The Wall Street Journal reported this week that hedge funds are using a tax avoidance technique offered by big banks with “one well-known trading firm potentially saving $6.8 billion in U.S. taxes.”
Last week, we learned that Mylan Pharmaceuticals is merging with a company from the Netherlands to take advantage of a lower corporate tax rate overseas. It’s estimated that the technique, known as “inversion,” will save U.S. companies (or, depending on your perspective, cost this country’s treasury) $20 billion over the next ten years.
Tax avoidance is as old as tax collections, and it has evolved into a multi-billion dollar science with taxpayers and politicians complicit in creating the 70,000 page labyrinth that constitutes the country’s tax law. At just under four million words, our tax code is seven times as long as War and Peace.
National Taxpayer Advocate Nina Olson says the intricacies and inequities of the code have many authors. “Tax complexity doesn’t occur just because of ‘big money’ special interests. It occurs because of the tax provisions that benefit each one of us,” Olsen told Congress in 2010. “We are the special interests.”
The result is an expensive, confusing and unbalanced system. As the late economist Milton Friedman said way back in 1978, “People who are fundamentally in the same economic position will pay very different taxes according to all sorts of accidental elements.”
Of course, as Friedman went on to explain, much of the inequity is no accident at all. It’s driven by the relationship between politicians and constituent groups that mutually benefit from manipulation of the tax code.
“(Politicians) get people who are willing to contribute to you and work for you in order to try to get a special provision that will benefit them,” Friedman said. “On the other hand, you have people who are willing to contribute to you in order to avoid having a special burden placed on them.”
And that explains why the conversion to a simpler, more equitable system is nearly impossible in our political system. Too many people, including those in power, have too much to lose by removing the possibility of manipulating the code.
Additionally, Friedman pointed out, neither side trusts the other. Let’s say the Congress adopts a simplified tax code with a couple of basic rates and no deductions. The left fears the right would immediately start adding deductions for businesses and corporations while the right fears the left would raise the marginal rates.
Olsen said, “The road to true tax reform requires each and every one to be willing to stop protecting our own tax breaks long enough to begin a dialogue about what we want our system to look like.”
That’s the altruistic approach; admirable, but highly unlikely.
Friedman was more realistic. He predicted true tax reform would happen only when those in office found a way to benefit politically from it. That was his prediction 36 years ago, and it hasn’t happened yet.