The Trump Campaign (and the Republican Party---and Actually the Two-Party System) in Context: (Part U)

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Tonight's Episode: To Clone The Truth: Part One

Today what I'd like to do is to simply survey the double-talk of the corporate rich and their senior political associates. I think we can learn a lot that way.

Without further preamble, here we go.

Number 1: It was a land deal that they "lost money" on.

I'm going there. I'm, in a way, revisiting the Clinton Whitewater scandal. But let me make myself clear. I have no new information about the case; and I don't have a particular opinion about it, one way or the other.

All I want to do is impress upon you the fact that, the words "lost money" have a different and/or expanded meaning for the corporate rich, than they do for you and me. I hope the following case study illustrates that.

Now, first of all, as you know, when the Clintons hit the national political scene, back in the early-1990s, one of the clouds hanging over their heads was something called the Whitewater real estate scandal. Those of you old enough to remember, will recall that their principal defense, in the court of public opinion, was that they had "lost money" on the deal.

Since they had "lost money" on the deal, they couldn't possibly have engaged in any malfeasance.

Okay.

A different perspective is provided for us, once again, by economics journalist, David Cay Johnston, who consulted with a man called Jerry Curnutt, at the time an Internal Revenue Service specialist in something called real estate partnerships. At one time, Mr. Curnutt was the only person in America authorized to look at every single real estate partnership tax return filed in the country.


Real Estate Partnerships As Tax Evasion Devices

The first thing to say about real estate partnerships, according to Mr. Curnutt, is that they typically last for about twenty years. The key in trying to detect the tax evasion is to pay attention to the final year of the partnership, when they have used up all of the tax benefits in its buildings and prepare to sell them (1).

"For every year but the last one or two," wrote David Cay Johnston, "the investors in many real estate partnerships expect to receive reports showing that they lost money." Copies of those reports go to the IRS (2).

But Mr. Johnston would have us know that the partners really have not lost money. Each year and expense is taken for depreciation to account for the so-called declining value of a building as it ages, often creating a "loss" on paper. However, again, most buildings actually gain value over time; nevertheless, the depreciation rul is well established in accounting rules and tax law (3).

Stay with me, this part's tricky!

When a building is sold, the partnership report the sales price, subtracting it from the value of the building. The difference is profit. Since the value of the building has been reduced by the annual depreciation, most or all of the sales price is supposed to be reported as taxable profit (4).

Suppose I own a building that is really worth $200. But through the lawful depreciation allowance, I say its only worth $50.

Then I sell the building for $175

I am supposed to pay tax on the $125 profit. Remember, I've had twenty years of tax benefits from the depreciation allowance. But I can, indeed, say that I sold the property "at a loss," for whatever reason --- that is, if I backdate the sale of the property to a theoretical time when the property was the $175 (you know, although it was never actually worth less than $200).

But when you think about it, this would require collusion on the part of the "buyer," as well. "Dummy" or "shell" companies would have to get involved, I would imagine.

Now, Jerry Curnutt found "a small but lucrative minority" of real estate partnerships simply did not report the profit. You know, as if I only sold my building for $50. Many more reported the profit as capital gain, which is taxed at about half the rate of straight income (5).

A capital gain is just a return on investment in a stock.

Other returns ignored a rule imposing a special tax rate of 25 percent, which is more than the capital gains rate, but less than the tax on straight income. Perhaps one-in-twelve returns that Jerry Curnutt looked at, used these techniques (6).

What It Means

David Cay Johnston says that, for investors with a million dollar cash-out from a real estate partnership in 1998 (which means that the process would have started way back in 1978, remember), the savings could have been as much as $396,000 by not reporting the profit at all, and $196,000 by reporting the profit improperly as capital gains. And, once again, this is on top of the twenty years of tax credit for "depreciation" losses (7).

Here's the good part. How do you detect the fraud?

Chapter 12 of Mr. Johnston's book is appropriately titled, "For Want of a Keystroke." It has a "so near yet so far" kind of ring to it.

Anyway, to detect the fraud you need only match individual partner reports to individual income tax returns. Its like this:

"While partnerships do not pay taxes, they file annual tax returns on Form 1065 that detail revenue, expenses and earnings. The partnership sends partners reports called K - 1s that detail how much money each of them made or lost as well as identifying whether this money should be taxed at rates for ordinary income or at the lower rates for capital gains.

"The IRS receives copies of both the partnership and K - 1 income data, just as it gets salary information from both employers and individual workers. But the IRS does not treat K - 1 income the same way it does reports of people's wages filed on W-2 forms or the reports of income from dividends, interest, royalties and contract jobs reported on Form 1099. IRS computers match every wage, dividend, interest, royalty and contract job report to what is listed on individual tax returns to make sure that every dollar earned in these ways is taxed. Not so partnership and K - 1 reports" (8).

Still quoting:

"There was no matching of partnership reports to individual or corporate income taxes," wrote David Cay Johnston. "Congress did not require such matching. Perhaps that's because the members whose job it is to oversee the IRS pay little attention to such administrative matters, which carry with them little opportunity to raise money from donors. Perhaps it's because they do not want the tax police looking too closely into the activities of those who finance their campaigns. Whatever the reason, Congress did not give the IRS special money to match partnership reports and K-1 income to tax returns of individuals and corporations, as it did with the extra funding it voted starting in 1995 to police the tax returns of the working poor. But even if Congress had, the matching would not have done much to find tax cheats. That was because of the way that the IRS had designed its various tax forms. The IRS carefully crafted the W-2 and 1099 reports so that the income they reported flowed to specific lines on the tax returns filed by individuals. Mismatches were spotted by IRS computers, which automatically sent out notices in minor cases and prepared lists of audit candidates that were sent to revenue agents. But the IRS neglected to coordinate the partnership tax returns and K-1 reports of income and losses with specific lines on individual and corporate tax returns" (9).

Charitable Giving As A Function Of Tax Evasion

You might have read the above and thought to yourself something like: "Big deal! The rich avoid some taxes. Hardly breaking news. So what?

Here's the "big deal" and "so what."

Number 2: "I have given hundreds of millions of dollars to charity."

What happens when tax-allergic reactionary politics joins up with so-called "compassionate conservatism" (remember, George W. Bush first hit the national scene as a 'compassionate conservative'?), to produce the idea that religious and other private charities are a more ideal way to provide social services than big, bad, mean, old, tyrannical government?

What happens when such "charitable giving" replaces the multiple times more in taxes that the billionaire individual, couple, or corporation rightfully owes the government?

What happens when such "charitable giving" starves the government of funding, disabling it from delivering much needed social services to the most vulnerable in our society --- which thereby necessitates more "charitable giving"?

The word you are looking for is vicious circle.

The story

Once upon a time there was a brilliant tax attorney who "devised a way that Bill Gates, the richest man in America, could reap $200 million in profits on Microsoft stock without paying the $56 million of capital gains taxes that federal law required at the time" (10).

"The plan was so lucrative," David Cay Johnston would have us know, "that Gates would not have to pay a single dollar in tax and would even be entitled to an income tax deduction of $6 million or so. And that was just the initial plan" (11).

Remember: No taxes and a $6 million rebate on the taxes not paid!

Still quoting:

"The concept could be applied endlessly, allowing Gates to convert billions of dollars of Microsoft stock gains into cash over the year. So long as the Internal Revenue Service did not challenge the deals, then Gates could realize unlimited capital gains without the pain of taxes" (12).

The trick is to manipulate "charitable trusts" (13).

Step One: Take an asset, like a stock or building, which has appreciated in value (14).

Step Two: Instead of selling that asset and investing the after-tax proceeds, you donate the asset to a charitable trust you, said billionaire, control (15).

Step Three: The trust sells the asset tax-free (because its charity, remember) and invests the proceeds, giving the donating individual or couple an annual lifetime of 6 percent (16).

Step Four: When the donors die, what remains in the trust, typically around half its value, goes to charity (17).

But what if you don't take a scant 6 percent a year for life? What if you take 80 percent for a year or two? The scheme offered to Bill Gates would have allowed him to pocket $192 million without paying any tax (18).

Remember, everything is happening behind the shield of the legally tax-free charitable trust!

Step Five (in the hypothetical Bill Gates case): The trust would fold and a charity would get the remaining sum of less than $8 million (19).

The scheme even included a tax deduction that would have saved Mr. Gates an additional $2 million in income taxes. It is not known whether or not Bill Gates took advantage of the plan, because individual income tax returns are legally confidential (20).

"Billions of dollars of assets poured into these short-term charitable trusts," according to Mr. Johnston, "and their super-rich owners took many millions of dollars of income tax deductions that further cut into the flow of revenue to the government" (21).

Now, it seems that this technique was considered so outrageous by other tax lawyers that they referred the matter to the Department of Treasury in March of 1994. Treasury stopped it and made it well known that they would pursue anyone who used it. But the IRS never announced that they had collected the taxes; and there was no indication of such in the public record (22).

Personally, I find it hard to believe that a manuever something like this doesn't persist to this day. Its worth noting, in aid of this, that corporations lowered the part of their profits that go to federal income taxes from 26% in 1998, to 22% in 1998, even though the official corporate rate remained unchanged at 35% (23).

This is, of course, what is known as the difference between the official and the effective tax rate. In other words, its the difference between what the government charges and what the government actually ends up collecting.

Let's move on.

The Metaphysics of Stock Ownership

Number 3: "I believed in the company. I kept my stock."

The operative words are: "I kept my stock." It turns out that those very words also have a different and/or expanded meaning for the corporate rich (and their senior political associates as well, perhaps) than they do for you and me.

David Cay Johnston:

"Another technique, one that can trick investors, was pioneered by Goldman Sachs, but is only open to people with $10 million or more in a single stock" (24).

Mr. Johnston lays out a hypothetical scenario for us. He says, suppose you started a start up Internet company, or some such. You issue an initial public offering (IPO) and your shares "head for the moon." All of the sudden you have a billion dollars on paper "but no cash in your pocket." Should your stock collapse, you're wiped out, left with nothing. The Catch-22 is that if you sell a lot of your stock, you risk signalling the market that there is a problem with your company, and your stock price might tank as a result (25).

But did you know that there is a way to split the legal ownership of stock from economic ownership?

Let me back up just a little bit.

Those of you old enough to remember, cast your mind back ten to twelve years. Remember watching C-Span and being mildly interested in a Congressional inquiry into the spectacular collapse of (fill in the blank) corporation? The human fallout was, somehow, so bad that an official look-see was deemed warranted

Corporate leaders were brought in to account for themselves. Oftentimes an uncomfortable fact would come out: that they had unloaded... uh, I mean sold lots and lots and lots and lots of their own company stock shortly before the spectacular collapse.

It was as if they had had some inkling that something was up, that the ship was about to hit rough seas. There wasn't necessarily anything illegal about their massive sell off of stock from their portfolios; but it didn't look good from a public relations standpoint.

It sent a faint signal that perhaps they had not been dealing with their shareholders, in complete good faith.

But every once in a while, if you recall, a CEO sat in front of the microphones and looked just as dazed and confused, bewildered and sandbagged as anyone else. You see, no one was more heart-sick about the massive job loss and what this did to the prospects of all those families, and the futures of all those children, than he was.

No one looked more like he'd gone through a reality warp than he did. No one looked more like the universe had gone sideways on him, than he did. No one was more "shocked, shocked, shocked that gambling" was going on at this establishment, than he did.

And to almost prove it he offered up the notion that he had profoundly believed in the company, up to the very end; and that furthermore, "I kept my stock." This was meant to suggest that whatever happened, he had maintained good faith with shareholders.

He had not abandoned ship. And, looking haggard, he implied that, like any good "captain," he had "gone down with the ship."

How to keep your stock without keeping your stock

  1. Deposit your shares in an investment bank, like, say, Goldman Sachs (26).
  2. Sign a contract that says that the bank gets all of the capital gains on the shares, if they go up in value (27).
  3. The investment bank loans you more than 90 percent of the value of your shares, at 1 percent interest annually (28).
  4. You use the funds to buy a diversified portfolio of stocks and bonds, which you have to hold in the account of the investment bank you're dealing with (29).
  5. Now you have freed yourself from all of the risk of having all your eggs in one basket, as it were, "... while investors continue to buy shares believing that your fortune is tied to the company's fortune's" (30).

It is also very important to note that, "[y]ou... have replaced your Internet shares that did not pay a dividend with a mix of stocks and bonds that pay dividends and interest both to cover Goldman's fees and to put spending money in your pocket" (31).

And furthermore...

Goldman Sachs goes out and "shorts" the market in your company's stock --- something which you, by law, as an executive of a publicly traded company, may not do. Goldman borrows some shares and sells them (32) --- you know, to get the downward movement started?

Goldman Sachs, therefore, profits handsomely if the price of the company's shares falls (33).

Moreover...

If the share price rises, Goldman gets the first 35 percent, or so, of the increase. This move "hedges" their position, giving the bank plenty of room to get out of its "short position" with no risk (34).

Let's back up a little bit again

Cast your mind back again, ten to twelve years. Recall seeing on C-Span some Congressional inquiry into some spectacular (fill in the blank) corporate collapse. Recall the anguished CEO who "kept" his stock.

Now also recall that at the other end of this, the name Goldman Sachs would turn up. The investment bank would come under suspicion of having committed fraud against investors. It would be said that Goldman had knowing sold investors stock, that the investment bank were simultaneously "shorting."

Basically, the accusations amounted to this: Goldman Sachs had knowingly sold investors a "lemon."

Of course, the very idea offended then Goldman CEO, Lloyd Blankfein --- him for whom his work in the financial industry was a God-given calling (35). Remember?

Basically again, Goldman tended to come out of situations with their reputation generally enhanced. These were real smart, slick operators with a lot on the ball. Remember?

The Metaphysics of Home Buying

Number 4: Are we subsidizing housing in the United States of America or aren't we?

The Mortgage Interest Deduction

This tax credit was designed to help people buy their homes. But the way it worked out, says David Cay Johnston, it became a subsidy for the rich, "because home buyers could afford to purchase bigger houses with these subsidies" (36).

I'm going to disagree very slightly with Mr. Johnston's conclusion here. It would appear that the real winners here are the realtors, companies that sell houses. After all, it is the case that "over the years, housing prices had artificially risen, discouraging first-time home buyers" (37).

Higher commissions from more of a higher income clientele.

The more the house costs, the larger the subsidy (38). Fair enough, but its not like the house price doesn't move in the face of the subsidy.

"This subsidy was so valuable to the affluent," wrote David Cay Johnston, "that the National Association of Realtors estimated that eliminating the ability to deduct home mortgage interest on individual income tax returns would cause the housing prices to fall by about one-third, with the biggest declines among the more expensive houses" (39).

One-third

Question: If that is true, why doesn't the government just drop the deduction and let the housing prices fall?

Hold that thought!

Suppose a house originally costs $600.

That is the price before you, home buyer Hilda, arrive at the "market" to buy a home.

The government knows that you, Hilda ("you" as a socioeconomic class), could use a hand in buying that house. So the government creates a mortgage deduction of, say, three hundred dollars.

If everything works out, you will have effectively paid only $300 for the house.

Realtors, through the industry's lobbyists and other possible "agents" in government, learn about this mortgage interest deduction. They then race back to inform their paymasters.

Realtors raise the price of the house to $900. But, of course, we're back to the original $600 (the difference between the $300 credit and the inflated price of $900) that the government thought you could use help with in the first place.

You, home buyer Hilda, know nothing of this. By the time you get to the "market," ready to buy a home, X-house is standing there, waiting for you at $900.

You see, as far as you know, Hilda, the house was "always" $900.

You go to buy the house; and if you don't know about the tax credit, the realtor will tell you about it.

You, Hilda, will receive this news gratefully. You will be grateful to the realtor for providing such excellent customer service; and you will be grateful to the government for providing the credit.

Of course, the realtor is being less than completely forthcoming with you, isn't she? The information she provides to you is perfectly accurate, but not truthful --- since she is not representing the true relationship between the tax credit and the price of the house she is quoting to you.



In other words, the realtor is not telling you that the mortgage interest deduction is the very reason the house is $900 instead of $600.

None of that helps you very much, however, because we're still back to the $600 the government thought you needed help with in the first place --- and which you know you need help with. How are you going to swing it?

And how are you going to swing it, given the fact that real wages for most workers, in the United States of America, have stayed about flat since the late-1970s? (40).

Well, that's what credit cards are for, right? And it so happens that credit cards were first made widely available in the 1970s (41).

If you get the house, Hilda, may be someday you can take out a second mortgage to pay off your credit cards.

And then, if you hit a geyser of oil in your backyard, or hit upon a gold strike somewhere, maybe you can pay off the multiple mortgages...

Number 5: Let's call this one the ever-elusive goal of "productivity."

What on Earth is he going on about now, you ask?

I'd like to talk about the executive pay deferral option, because David Cay Johnston makes the connection, for us, between this technique of executive compensation and the very working conditions of non-supervisory personnel.

Spoiler alert: The effect on the working condition of non-supervisory personnel is not good!

Please follow along with me now. What is the executive pay deferral option?

Well, it works like this:

  1. The executive declines to take delivery of a big chunk of his pay. Instead, he "defers" payment to some future year (42).
  2. No taxes are taken because, technically, the executive has not been paid (43).
  3. The executive gets to invest the full amount that is deferred (44).
  4. The company he works for invests the deferred amount for him. The money could be put back into the company (most often its put into a separate account and it cannot be used to finance the organization's operations) (45).
  5. Money set aside in such separate "trusts" are often invested in life insurance, mutual funds, or company stock (46).
  6. The dividends and interest earned in the deferral account usually keep building inside the account, untaxed. A few executives do choose to have the dividends paid out, in which case they become immediately taxable (47).
  7. When the executive "cashes out" (usually at retirement), the company withholds the taxes and pays the executive the balance, usually in installment over a period of years (48).

Now, executives, senior sales agents, movie stars, and athlete get such a deferral deal (49). But, as I indicated, what we are concerned with here is the direct effect of executive deferred pay, on the very working conditions of non-supervisory personnel within the same corporation.

Obviously, the first thing to say, the first thing Mr. Johnston would have us know, is that when a company pays no interest to an executive on deferred pay, there are still enormous costs (50).

If a company should used the deferred money to buy bonds, the executive's gains on the deferral comes from the market. The company is still, effectively, making an interest-free loan to the executive on the amount of taxes the executive did not have to pay. The company did this because they were not get to deduct the pay immediately (51).

Stay with me.

The corporate tax rate, in the United States of America, is 35 percent. This means that each million dollars of deferred pay costs the company $1,350,000. There's the amount of the deferral and the income taxes to be paid on it later (52).

Mr. Johnston puts it all together for us:

"Consider a company in which the deferral accounts of its executives, including the tax cost, totals $1.5 billion and the company has $7 billion of total capital" (53).

I believe what he's saying is that out of $7 billion in total capital, $1.5 billion of it is deferred for its executives in question. This would leave $5.5 billion operating capital, you might say.

Now we're resuming our quote:

"If the company's board sets a goal of earning 20 percent on capital, then it really must earn more than 25 percent on the capital that remains available to grow the business and is not subsidizing the executives" (54).

Why?

Because:

"A factory that is earning 20 percent or even 22 percent on the capital invested in it is at risk of being shut down because of the need to generate a return that masks the subsidy to the deferring executives" (55).

Because of the need to generate a return that masks the subsidy to the deferring executives.

I have never been wonderful at mathematics, but here is what I think Mr. Johnston is saying:

  • You start off with $7 billion in total capital to grow the business.
  • The board of directors set a goal of earning 20 percent on capital.
  • Ordinarily that would mean, to start with, earning another $1.4 billion (1.4 X 5 [20 percent] = 7).
  • You should, therefore, under ordinary circumstances, end up with $8.4 billion, to start with --- if all goes well, of course.
  • But: $1.5 out of the $7 billion has been put into deferral accounts for certain choice executives of the firm.
  • This leaves you with only $5.5 operating capital to start from.

Let's pause and take a breath.

Now, the board's goal of earning 20 percent on capital remains in effect.

However...

First Step:

Starting from $5.5 billion, the earnings must, first of all, recoup the deferred $1.5 billion --- which is not supposed to be "missing," as it were. This brings you back up to the $7 billion that you were supposed to start with all along.

Second Step:

Now you have to earn another $1.4 billion, on top of the $1.5 billion you had to recoup.

Third Step:

What this means is that you have to earn $2.9 billion to "break even," as it were.

But what if you only earn the 20 percent from the starting position of the $5.5 billion?

Twenty percent of $5.5 billion is $1.1 billion. In other words, you have not even fully recouped the "missing" $1.5 billion, which was put into deferral accounts of certain executives.

You have only brought your total operating capital to the $6.6 billion. How can you have "earned" money and ended up with a 400 million dollar loss? You will probably have some explaining to do to the board and/or shareholders.

Belts will have to be tightened, workers laid off...

I think we can begin to fathom how it is that, in the $5.5 billion ("missing" $1.5 billion) scenario, workers would need to be pushed a lot harder to work a lot faster to produce a lot more simply to "break even."

Question: Why do corporations do these deferral deals, if they're such a hassle?

The only thing I can think of is that there are a lot of executives, who want to both minimize their tax obligation and, perhaps, hide money from their spouses.

So it seems that in our system, non-supervisory workers have to suffer for it.

I'm going to pick this up in Part V, To Clone The Truth (Part Two), where we'll talk about "creating jobs," the real meaning of what's called "small business growth," "trade," the so-called "death tax," and one or two things you may not have learned, watching School House Rock, about how a bill becomes a law.

Thank you for reading.

Works Cited

1. Johnston, David Cay. Perfectly Legal: The Covert Campaign To Rig Our Tax System To Benefit The Super Rich --- And Cheat Everybody Else. Portfolio, 2003. 176

2. ibid

3. ibid

4. ibid

5. ibid, 177

6. ibid

7. ibid, 178

8. ibid, 179

9. ibid, 179-180

10. ibid, 7

11. ibid

12. ibid

13. ibid

14. ibid

15. ibid

16. ibid

17. ibid

18. ibid

19. ibid

20. ibid

21. ibid, 7-8

22. ibid, 8

23. ibid, 12

24. ibid, 268

25. ibid

26. ibid

27. ibid

28. ibid

29. ibid

30. ibid

31. ibid

32. ibid

33. ibid, 268-269

34. ibid, 269

35. Carney, J. (2009, November 9). Lloyd Blankfein Says He Is Doing "God's Work." Retrieved October 6, 2016, from businessinsider.com

36. Johnston, D.C. Perfectly Legal. 21

37. ibid

38. ibid

39. ibid

40. Wolff, R. (2011, January 18). The Myth of 'American Exceptionalism' Implodes. Retrieved October 6, 2016, from theguardian.com

41. Fronda, A. (2016, January 13). Escalating Global Debt Threatens New Financial Crisis. Retrieved October 6, 2016, from worldfinance.com

42. Johnston, D.C. Perfectly Legal. 47

43. ibid, 47-48

44. ibid, 48

45. ibid

46. ibid

47. ibid

48. ibid

49. ibid, 48-49

50. ibid, 51

51. ibid

52. ibid

53. ibid

54. ibid

55. ibid


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