David Cay Johnston, Author of "Perfectly Legal: The Covert Campaign to Rig Our Tax System to Benefit the Super Rich -- and Cheat Everybody Else": 2004 BF Interview
David Cay Johnston is best known now for his books and his media appearances that expose Trump’s financial shenanigans, malfeasance and lies. He also founded the DCReports website to investigate financial chicanery and Trump administration wrongdoing. BuzzFlash first came to know him in this 2004 interview about his book, "Perfectly Legal: The Covert Campaign to Rig Our Tax System to Benefit the Super Rich - and Cheat Everybody Else." Johnston’s specialty when he was a Pulitzer Prize-winning reporter for the New York Times was and is tax law , so he knows hot to look at income tax returns, spreadsheets and business financial filings. BF interviewed Johnston again in 2008 about another book, Free Lunch: How the Wealthiest Americans Enrich Themselves at Government Expense (and Stick You with the Bill). Our synergy with Johnston was so strong, the interview ran in two parts, which we are combining for the archive.
Originally Published in March, 2004
.Is the American tax system ripping off just about everybody but the super rich Bush supporters? You bet.
Award-winning NYT reporter David Cay Johnston reveals the corrupt truth of the American tax system in "Perfectly Legal: The Covert Campaign to Rig Our Tax System to Benefit the Super Rich - and Cheat Everybody Else."
This is not your usual tax book. It was an immediate bestseller. John Kerry took two days off of campaigning in February to read it, Knight-Ridder Newspapers reported. (He also bought another copy recently at a much-covered trip to a Boston Borders.) A broad spectrum of Americans have endorsed the book, from Ralph Nader to Lou Dobbs.
What "Perfectly Legal" does is show how our national myth that the rich are heavily taxed to benefit everyone else is untrue and that the middle class and the upper middle class, those making $30,000 to $500,000, are heavily taxed to subsidize the super rich.
"Perfectly Legal" is based on nine years of reporting by David Cay Johnston, who won the Pulitzer Prize in 2001 and was a finalist for that award three other times.
And the story is told not in dry text, but through the lives of individual Americans from all walks of life who were rewarded, or punished or cheated and got away with it. The book even names two billionaires who did not file tax returns for 30 years and were never prosecuted.
You will learn that the income gap is vastly greater than you ever imagined -- the top 29,000 Americans have as much income as the bottom 96 million. And tax burden for the richest Americans has been falling sharply while everyone else's has risen. Most people making $60,000 pay a larger share of their income in federal taxes than the top 400 Americans, whose average income in 2000 was $174 million each. They paid just 22-cents on the dollar in federal taxes and under the Bush tax cuts would pay just 17.5 cents on the dollar.
Indeed, in 1970, the bottom group, a third of all Americans, had more than ten times the income of that very top group, the top 1/100th of 1 percent or top 29,000. By 2000 they were equal because the bottom third's income fell while the top group's income went through the roof.
"Perfectly Legal" shows how the tax police, the IRS, have been cut in size and then handcuffed, ordered to go after the working poor and to ignore tax cheating by the politically connected rich. And it names names throughout.
This book is written for the American public, not accountants.
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BuzzFlash: We were reading a Forbes interview you did. You're a reporter, of course, with The New York Times, and yet you take a position as an individual: You believe that taxes are an important part of government. And I'll quote from the Forbes interview: "Taxes are the means by which we decide how we're going to finance maintaining our democracy, who pays how much, how the burdens are distributed."
David Cay Johnston: It strikes me that that's the most fundamental, classic conservative statement you could imagine making about taxes. All civilizations have taxes. All civilizations that have lost their tax systems no longer exist. The Founding Fathers understood the importance of taxes. It's in Article I, Section 8, of the Constitution: "Congress shall have the power to lay and collect taxes." And except for three minor nits, one of which we've removed, the power to tax is virtually unlimited because the Founding Fathers understood that this was a political matter that needed to adjust with the times.
Let me just carry one further on that. You know, Athens was a tyranny at one time. And when it was a tyranny, it had a flat tax. Everybody paid the same tax. When the Athenians went to a tax based on ability to pay, democracy flourished. Your taxes are absolutely at the core of our democracy, and without taxes, there is no democracy. And I think that's a very classic, conservative observation.
BuzzFlash: You mentioned one has been removed. What were you referring to?
David Cay Johnston: The 16th Amendment removed the requirement that would have made an income tax impractical. And it's because of the 16th Amendment that we can have an income tax. Otherwise, each state would have ended up paying the same amount, even though there are different populations in each state.
BuzzFlash: Okay, let's play devil's advocate. Some would argue that basically we are a country with an anti-tax sentiment. After all, one of the events leading to the American Revolution was the Boston Tea Party, the revolt against the tax on tea imposed by the Crown of England.
David Cay Johnston: Actually that's not what happened. The Boston Tea Party was a demonstration in favor of a tax. What happened was that the Crown gave the East India Company an exemption from a tax. And the Colonists understood that that meant that anyone in the domestic tea business in the Colonies would be driven out of business over time, and would lose business. And so this was actually a demonstration in favor of fair and equal taxation, not giving a tax break to a favored few.
BuzzFlash: Opposing a tax break to a favored few.
David Cay Johnston: That's exactly right. It was in opposition to that. And understanding that story and how it is mis-taught in American schools is one of the most important lessons that I hope people get -- that the issue then was not against taxation. The revolutionary call was "no taxation without representation."
BuzzFlash: This has been misrepresented. And obviously when the Bush administration has used the slogan of "tax relief," that is a framing device that professor George Lakoff, a sociologist at University of California at Berkeley, has indicated is a hard slogan to resist, because it implies healing and relief, and taxes as a burden, rather than as a contribution to the community.
You, on the other hand, point out in your book that in reality -- and this is true under a Democratic or a Republican administration, because you go from the 1970s to 2000 -- the percentage of income tax paid by the most wealthy Americans has actually decreased as a percentage through Republican and Democratic administration alike. Your argument would be that the middle class -- people making $30,000 to $500,000 per year -- actually aren't getting relief.
David Cay Johnston: That's exactly right. What's going on in our system is we have representation, in that we have an elected Congress, but the people who are seriously involved in politics are people with really big incomes, and large corporations. Every member of Congress will say to you, "You can't buy my vote." Okay, I accept that. Occasionally we get a congressman who did sell his vote, but that's not the norm. The norm is you can't buy. What you buy is access. And the only people who have real meaningful access to members of Congress are the political donor class and the professional lobbying groups in Washington. They have been very actively involved in government, when millions and tens of millions of Americans have quit voting and have quit paying attention to what's going on. There actually was a survey in which more Americans were able to identify Jennifer Lopez' lover than their congressman.
So what we have is a small group of people within a huge economic stake in the government staying deeply involved in politics, and being able to increase their access because of our campaign contribution system, while at the same time tens of millions of other Americans were withdrawing from politics over the last 30 years, and amusing themselves with nonsense -- the glitz-mongering media. And, surprise, surprise, our government increasingly reflects the concerns and interests of those people who've stayed active in exercising their Constitutional rights. So if we want a tax system that serves all Americans, that rewards strivers, that rewards people who play by the rules, that rewards people who are trying to get ahead, we have to all exercise our duties as participants in a democracy, instead of ceding our democracy to a very narrow group of people.
BuzzFlash: There are some startling statistics in your book. You mention that in 1970 -- and I'll quote this; it's a paragraph -- the top 1/100th of 1 percent of Americans had about 1 percent of the income, and the bottom third had more than 10 percent of the income. Now they are equal, and just 27,000 people have as much income as the bottom 96 million Americans. And the number of people it takes today to account for 1 percent of all income -- well, in 1970, it was more than 20,000 people, and today, it's less than 400. How has this happened?
David Cay Johnston: President Bush actually explained this really well to people. President Bush says that the way to measure tax burdens is how much of your money do you get to keep. Now without quarreling with his interpretation, let's examine what he says. How much of your money do you get to keep? The more that you get to keep, the more you have the freedom to either spend it on your lifestyle today or save and invest for the future. Well, for people at the very top of the income pile, their tax burden has been falling, and they have more and more income to save and invest. Now if you are in the top group -- if you're making $10 million or more -- you can't spend your entire income unless you're a gambling addict or, actually, I don't know how you could spend it unless you're a gambling addict, because, if you're buying oil paintings, those don't lose value unless you're a complete idiot. You mostly are investing that income, okay? Well, investing works, as anybody who got in a 401k plan knows, over the long term. Forget about the downturn of the market right now. It's a snowball. You add new contributions to the snowball and the market returns part of it to you. And pretty soon the magic of compounding interest is bigger than your contribution, and that snowball gets bigger and bigger, and your income gets bigger and bigger. So that if you are relieved of a substantial burden of taxes, and you have the capacity to save substantial amounts, you will get wealthier and wealthier.
Meanwhile, people in the middle class and the upper middle class are confronted by two things. A growing share of their income is going to taxes, and we have seen falling wages for the bottom, about 40 percent, of Americans; stagnant wages for the next 40 percent of Americans; infinitesimal growth in income for the next 10 percent -- that brings us to the 90 percent percentile -- and this incredible concentration of incomes at the very top. When one-third of Americans belonged to unions, more than two-thirds of Americans benefited from that because there were employers who did not want to have unions, so they paid premium wages -- and by the way, tended to get the very best workers as a result, as classic economic theory says they should. Lots of low-level managers at companies, their wages were basically set by the unions. To the extent that we set up the rules to shrink unions, we drive down wages -- and America is the only nation in the modern world that is driving down wages.
BuzzFlash: That's extraordinary.
David Cay Johnston: They get a 15-cent-an-hour job in Malaysia making Nike tennis shoes -- that is a wage growth strategy for Malaysia. We are the only country in the world that is in the pursuit of lowering wages. And it's been a very successful program. So you combine all of those forces, and you can see why the data, the official government data, which were right there for anybody to report on, but nobody in Washington announced: Oh, the top 400 taxpayers -- it's actually about a thousand people when you count the spouses and children -- the top 1,000 people in America are earning more than 1 percent of the income, when 30 years earlier, it took more than 25,000 people to earn the top 1 percent of income in America. No one announced it, and, therefore, to most of the news media, it's not a story.
BuzzFlash: Again, to play devil's advocates on a political level, let's take Howard Dean. Howard Dean says let's roll back the tax cuts, and pundits and your fellow journalists, the ones on television, say that's political suicide. The American public -- you just can't tell them you want to roll back tax cuts.
David Cay Johnston: Well, if that's what you tell the American public, of course people would be against that. That's like the question that was asked by the opponents of the estate tax. Since the estate tax represents third, fourth and fifth taxation of the same dollar, and it's destroying American jobs, are you in favor of the estate tax? And, surprise, surprise -- 80 percent of Americans or 90 percent said no, they're against that tax. The question's not true. The people you see on television, in most cases, are not serious journalists. And many of those who are serious journalists, they're not investigative or enterprising reporters; they're political reporters. And they're telling you the perceived political wisdom. I don't do that. I do enterprise work. I decide what I think is news based on what I find, and this is what I've done my whole career -- well, maybe not the first five years when I was learning. But I decide what's news, and I go persuade my editors that it's news, and get it in the paper.
It is one of the great bad things happening in America -- that we do not have the degree of skepticism in journalism that we had in the 70s and the 80s. It is this constant acceptance of this official version of events. There's a very tricky number, Mark, to get to the real key people who do not want to pay taxes in America: the Koch brothers, the Mars family, Richard Mellon Scaife. (J. Howard Marshall Koch was the doddering old man who married Anna Nicole Smith). The people who've been financing the anti-tax movement have hired a whole coterie of very smart people in Washington to figure out how to design arguments that favor what they want, but make it sound like it's good for you. And one of the best ones they've got is: The top 1 percent of Americans pay 37 percent of the taxes -- that's for the year 2000, more than 37 percent. Well, actually, the top 1 percent, who made 21 percent of the income, paid more than 37 percent of the income taxes. When you look at all federal taxes -- gift taxes, estate taxes, Social Security taxes, Medicare taxes, excise taxes on gasoline and things like that -- the top group only pays 25 percent, which isn't much more than their 21 percent share of the income.
But the measure is a bad measure. Every top businessman and every senior executive believes that if you want to make profits, you have to measure what you're doing. You have to measure, measure, measure. You have to spend a lot of money measuring. But you have to measure the right things. Well, the entry point for the top 1 percent income group in America is not much above $300,000. Because my wife works and I work, and I have this book out, I'm in that group at the moment, okay? But it goes all the way up to a couple of billion dollars of annual income. I have nothing in common with somebody who makes $10 million a year economically. And when you break down the top 1 percent, and you say what's going on here, you find out the people at the bottom of the top 1 percent -- people making $300,000 $400,000 $500,000 a year -- they are being squeezed by the system. And people who make tens of millions of dollars a year are getting enormous relief on their taxes.
Who are the typical leaders in cities and towns across America? The minute you get away from Los Angeles and New York, and you go to Cincinnati, or Rochester, New York, or Anytown, America, what is the income level of the leaders of that community? $200,000 $300,000, $400,000, $500,000? There's a few people who make a million. There are one or two there who make $5 or $10 million. But for the core group, that's their income range, $200,000 to $500,000. They're being squeezed. And when your civic and local business leadership class is being squeezed it assumes the people above are being squeezed even more because that's what they see. But the people who make 10 or 100 times more are not being squeezed. And this false belief that the higher your income the bigger the share of it you pay in taxes is being exploited by people above them, so that the people at the very, very top who don't want to pay taxes can continue to benefit from tax relief. And the people down below haven't figured out that they don't have common cause with those people -- and are actually subsidizing those who make much more than they do.
People who make $200,000 are very well off. But they still go to work every day. They still have mortgages on their houses. They're not in the group of people who own a private jet, and have limousines, and own six houses. That's a totally different world. And innumeracy is a fundamental part of this problem. People don't grasp the difference between $200,000 and $200 million.
BuzzFlash: Your book is called "Perfectly Legal" and in it you're describing a tax code that has been worked upon by the very rich.
David Cay Johnston: Most Americans believe we take from people at the top to benefit those below. And what I show in the book from the data is that's not the case. Our national myth -- and I use that in the classic sense of the word "myth" -- is wrong. We take from people who make $30,000 to $500,000 to give relief to those, who make millions, or tens and hundreds of millions of dollars a year.
BuzzFlash: And you mentioned one of the vehicles that undercuts the notion that the middle class -- let's say the person earning $50,000 or $60,000 -- is getting tax relief is the alternative minimum tax. Can you explain that? Because I think a lot of people don't really know what that is, or how it's affecting them.
David Cay Johnston: I often call it the stealth tax, because it sneaks up on you. In 1969, it was revealed by the Johnson administration, three days before it ended, that 155 Americans who made the equivalent of a million dollars a year or more in today's dollars paid no income taxes. Remember, the U.S. government taxes you on your worldwide income to Americans. So nowhere in the world did the 155 people pay taxes. Congress got more letters about that that year than they did about the Vietnam War. It really struck home with people. So Congress passed a law that was designed to make sure that if you made the equivalent of a million dollars or more, you have to pay some taxes, because most people that make that pay a lot of tax.
Well, over the years, the laws morphed and were changed by Congress. And it largely ceased to be a tax on people who make more than a million dollars a year. But under the Bush tax cut, it will become a huge government moneymaker from the middle class and the upper middle class. Since 1986, under this law, if you take a lot of deductions, you lose your exemption for yourself and your spouse, and your children. You cannot deduct your state income taxes. You cannot deduct your property taxes on your home. If you or your spouse or one of your children is sick, and you're trying to keep them alive -- let's say they have cancer, and you're spending 10 percent of your income or more on your medical bills -- our government will tax you for trying to keep your loved one alive. You can even lose the standard deduction -- the most passive thing you can do as a taxpayer. You don't itemize; you just take the standard deduction. If you're a married couple with three children who made $75,000 last year, you lost part of your standard deduction to the alternative minimum tax or stealth tax.
Now under the Bush tax cut, by the standards of President Bush, there is a one-half trillion dollar increase in alternative minimum taxes. And that money is explicitly being used to finance the reduction in taxes for people at the very top who make millions of dollars. You can go back into the government documents and see this. It was even discussed at the time in the general news media that Congress would only approve a $1.3 trillion dollar tax cut. The President wanted $1.6 billion. It was probably as a number of critics have argued really a $2 trillion dollar tax cut -- but how do you stuff more than $1.3 trillion into a $1.3 trillion dollar bag? Well, the way you do it is the alternative minimum tax takes away the Bush tax cuts for millions and tens of millions of people in the middle class and the upper middle class, and that allows you to maintain the full Bush tax cuts for people at the very top.
If you are married and have children, you are 30 times more likely to pay this tax than if you're single. So much for, "We're here to help the American family." If you make $75 to $100,000, and have two or more children, there's a 97 percent chance you are going to lose part of your Bush tax cut to this tax. And, overall, 42 percent of the tax cuts for people in that income group will be lost because of this stealth tax. By the way, the only way you know if you pay it is you look on your tax return on line 43.
BUZZFLASH INTERVIEW, Part 2
"The facts are that we're down 9 million jobs. You keep hearing in the news media we're down 3 million. You have about 3 million fewer jobs than we had in 2001. But during that period of time, normally we would have created about 6 million jobs. So we're really down 9 million jobs in America." -- Award-winning NYT reporter David Cay Johnston reveals the corrupt truth of the American tax system in "Perfectly Legal: The Covert Campaign to Rig Our Tax System to Benefit the Super Rich - and Cheat Everybody Else."
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BuzzFlash: I know you're basically an economic journalist, but --
David Cay Johnston: No, I've been in investigative reporting my whole career. This is just part of investigative reporting.
BuzzFlash: In this case, you certainly would persuade anyone you had a background as an economist.
David Cay Johnston: Oh, sure. And I'm not an economist. I studied economics a great deal because I realized, early on, they were important to doing investigative reporting. But I've used this knowledge for other things, like I was the first reporter to seriously expose the Los Angeles Police Department in the L.A. Times. And a lot of what I was able to do was because I was able to show how they were spending money, and what it told you about the priorities of the police department.
BuzzFlash: With that in mind, let me ask you to speculate why, given the economic facts that you marshal in your book -- and again, it's quite detailed and well documented --
David Cay Johnston: It's all empirical evidence.
BuzzFlash: Why, politically, can't progressive Democrats make the case to the middle class that they're being pick pocketed by the Republicans?
David Cay Johnston: First of all, I don't think Democrats need to make it. I think politicians need to make it. I think it needs to be made to politicians. The principal thing that's going on, however, is that the conservative elements in Washington have a number of large institutions, which the media generally treats as think tanks, but which I think are primarily ideological marketing organizations. They craft and hone and develop arguments that appear to the general public to be for their benefit, but that, when carefully examined, turn out repeatedly to favor the super-rich. And the Democrats and the liberals, and the moderates in the Republican Party, they don't have anything like that. There is just nothing at all like that to develop and hone arguments for them. So we end up with a situation in which the conservative anti-tax Republicans have an agenda, and the moderates and the liberals, don't have a clue. There's no heavy ideological background for them.
Secondly, it's easy to be against something, and they've spent years demonizing both the tax system and the IRS. And that's a bizarre theme for conservative Republicans to be doing because I can't imagine a conservative Republican attacking law enforcement. But the IRS is the tax police. And the public needs to understand that they're the police. And if you're a businessman, and you're competing against businesses who are cheating on their taxes, and the government's not doing anything about it, you're going to get run out of business. Only when you demonize people and make them illegitimate can you get away with what is fundamentally an attack on the integrity and capacity of law enforcement. And that's what we're seeing.
The people who have benefited from that are the very wealthy, highly aggressive, anti-tax crowd. They have now succeeded in having a system in which we have two tax systems in America, separate and unequal. One is for wage-earners. The government knows what you make. It takes the money out of your check before you get paid. The government even knows how much you paid in mortgage interest. You can't cheat it. It's an effective and efficient system. You can chisel; that's all you can do. But if you are a super-wealthy individual who owns assets, and owns businesses, particularly if you're able to operate on a multi-national level, you are able to engage in all sorts of complex transactions and structures to make it appear your income is not as high as it is. And there's no law enforcement going on. Your odds of being audited if you invest in a partnership -- and those are primarily the province of the very wealthy -- one in 400. I've interviewed literally more than a hundred IRS auditors, economists, historians, sociologists, appeals officers, and tax collectors, who have all told me stories of how, when they have been digging into tax returns of the politically connected rich, have been ordered by low-level supervisors to back off. And I tell in the book about this. The system is rigged for those folks.
BuzzFlash: But you do point out the IRS doesn't hesitate to go after women, Hispanic, who earn $7,000 a year in East Los Angeles.
David Cay Johnston: Congress specifically gave money at the agreement of President Clinton and the urging of Senator Don Nickles of Oklahoma to go after the working poor. They didn't give them extra money to go after offshore tax cheats, corporate tax shelters. They gave the money to go after the working poor. Now think about this for a minute. If you were in the group that doesn't want to pay taxes, and you want to shift the burden of taxes off, you create a system that constantly says that poor are the problem. And you badly design the system for the poor. You generate statistics that show mostly mistakes, but you can lump in with abuse and fraud with the emphasis on fraud in your sentences.
If there's fraud -- all capital letters -- and abuse -- all capital letters -- but mostly there are just errors you can demonize the poor as unjust beneficiaries of your taxes. Then there's a fair amount of auditing of people who are in the moderately prosperous class, people who are making $100,000, $200,000, $300,000 a year. They will get audited somewhat. And then you say there's no money to audit the very rich, and you set up mechanisms within the IRS that allow, behind closed doors, to shut down a lot of audits of the super rich if the audits are getting into troublesome areas. This goes on again and again and again. The audit bosses tell the front line auditors to close an issue. That's the phrase used -- the term of art -- "close an issue." And you have the best of all possible worlds. Then you get Congress not to investigate this favoritism for the politically connected rich, but instead Congress investigates the alleged -- and it turns out, non-existent -- abuses by the jack-booted legs of the IRS. And you also reduce radically the number of employees at the IRS who are law enforcement people. Auditors are detectives. They're just tax detectives instead of burglary detectives.
BuzzFlash: Now in the interview with Forbes magazine, they challenged you. They used a phrase that is used, I believe, by the Bush administration, or certainly it's a perception that the Bush administration believes, which is that the super-rich are really wealth creators. And therefore, tax cuts for the wealthy are basically something that benefits society as a whole. What is your response to that?
David Cay Johnston: Well, the dollar that I invest or that you invest is the same as the dollar invested by someone who's very wealthy. And in all likelihood, you and I put it into an investment pool through a mutual fund, which is a secondary investment. Or we save it, and it's invested. And its yield is just as valuable as anybody else's dollar. That would be my first argument. Now some economists will come back and say: No, no, no. You are not going to take the high-risk investments that people with very large incomes will. Okay, I'll buy that. That's actually true. But at the same time, if I spend that dollar, then I'll spend it on something which those high-risk investments are trying to exploit through selling a product or a service, one way or another.
Secondly, and perhaps much more importantly, because we have one set of rules for capital on a global scale and another for labor, we are creating what is known on Wall Street as an arbitrage. There is no question, I think, at this point, that tax cuts for very wealthy Americans have resulted in investments and job creation. And right now we're seeing that a great deal of the money that people are not paying in taxes is being invested to create jobs in India, and in China, and in Malaysia, and in other countries where there is little or no tax on these companies. And once you move your money out of the United States -- trust me, if you're not going to Europe or Japan or Canada, you can arrange to pay little or no tax on the profits you've earned. And as long as you don't repatriate the money, the U.S. government won't tax you on that money.
We have a tax system that says to people with great wealth: Move your money out of the United States. Invest it offshore where labor costs are lower, where taxes are lower, and make a higher return and get even richer. The problem is that, back in this country, you are creating economic illness. You are draining the life out of our democracy. Now those people who believe we should have a big foreign aid program should be thrilled-- you know, foreign aid has been a fraction of 1 percent of the U.S. budget, and it's mostly spent in America, buying American goods. If we give a hospital somewhere to a foreign country, they have to spend the money buying American technology and having Americans come in and build the hospital for them. We now have a very massive foreign aid program, and it's called tax cuts for the super-wealthy.
BuzzFlash: So in some ways, the series of Bush tax cuts has created jobs, but the irony is that the jobs have been created then overseas.
David Cay Johnston: The facts are that we're down 9 million jobs. You keep hearing in the news media we're down 3 million. You have about 3 million fewer jobs than we had in 2001. But during that period of time, normally we would have created about 6 million jobs. So we're really down 9 million jobs in America. And the reason we have low unemployment is lots of people have quit looking for work. Now this trend, though, did not start with the Bush administration. It started with the Democrats. The Bush administration has simply run with it. And that's the ball on that thought. It is important, and the news media has not made this clear to Americans. I don't think most Americans, from my talking around the country -- and in the first two months of this year I made 31 flight segments this year around the country, talking to people -- most Americans do not understand that it is the stated policy of the Bush Administration to eliminate all taxes on capital. Now we can decide to eliminate all taxes on capital. The Constitution allows that, and if Americans want to stop all taxes on capital, then we should do that. But the news media has not explained to people both that that's the policy and what it would mean. Fundamentally what it means is if you don't tax capital, there's only one other thing to tax: labor.
BuzzFlash: Can you define capital?
David Cay Johnston: Sure. That's the money that you get from dividends, rents, interest, some royalties -- not all. Book royalties, for instance, are labor income, but royalties from a patent that you own, or for licensing something, those are capital royalties. And then capital gains -- that is, you buy an asset for a dollar, and you sell it for 10 dollars. That's a gain. And people think of that in the stock market, but it's true of all kinds of activities.
BuzzFlash: Buying a building and selling the building.
David Cay Johnston: Buying a building and then selling it later. And so if we want to have a system where we only tax labor, we can do that. I just think Americans need to understand what we're doing. And we're not hearing a rounded, focused debate about the issues.
BuzzFlash: Just a few more questions. I came across an article that quotes you. I thought I would bring it up because it's the kind of example of a legal taxpayer rip-off we read about all the time around the nation. It was, in the scheme of things, a relatively minor municipal project that offered investors an 11 percent annual return tax free. But it symbolizes so much.
David Cay Johnston: Right.
BuzzFlash: This one was specifically in Texas. In Grapevine, Texas.
David Cay Johnston: Which is a wealthy suburb of Fort Worth.
BuzzFlash: And it involved an aquarium that would eventually revert to the city after 20 years in the form of a nonprofit organization. And the city needed like $12 million additional investment, so they set up this scheme. And they asked you for your response here. What's wrong with this? The journalist did a pretty good job in explaining how the whole project unfolded, and how it came to be. And, of course, it was all perfectly legal.
David Cay Johnston: Now my observation was that this is part of a trend of what's called narrowing the tax base. In 1986, we had fundamental reform of our tax system. And the reason we were able to lower tax rates, at least for those at the very top, and at the top the rate fell to 28 percent of your income, was that we said we're going to tax more income. Currently in America, according to John O. Fox, who is a professor at Mount Holyoke, almost half of the income in America is not currently taxed, because of deferral devices and loopholes, and explicit policies of Congress. When we say to people: You don't have to pay taxes on this income, and we're going to create a device over here for you to not pay taxes, we are narrowing the base and shifting the burden of taxes onto other people.
BuzzFlash: So the small 11 percent project --
David Cay Johnston: I'd love, in today's market, to find a safe 11 percent investment.
BuzzFlash: But in the scheme of things relative to all the schemes going on, this is, I mean, it's a $12 million project. But let's look, for instance, at how many stadiums are built nowadays with tax-free --
David Cay Johnston: Sure. Yes, yes, yes. It's not substantial; it's a little project. But you have hundreds of these little projects all over the country, or thousands of them. A billion here, a billion there -- now you're talking real money.
BuzzFlash: And in some cases, I know Jim Bouton, the former baseball star, wrote a book about how for a minor league team, he was trying to save a historical stadium in Pittsfield, Massachusetts. And there were all these forces that were conspiring to build a new stadium no matter what, because there were tax deductions involved and investors who stood to gain. (http://www.jimbouton.com/foulball.html)
David Cay Johnston: There were big tax benefits and other economic benefits doing the other projects.
BuzzFlash: So even though people wanted to save this traditional, great city ball park, the investment scheme was so powerful, as were the forces around it, that he was basically railroaded. This little example of what's happening in Grapevine is really a model of what's happening everywhere. And this 11 percent that these investors are getting, you're saying, is, when you keep adding it up with all sorts of other things, contributes to the half of an income that isn't taxed in the United States.
David Cay Johnston: Exactly correct. And most of that untaxed income is not from working stiffs.
BuzzFlash: Someone's got to pay it, and it ends up that the working stiffs pay it. So even if they're getting minor tax relief, they're paying it more in the end because the wealthier are paying less.
David Cay Johnston: That's exactly right. The people with higher incomes are paying less; paying a shrinking share of their incomes, which are exploding. Wealth and incomes don't always go together. There are people who have enormously high incomes and no wealth because they spend it all. Or they're profligate, or they're idiots. But we are fundamentally, in this country, without a public debate about it, and without people understanding it, not just giving tax cuts to people at the top -- there's been news coverage about that -- but more importantly we are shifting the burden of government off of those people who had received the greatest economic rewards from being in America onto everyone else.
We live in a society where -- and you see this in CEOs all the time -- there is the culture of what I call "I." How many times have you seen a CEO say: I did this. I did the following. I created this wealth. I should get paid all this money because I did this. Not the tens of thousands of people who worked for the company -- "I." And the fact is nobody who is wealthy in America did it on their own. Bill Gates is a wealthy man because, long before he came along, we invested in an education system that created the knowledge that made computer technology come to life in our age. Hilton Hotels, the Hilton family -- Paris Hilton running around, you know, behaving as she is -- had that money because we have political stability and peace in this country. And Conrad Hilton, in his will, talks about how he owes his fortune to that, and how bad war is for being in the hotel business. It was we as taxpayers who built highways, and airports, and we improved ports, and we have an education system, and we have honest courts, and we have a system to enforce property rights and contracts -- without those things, you can't be wealthy.
Many, many wealthy people got there because of their hard work or their smarts. But many of them got there because of the family they were born into what Donald Trump calls "the lucky sperm club." But all of them owe that fortune, and their good fortune, in part, to the society in which we live.
If we don't pay attention to our tax system, America will not endure. It is not written in stone there will always be an America. People fought to create this country. A lot of people died to keep this country. And if all you think about is how much money can I have today, then you're not thinking about perpetuating our society, about making America endure. And taxes are fundamental to making the idea of America, the greatest idea in the history of the world, endure.
BuzzFlash: We saw a period, and it hasn't ended, where many CEOs of companies were rewarded with lavish bonuses even as their companies were tanking. Is that in any way tied to the tax code -- that a company can make out well for its board and its CEO, while going down the tubes?
David Cay Johnston: Yes. I wrote a story in The New York Times a few years ago about a little chart the IRS produced that I've never been able to find them having produced again. And it tracked increases in executive compensation over a long period of years. I took that data and compared it to increases in a wages overall, and in corporate profits. And -- surprise, surprise -- executive compensation was growing faster than both, which means that the executives were gouging the shareholders.
The fundamental problem in a publicly traded company is that the managers of the company -- we're talking about the hired help, the Jack Welches of the world, as opposed to the Ted Turners and the Bill Gateses who created the things -- they're hired help. And it's called by economists the agent-principle problem. You hired this person to run the company for you, and you want them to run it in your interest as a shareholder, but they want to run it in their interest as an executive. So you've seen this era of CEO greed brought on in large part by computerized financial records, in which executives have basically learned how to do something called net present value, or NPV. They say: Oh, well, look -- here's the stream of income for the next 10 years. Let's reduce it back to what its present value is today, and I'm going to take that money now.
First, you haven't earned the profits yet. They may not be there. But you're going to take them. We see this in stock options, where, by running up the price of your company temporarily, and exercising your options, you reap a profit. But the shareholders who remain may or may not. It depends on how healthy the company is.
One of the ways to reform this would be to say to executives: You can be paid with company stock, and we'll pay you as much as the market will bear. But when you leave the company, you can only cash out 20 percent a year for five years. That means you better leave the company pretty healthy so the next guy doesn't run your fortune into the ground. That is an example; I'm not specifically promoting that idea. But it would be an example of how we could design systems that tend to encourage long-term responsible conduct.
BuzzFlash: Your last chapter, asks the question: Are we ready for reform, or can we reform the tax code system? There don't seem to be, other than the flat tax proponents, many people who at least rise above the level of babble and who are articulating a vision of a new tax code that might be a fairer one.
David Cay Johnston: But there's really two questions here, Mark. First, let me deal with the flat tax. The flat tax isn't what you think it is. If we enacted the Steve Forbes flat tax plan, Steve Forbes would never pay taxes again for the rest of his life. Under the flat tax plan, anyone who is an inheritor of great business assets -- not financial assets, business assets; that is, someone who owns a company, not someone who owns stock in a publicly traded company -- would no longer have to pay taxes just so long as their lifetime consumption was less than the value of those assets on the day they began paying taxes under the Forbes flat tax. And it would heavily shift the burden of taxes off of high-income people and people who have asset incomes, and onto people who have those capital incomes and people who have labor incomes. The genesis for that idea is, of all things, George McGovern's promise in 1972 that if elected he was going to give each American a thousand-dollar check every year. It was the final nail of the coffin of his miserable campaign. So the flat tax isn't what people think it is. It's been sold, like many of these other things, by not telling people what it really is.
Now the other question about fundamental reform. We have been told again and again in America we have problems that are so intractable we can't do anything about them. Well, that's the prescription for the end of the United States of America. We started this country on the principle that we don't need King George to tell us what to do. We can solve our own problems. It says in the Preamble to our Constitution that we created this Constitution to promote the general welfare. We can solve every single problem we've had, but we have to be citizens, and we have to do the hard work of maintaining our democracy. The reason we can't solve lots of problems in our society is that we aren't trying. We're hoping somebody else will.
People say to me everywhere I go to speak: Well, how would you fix this? And my answer is: I don't know. Because I'm not God. I'm not omniscient. Here's what I do know: If everybody in America will pay attention to our tax system, and you think how much money you pay in taxes, think about whether it's worth spending less time worrying about who Jennifer Lopez is sleeping with, and more about your tax dollars. If all of us paid attention and listened, and spent some time learning, we would get out of our collective wisdom a tax system that does what a good tax system should do. A good tax system greases the wheels of commerce. It rewards responsible conduct. It rewards strivers. It encourages investments in the most valuable asset we have, which is the human mind. Whereas now, we put huge economic obstacles in front of intellectual development in this country. A good tax system promotes political stability, without which there is no great wealth. And we can come up with a tax system that will do those things.
Now we are going to have to come up with that tax system, or a new tax system, because the economic order has changed. Tax systems must flow from the economic order. If you live in a pirate society, the tax is what the chief pirate takes as his share of the booty. If you live in an agrarian culture, the tax is that share of the crops taken by the king to support the operation of the government. We have a tax system designed for a national industrial wage economy. It worked real well for a long time because we basically were an industrial national economy, with mostly wage earners. We are moving into a global services, assets-based world in which capital in the punch of a button moves across borders, and labor cannot, even if it wanted to -- you're not going to take a job in India, in all likelihood.
So we have to have a tax system that recognizes those things and adapts to it, and that promotes the economic order instead of getting in the way of it. But what we're getting instead is a big, huge moat being put around the incomes and fortunes of those who are already rich. Of the super-wealthy in America, some of the super-high-income people don't want to pay taxes, but that's not all of those people. Many people in that group are very responsible and understand what's going on. But the narrow segment within that group that hates taxes -- that group is having enormous success in putting a moat around its money and its finances, and saying: We got ours. That's not America. That's not American.
Warren Buffet the other day said that if class warfare is being waged in America, his class is very clearly winning. And he did not mean that as a good thing. I'm in favor of higher incomes, more wealth. But what we need to have is a system that creates higher incomes and more wealth, not protects those who already got theirs.
BuzzFlash: One could argue that the second system you describe, with the moat around the currently wealthy, does not promote economic stimulation. It leads to economic stagnation.
David Cay Johnston: I agree. That's exactly what it does. In fact, one of the reasons for the French Revolution was that because of trusts, all of the wealth and opportunity to get ahead was tied up. There was no movement. There was no ability to get rich unless you already were rich. And we have this current notion that if I work my whole life and I make a fortune, that my children and grandchildren and great-grandchildren should also have that fortune. That's not how it works. I made the fortune. I'm entitled to it. But my children and grandchildren are not entitled to it and if we want future children to grow up and, by dint of their hard work, make new fortunes we have to create a system that allows that. Fortunes come and go. A tax system that says once you have your fortune the government will help you keep it forever by making it harder for others to build their own fortunes is a system that will, in the long run, destroy America. And that is the worst possible tax policy.