in 1991.

CD: And this lead to a tightening up of enforcement?

JB: It was like what happened with Dodd-Frank. There was much hand-wringing about the holes in the international system, pronouncements from the Bank for International Settlements about the need to do something about banks’ capital. There was talk of regulations to keep banks from elsewhere from setting up in a new market and circumventing the law. After so much notional reform, we learned that very little of it had any effect. The problem has been the continuous pushback from the bankers, who don’t want the regulation and have profited from the status quo. They think they’re entitled to operated without government supervision, even though they have government licenses to print money, and even though there’s a global expectation that governments will make up for catastrophic losses.

CD: Shall we jump ahead to the LGT affair in Lichtenstein and your role there?

JB: It’s important to understand that LGT was the premier bank in Lichtenstein and owned by the ruling family. I represented the man who took records from the trust company run by the LGT bank. That showed the structure that wealthy families and individuals used to create anonymous accounts in the bank itself and thus hide money from the authorities or the tax collector. You could see from these records that people all over the world were being actively solicited by LGT to come hide their money there and avoid paying taxes—some of the most important of which were inheritance taxes.

CD: Can you tell us, Jack, about any other whistleblowers you’ve been involved with?

JB: There are some I can’t tell you about, but I have been involved with Rudy Elmer and his fights with Baer bank, which continues to this day. This unraveling of the bank secrecy system in offshore jurisdictions has come about because of these whistleblowers, and that in turn has undercut the customers’ sense of security in hiding the money. They no longer trust these banks to keep their secrets. That has done more to curtail the activities of these banks than all the government involvement put together. But I am continually stunned by the brazenness of the Swiss in sticking to business as usual. After the UBS affair, which I had some minor role in, the Swiss negotiated agreements with both the UK and Germany on the money that their citizens had in Swiss banks. One of the clauses was not only to keep the accounts secret, but to forbid either country from paying reward money for information on tax cheating by their own citizens. If Switzerland were serious about reform, or about paying withholding tax, I’d expect them not to care if that information were given to the British or German governments. They’re trying to negotiate a similar deal with the United States, but so far that hasn’t happened.

CD: In this regard, what about the U.S. role as a tax haven for people in, say, Mexico. Are we innocent and clean, or should the Swiss be sending the ball back somehow?

JB: Miami is sort of the poster child for what’s wrong with the U.S. role in this whole system. It’s where much of Latin America goes to hide money from its tax collectors. You need only look at the proposal that, thankfully, the IRS proposed and adopted to require that banks report information to the IRS about accounts held by foreigners. Every bank in Florida and the whole Florida congressional delegation paraded in to say, “Horror of horrors! It’ll kill our business!” They were afraid it would put the United States in a position to hand over information to various Latin American governments about those who were cheating on taxes. There are massive amounts of money here from Mexico, whose citizens put their money in banks in California, Texas and Florida rather than keep it in their own country and pay tax there. We’ve been very slow to do much of anything in tax information exchange. The Mexicans ask for it, we refuse; we didn’t even answer their letter. This is a problem.

CD: Thanks, Jack. Let’s return to the question of tax reform. We have an essay at the American Interest by a very experienced tax lawyer, which argues that tax credits are a bad thing. After all, the Code was initially developed to fund the Federal government, but over time it has been used for various kinds of social engineering and behavior modification schemes. So tax credits are a sort of carrot designed to encourage or mitigate certain kinds of behavior. But the author points out that there’s nothing you can do with a tax credit that you can’t also do directly through the legislature. The real reason for the surfeit of tax credits is their lack of transparency. You can hide them in bills that have nothing to do with the topic of the credit. He further argues that if we ever want to make the tax code simpler and fairer, we have to start by eliminating all tax credits. What do you make of this argument?

JB: I think that’s right on target. It takes me back to proposals made as early as the Kennedy Administration for what was then called a “tax expenditure budget”, which would show how much money the United States was giving up in tax revenue to support various social priorities. With that budget in hand, legislatures could ask whether that amount of money would be directly appropriated if indeed it had to go through the appropriations process. So if there were an argument over, say, purchasing goods for manufacturing, and instead of depreciating them you could get an immediate expense write-off, somebody would do the numbers on what it would cost, it would go into the budget and legislators would have to vote publicly on whether it deserved public funding. For every dollar you put into some chicanery that hides or supports a public policy without a congressional vote, you have to collect an extra dollar from someone who won’t benefit from that particular loophole.

CD: Let’s move to another tax idea, one that we’ve also published on in the past. A tax expert at Columbia University argued for doing away with the income tax, shrinking the IRS and moving to some form of a value-added tax. Note that he was not talking about a European situation in which there’s both income tax and a VAT. He wanted to design a tax on consumption that rewards earnings and work and penalizes in effect excessive consumption. Have you given any thought to alternatives like this?

JB: I have, indeed. I’ve been involved in a couple cases involving VAT fraud against the British and other governments in Europe. The fraud against the EU alone amounts to billions, maybe even a trillion dollars per year. Someone has to enforce the law on that, or governments will be picked clean by people who know how to beat the VAT. We’re talking here about schemes to export things, create rebates, and re-import. The system is not perfect, and we can’t expect it to solve anything. Over the years I’ve worked on enforcement problems surrounding excise taxes in the United States. Cheating on gasoline taxes in the 1980s was rampant. People were buying gasoline at the refinery tax-free and then sold it at the pump with a sign saying that they had just paid $0.36 in Federal tax. Well, they hadn’t paid a dime; they just took it through a daisy chain of corporations. Cigarette smuggling is another example. And, we have a long tradition of this, starting with the moonshiners who did not pay the excise tax on booze.

CD: This is interesting, because many of the proponents of the VAT say that it is highly collectible as opposed to other forms of taxation. It sounds like you disagree.

JB: I vociferously disagree. Just ask the New York City prosecutors who have tried to go after sales tax cheating. This will happen no matter what tax system you have, and you’ll always need cops on the beat monitoring the system. I don’t know what fantasy land these people are in, but whenever there’s an arrangement that leads people to think they can get away with it, they will try.

Jack Blum is chairman of Tax Justice Network USA and one of the world’s premier experts on tax evasion, money laundering, banking and real estate scams, and corporate fraud. Mr. Blum, a Washington, D.C. lawyer in solo practice, also served as Special Counsel to the Senate Foreign Relations Committee from January 1987 to May 1989.

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