Death by Taxes

‘None of these people have any incentive to undertake the job of decreasing the complexity of the tax system.’

primatologist writes: If most people in the US knew the truth about the tax system in their country, there would be blood in the streets.  Most individuals file a very simple federal income tax return – perhaps they take a few deductions for their mortgage interest, medical costs and the like.  But this annual experience for the vast majority of Americans gives them a very skewed view of the great mass of the US tax system – it is the tiniest visible sign of an enormous tumor that grows beneath the surface, invisible to most US citizens and tax payers.

“This is how it works:  To escape the high tax rates on business activities in the US, armies of lobbyists work ceaselessly to insert arcane, narrow exceptions and exemptions into federal and state tax laws at the legislative level.  The exceptions and exemptions are as narrow as possible and often use very convoluted and technical language.  The use of opaque language is intentional: it helps legislators avoid the kind of political trouble that comes from handing out tax exemptions.”

Two facts that are rarely discussed by the US media and which never come to the attention of the majority of US individual taxpayers illustrate this: The US has by far the highest corporate income tax rate of any developed country (and among the highest marginal tax rates for individuals who live in high tax states), and the US has an incredibly large and complex structure of tax laws.  While most US taxpayers don’t know about the relatively high rates of US taxation, the crucial reality of the US tax system that is hidden from almost everyone is the insane complexity of the US tax code that applies to investment and business activities.

“Why uncertainty?  Because as the tax laws and regulations become more and more complex, and the language in which they are expressed becomes more and more divorced from normal usage, only very intelligent people who spend all their time doing nothing but learning and manipulating tax language can even begin to know what the laws and rules mean.”

This is how it works:  To escape the high tax rates on business activities in the US, armies of lobbyists work ceaselessly to insert arcane, narrow exceptions and exemptions into federal and state tax laws at the legislative level.  The exceptions and exemptions are as narrow as possible and often use very convoluted and technical language.

[Yes, We Still Have the World’s Highest Corporate-Tax Rate]

The use of opaque language is intentional: it helps legislators avoid the kind of political trouble that comes from handing out tax exemptions.  (There is also the factor that legislators all play the game of “I’ll vote for your campaign contributor’s tax exemption if you’ll vote for mine.”)  Tax authorities (that’s the IRS for the federal government, but it happens at the state and local level, too, in high-tax states and cities) create voluminous regulations to implement these tax laws.  Lobbyists also work to influence that process, as well as returning to the legislature to create exceptions to the exceptions to the exceptions created in the regulations.

“Trying to undo the complexity of the tax code would reveal all this incredible responsive complexity: And it would cause massive economic losses.  Trillions and trillions of dollars worth of value is invested in ways that are structured in response to the complexity of our tax laws.  Without those giant stacks of tax rules and exceptions and exceptions to exceptions, etc., those investment and business operations structures would not make sense legally or economically.”

Meanwhile, “tax planning” to take advantage of this constantly growing and increasingly complex web of laws and regulations becomes a bigger and bigger part of how businesses structure their enterprises and investments.   “Tax planning” is carried out by armies of accountants and lawyers and consultants, all of whom are handsomely paid to do work that contributes nothing to economic growth or prosperity.

[Also see – Nobody Knows How Many Federal Agencies Exist]

The work of the “tax planning” professionals becomes more and more complex and incomprehensible to those outside their fraternity, as it is essentially the incantation of linguistic “magic spells” that have nothing whatsoever to do with the actual business enterprise, and everything to do with fitting into the ever-more-convoluted language of the tax codes.  More and more layers of complexity are added, each with additional cost and uncertainty.

“The same process applies to entirely domestic business.  Entrepreneurs and investors spend huge amounts of money on lawyers, accountants and consultants to create complex – and completely unnecessary – corporate and operational structures aimed solely at taking advantages of complex tax benefits.”

Why uncertainty?  Because as the tax laws and regulations become more and more complex, and the language in which they are expressed becomes more and more divorced from normal usage, only very intelligent people who spend all their time doing nothing but learning and manipulating tax language can even begin to know what the laws and rules mean.

“One consequence of this process that everyone who is involved in international business knows very well is that no one wants to do business in the United States if they can help it.“

And they won’t all agree – until a very clear case is litigated to conclusion in a court or the IRS issues a “clarification,” it’s all just educated guesses.  By the time a term comes to have well-understood meaning, the exceptions to the rules that use that term – using new words that were intentionally difficult to understand in the first place – have to be interpreted and clarified.

“And here’s the real horror: No one outside the fraternity of tax regulators, lobbyists, tax lawyers, accountants and consultants really perceives how enormous the structure of tax complexity is.  Investors and entrepreneurs learn no more than they have to – just what they have to know to do the specific deal they’re working on or carry out their own narrow business operations.”

This process has been going on for well over a hundred years with no let up.  In fact, the scale and complexity of the tax codes continues to grow exponentially, as the feedback process of high tax rates leading to exceptions leading to exceptions to exceptions continues ad infinitum.

 “Unwinding all that complexity would wipe out huge swathes of the US economy – and create a whole new set of winners and losers that has nothing to do with the underlying matter of actually creating real value in the real world.”

One consequence of this process that everyone who is involved in international business knows very well is that NO ONE WANTS TO DO BUSINESS IN THE UNITED STATES IF THEY CAN HELP IT.  This is the world I work in.  In my professional world it is simply taken for granted that people with money to invest will do anything in their power to structure their business so that no possible argument can be made that they did business or invested in the US.  Companies and wealthy individuals go to extreme lengths to avoid putting any kind of investment into the US if it is at all possible.

[More – Reminder: The Federal Tax Code & Regulations are Now Over 10 Million Words in Length]

Does this mean that no one invests in US businesses?  No.  The US consumer market is too big, and innovation in the US is too valuable for that to be true.  What it does mean, though is that below a certain very large scale, it just doesn’t pay.  Even more important, it also means that every investment in the US is “taxed” in a way that does no one (outside of the business of avoiding tax) any good:  Huge amounts of money are spent creating unnecessary complexity to minimize US taxation as much as possible: Extra layers of incorporation and complex accounting structures are created to do everything possible to minimize the amount of income earned in the US.  All that time, effort and money spent avoiding US taxation adds to the cost of investment without creating one dime of revenue for the US government.  Finally, foreign investors in the US do everything they can to get their money out of the US as quickly as possible: The more time an investment is exposed to US tax law, the larger the chance that some tax law magic spell will be countered by some other tax law magic spell and – BANG! – there go all the profits. Read the rest of this entry »