The Tax Man Cometh

by B. Lana Guggenheim


‘Tis the season - tax season, that is. Yours are due April 18th, unless you’ve filed a timely extension.

There is much muttering and moaning about the dreaded tax man, though when pressed, most of us would admit that some level of taxation in return for government services is both fair and necessary. However, today’s tax code is a dizzying labyrinth of laws that seem invented to torture rather than merely tax. It is such exhausting work to navigate that there are entire professions centered around helping people properly file their taxes. Tax laws are so filled with loopholes, it’s as though the system lacks integrity altogether. Unlike individuals, large businesses have the power to gain industry specific tax breaks, and corporate taxes have reduced over time as a result. And the IRS seems to make little effort in tracking down corporate tax law-breakers, resulting in nationwide distrust of this organization.

Why is our tax code such a monstrous mess? Part of the answer is that our tax laws weren’t formulated in a particularly organized matter. Rather, the laws we have evolved and changed in bits and pieces over time, resulting in many layers, some of which are very confusing. In order to collect taxes and administer the Internal Revenue Code, the domestic portion of federal statutory tax, the IRS or Internal Revenue Service was created. Though this name was only made official in 1953, though it was used as early as 1913, the government body collecting taxes has been in place since 1862, when income tax was first levied by President Abraham Lincoln to raise funds to fight the Civil War. By war’s end, the Union had raised 21% of its funds via this tax. At the time, income tax was meant to be a temporary measure, but it continued on to fund the Reconstruction, and was only allowed to expire 7 years after the war’s end. In 1894, the Supreme Court declared income tax unconstitutional (and there was probably much rejoicing, unless you were in the government). In the start of the 20th Century, there was a populist movement for tax reform, ultimately culminating in the ratification of the 16th Amendment in 1913, which essentially stated that the government had the right to tax its citizens without regards to apportionment among the states by population. Since then, income tax has been part of the landscape of the American economy, though less so than it is today. However, even the imposition of a modest income tax caused the IRS a ten-fold jump in their workload, and they fell behind in their duties almost immediately; they were still processing 1917 returns as late as 1919.

The twin pressures of Prohibition and the Great Depression were the next influences on the evolution of American taxes. Prohibition eliminated the income the government received from taxes on the sale of alcohol, and drove an entire economy underground into the hands of a professional class of criminals - gangsters. The financial strain, exacerbated by the onset of the Great Depression, meant that the government sorely needed the income both from taxing alcohol sales as well as from an increased income tax. In 1927, the Supreme Court ruled that illegally obtained income was subject to taxes (and that remains true today, though we would recommend leaving out the specifics of your occupation in such cases), giving the Feds access to money they sorely needed, as well as the legal means to seize some of the gains the gangsters earned from bootlegging. It is this law that ultimately put Al Capone behind bars, when he was nailed and jailed for tax evasion. However, the demise of Prohibition in 1933 did not mean the demise of the income tax, as some had hoped. The New Deal did cut taxes for those earning less than $3,000 a year, but was pretty harsh on the wealthy, who saw their taxes rise. Payroll and quarterly tax withholdings were introduced during WWII, and the marginal tax rates on income at different income levels have fluctuated wildly since then, reaching a height of 92% in 1952 on top individual earners, and down to 28% in 1987. Currently, the top tax bracket hovers at around 35%.

Today, the IRS processes taxes as well as institutes investigations. Some of these investigations are civil tax cases and audits, which are about money owed. If you are subject to an audit, you might end up owing a lot of money, but it is unlikely you will face criminal charges. Most Americans are unlikely to be audited - the odds are somewhere around 1%. If you earn over $200,000, your likelihood of being audited goes up to just under 3%, and if you earn above ten million, or alternatively, if you report no earnings, your chances of being audited go up (approximately 16% and 5%, respectively). So too if you report income from abroad, especially from a place like the Cayman Islands. As the IRS has fewer employees now than it used to (a low in 2012 of  89,000 versus a peak in 1996 of over 116,000), their ability to audit has been impaired, even as the work they have to do has increased. This sounds like good news, but in many cases, audits find that people are owed larger returns than they initially had received, so the inability of the IRS to do its job is more likely to harm than help. This is soon after the IRS had its reputation blackened by the reveal that more than half of its employees willfully violating tax law were not let go, and some were in fact promoted. In such a situation, things don’t look good for either the IRS or the average American.

In addition to audits, some IRS investigations are criminal investigations that center around the violation of specific tax laws. In such cases, even if all the money owed is paid, the case is not likely to be dropped. While the most common crime is tax evasion, other prosecutable ills include money laundering, identity theft, and fraud. The IRS website shows an entertaining list of the top ten biggest such cases in the past fiscal year. But tax-related crimes are a regular occurrence, for the famous, infamous, and average citizen alike. The 1989 case of Leona Helmsley, nicknamed “the queen of greed” by the press, evaded taxes by charging millions she spent in redecorating to her business. She was fined over $7 million and sentenced to four years in prison. Wesley Snipes is estimated to owe the government millions in tax debt, and was eventually convicted in 2008 to three years in prison. The IRS likes to make a big deal of celebrities they catch in tax fraud, hoping to scare the rest of us into being honest on our tax forms, provided we can successfully navigate them, that is.

Where does this money go? Primarily to the military and healthcare, it turns out. Of all the Federal tax revenue, a little under half of the total comes from income taxes, making it the single largest source of federal funds. From there, the budget is divided into discretionary and mandatory spending -- 30% and 64% respectively, the remaining being interest on federal debt. Discretionary spending is decided by Congress through the annual appropriations process, and mandatory spending refers to spending on programs required by law. More than half of discretionary spending is bestowed on the military, about 15% of the total budget, and the majority of mandatory spending is split between healthcare and social security, about 60% of the total budget. Tax breaks, which function as a type of federal spending, outstrip discretionary spending, by about $0.1 trillion - or ten billion dollars. That’s a huge amount of money, but the relative difference isn’t that large - tax breaks account for $1.22 trillion, and discretionary spending for about $1.11 trillion.

All told, untangling the federal budget, the tax law, and our own taxes is a taxing affair.

Works Cited

Brandeisky, Kara. "These Are the People Who Are Most Likely to Get Audited." Time. Time, 14 Apr. 2015. Web. 14 Apr. 2016.

Coleman, James William. "Fraud and Deception: Tax Evasion." The Criminal Elite: Understanding White-collar Crime. New York: Worth, 2002. 31-32. Print.

"Federal Spending: Where Does the Money Go." National Priorities Project. National Priorities Project, 2016. Web. 14 Apr. 2016.

Fishman, Stephen. "What Are the Odds of Being Audited by the IRS? | Nolo.com." Nolo.com. Nolo, 2012. Web. 14 Apr. 2016.

Henchman, Joseph. "How Taxes Enabled Alcohol Prohibition and Also Led to Its Repeal." Tax Foundation. Tax Foundation, 5 Oct. 2011. Web. 14 Apr. 2016.

Henderson, Audrey. "Tax Tips: The IRS Criminal Investigation Process." Optima Tax Relief. Optima Tax Relief, 14 Aug. 2014. Web. 14 Apr. 2016.

"Historical Documents Relating to Alphonse (Al) Capone, Chicago." Internal Revenue Service. Internal Revenue Service, 18 Aug. 2012. Web. 14 Apr. 2016.

"Internal Revenue Service (IRS) 2012 Data Book." The Concise Dictionary of Crime and Justice (n.d.): n. pag. The Internal Revenue Service, 30 Sept. 2012. Web.

"IRS Statistics." Infoplease. Infoplease, 2007. Web. 14 Apr. 2016.

"IRS's Top Ten Identity Theft Prosecutions; Part of Ongoing Efforts to Protect Taxpayers, Prevent Refund Fraud." IRS's Top Ten Identity Theft Prosecutions; Part of Ongoing Efforts to Protect Taxpayers, Prevent Refund Fraud. IRS, 3 Mar. 2015. Web. 14 Apr. 2016.

Okrent, Daniel. "No Closing Time for Income Taxes." The New York Times. The New York Times, 12 June 2010. Web. 14 Apr. 2016.

Prohibition. Dir. Ken Burns and Lynn Novick. Perf. Peter Coyote. PBS, 2011. Documentary Mini-series.

Thomas, Kenneth. "A Big IRS Job and Fewer People to Do It." US News. US News, 30 May 2013. Web. 14 Apr. 2016.

Wood, Robert W. "61% Of IRS Employees Caught Willfully Violating Tax Law Aren't Fired, May Get Promoted." Forbes. Forbes Magazine, 07 May 2015. Web. 14 Apr. 2016.

Panama and the 1%: Shell Games, Taxes, and International Law

By B. Lana Guggenheim

The Panama Papers, as the information leak from a law firm operating in Panama has been dubbed, is the largest information leak in history, clocking in at 11.5 million files, about 2.6 terabytes of data, which is most likely the bulk of law firm Mossack Fonseca’s database, if not its entirety. The well-known Wikileaks cache comparably is much smaller, but is still substantial at 718,000 documents. This event has blown open the operating procedures of offshore tax havens, money saving schemes for the extremely rich, and their less than savory ties to many families, government officials, and rogue regimes all over the world.

Though the story broke only days ago, Mossack Fonseca has been setting up shell companies to shelter funds for decades, and journalists have been poring over the data for months before they released the story. While an anonymous source tipped off the German newspaper Süddeutsche Zeitung, the data they received soon outpaced their ability to process, and they reached out to the International Consortium of Investigative Journalists, consisting of a team of over 400 journalists in over 100 countries, to help. Even so, going through this much data took months.

The results have been immediate and dramatic. Already on Tuesday, the Prime Minister of Iceland, Sigmundur David Gunnlaugsson, tendered his resignation due to he and his wife having been among the many clients who parked their cash in a Panama shell business, Wintris. Considering the scars from the country’s recent financial collapse and painful rebound, there was little tolerance from Iceland residents for their premier's secret money stash, and one tied to the failing investment banks from 2008 at that - which meant there was an enormous and undisclosed conflict of interest. More than $2 billion has been traced to Vladimir Putin and his associates in Russia, and Ukrainian premier Petro Poroshenko, sole shareholder of Prime Asset Partners Limited (PAPL), has come under fire for similar reasons. The candy magnate promised to sell his business when he took office, but Mossack Fonseca set PAPL up as a shell company based in the British Virgin Islands in August 2014, at the time of Russia’s bloodiest attacks on Ukraine, thus saving him millions of dollars in Ukrainian taxes and prompting some to wonder if his priorities were the country he leads or the finances he promised to liquidate. High ranking families in China’s Communist Party are under the lens as well for quietly squirreling their wealth away, and the US and UK don’t have their hands clean either, one client being the late father of British Prime Minister David Cameron. Even Nawaz Sharif, Prime Minister of Pakistan, is under fire, as is the monarch of Saudi Arabia, King Salman bin Abdulaziz bin Abdulrahman Al Saud, and even two cousins of Syrian dictator Bashar al-Assad, Rami and Hafez Makhlouf, among many others all around the world, and in various positions of power.

But how does it all work? One commenter on Reddit charmingly described the issue behind the Panama Papers as people stashing their piggy banks in someone else’s house to hide their savings from their moms, and while some were simply seeking privacy, others were hiding stolen money and engaging in other illegal and unethical activities (you can see it illustrated here.) The reality is slightly more complicated - in order to hide their funds, corporations create new bank accounts and new business ventures based in countries that have low tax rates and/or do not tax on income earned abroad. Such havens include the Cayman Islands, the British Virgin Islands, Luxembourg, Ireland, Panama, and yes, the United States, which is in fact one of the biggest tax havens for foreign money. Ironically enough, the United States holds other countries to a standard of transparency that it does not itself follow, as the USA did not sign on to OECD standards, though Panama did, though with conditions. Because these accounts are held under different names, their origin is hard to trace, and because these countries do not disclose the information to the corporations countries’ of origin, it is easy to avoid disclosing the true extent of one’s assets and thus avoid taxation on it. Banks often seek out relevant law firms, like Mossack Fonseca, on behalf of their clients to complete these services. (Mossack Fonseca created about 200,000 of these offshore entities.) The law firms charge a fee to set shell companies up and maintain this legal fiction, but this fee is often significantly less than the home tax rate rich individuals and corporations are looking to avoid by engaging in this practice. And a legal fiction it is: one building can be home to thousands of companies and accounts that are little more than a mailbox with a gilded name plaque, with no rooms or employees to speak of. But it’s one that allows many to dodge the tax man in a way that beggars belief.

The entire situation is a tangled web of how the top tiers of international finance are open to the rich, but not the average citizen. The offshore banking industry intersects with criminals, terrorists, corporations, and your average billionaire, and often enough, it’s legal - though not always. Academics estimate that about $7.6 trillion is held in overseas tax havens, costing governments a minimum of $200 billion a year in lost tax revenues. Tax havens are an ugly, but integral part of the global banking system. However, not everyone involved in offshore banking is a thieving criminal. Some folks place funds in tax havens totally illegally, but for reasons most of us would support, such as in defiance of authoritarian governments seeking to crack down and restrict potential actors that would upset their monopoly on power.

Mossack Fonseca offices in Panama City. From elcambur.com.ve

Much of Mossack Fonseca’s work isn’t for humanitarian or anti-authoritarian reasons, however. Though the two men behind the firm, Ramon Fonseca and Jurgen Mossack, insist they are the wronged party for having been hacked into and their privacy violated - and they have a valid point - they say that their business is like “selling cars”; they are not responsible if people use their products to do wrong. Still, a number of their clients are involved in some shady business. And while technically their law firm violates no Panamanian laws, among their clients are those placed under international sanctions, and those who have earned their funds through extralegal means. Some of these companies were based in Iran, Zimbabwe, and North Korea, including DCB Finance, which had links to North Korea’s nuclear weapons program. Even in cases when they were not yet sanctioned when Mossack Fonseca helped set up their shell companies, the firm continued to act as a proxy for them after sanctions were put in place. In the case of DCB Finance, Mossack Fonseca continued relations with them until contacted by the British Virgin Islands authorities in 2010 inquiring about a different North Korean company, after which Mossack Fonseca resigned as agents for DCB Finance. They also set up a shell company that hid the millions gained from the infamous 1983 Brink’s-Mat heist at London’s Heathrow Airport, dubbed “the crime of the century.” The company in question, Feberion, was set up a mere 16 months after the crime for the London-based money launderer Gordon Parry, who went to jail in 1992 for his role in the aforementioned robbery, and Jurgen Mossack was aware that Feberion was involved in laundering money from the heist, though the law firm later denied this when pressed. And yet, they only ended relations with Feberion as late as 1995.

The pressure is on, not just for this law firm, but for the various global tax havens to engage in greater transparency and close these legal loopholes. But international banking is likely to face some fallout as well. Banks have already faced an uptick in scrutiny, and are likely to be faced with more, as well as additional regulation and even fines. Untangling the industry’s many offshore entities would also be expensive and traumatic, and would make repairing any reputations difficult, even for banks that claim they weren’t involved in such activities in the first place. Some banks have already begun to overhaul their internal structures. HSBC sold their Panama bank in 2013, and Credit Suisse sold its Gibraltar and Monaco private-banking operations. Some tax havens are also becoming more transparent, as the OECD’s original blacklist of “uncooperative havens” has significantly dropped over the past decade, though Panama, Liechtenstein, and Barbados were still named as such on an EU list last year. Closing all these tax loopholes is going to be a long, messy process, and it is likely that inventive accountants will find new areas to exploit for future clients. But one lesson everyone can learn, from tax accountants to lawyers, is that cybersecurity will be an increasingly significant factor. Leaks this big only happen if someone scrapes the entirety of a database, a security breach that is the stuff of nightmares.

Cited Sources and Further Reading

Beauchamp, Zack. "The Panama Papers Revealed Lots of Shady Stuff. But Some Shell Corporations Aren't so Bad." Vox. Vox, 05 Apr. 2016. Web. 06 Apr. 2016.

Bilton, Richard. "Panama Papers: Mossack Fonseca Leak Reveals Elite's Tax Havens - BBC News." BBC News. BBC, 04 Apr. 2016. Web. 06 Apr. 2016.

Chang, Alvin, and Javier Zarracina. "The Panama Papers Leak, Explained with an Adorable Comic about Piggy Banks." Vox. Vox, 04 Apr. 2016. Web. 06 Apr. 2016.

Clark, Nicola. "How a Cryptic Message, ‘Interested in Data?,’ Led to the Panama Papers." The New York Times. The New York Times, 05 Apr. 2016. Web. 06 Apr. 2016.

Cox, Simon. "Panama Papers: Mossack Fonseca 'helped Firms Subject to Sanctions' - BBC News." BBC News. BBC, 04 Apr. 2016. Web. 06 Apr. 2016.

Díaz-Struck, Emilia, Et Al. "Panama Papers: Who's Who?" The Irish Times. The Irish Times, 04 Apr. 2016. Web. 06 Apr. 2016.

Drucker, Jesse. "Panama Has Company as Bank-Secrecy Holdout, as U.S. Offers Haven." Bloomberg.com. Bloomberg, 05 Apr. 2016. Web. 06 Apr. 2016.

Fitzgerald, Alison, and Marina Walker Guevera. "New Leak Reveals Luxembourg Tax Deals for Disney, Koch Brothers Empire." International Consortium of Investigative Journalists. International Consortium of Investigative Journalists, 09 Dec. 2014. Web. 06 Apr. 2016.

Gardner, Matthew. "Panama Papers and America's Problem." CNN. Cable News Network, 05 Apr. 2016. Web. 06 Apr. 2016.

Garside, Juliette, Holly Watt, and David Pegg. "The Panama Papers: How the World's Rich and Famous Hide Their Money Offshore." The Guardian. Guardian News and Media, 03 Apr. 2016. Web. 06 Apr. 2016.

Golshan, Tara. "The 8 Most Important Things to Read to Understand the Panama Papers Document Leak." Vox. Vox, 04 Apr. 2016. Web. 06 Apr. 2016.

Karmanau, Yuras. "Ukrainian President Under Fire Over Panama Papers." US News. Associated Press, 04 Apr. 2016. Web. 6 Apr. 2016.

Kroll, Louisa. "Panama Papers Fallout: Iceland's PM Resigns, Ukraine's President Pressured, Billionaire Responds." Forbes. Forbes Magazine, 5 Apr. 2016. Web. 06 Apr. 2016.

Maven, Duncan, and Lionel Laurent. "Banks Have a Panama Problem." Bloomberg.com. Bloomberg, 04 Apr. 2016. Web. 06 Apr. 2016.

Mullen, Jethro. "Panama Papers: Rich and Powerful Respond to Claims They Hid Billions Offshore." CNNMoney. Cable News Network, 04 Apr. 2016. Web. 06 Apr. 2016.

Nelson, Libby, and Zack Beauchamp. "How the Panama Papers Brought down Iceland's Prime Minister." Vox. Vox, 05 Apr. 2016. Web. 06 Apr. 2016.

"Panama Law Firm Says Document Leak 'a Crime'" RTE.ie. AFP, 04 Apr. 2016. Web. 06 Apr. 2016.

"Panama Papers: How Did Panama Become a Tax Haven? - BBC News." BBC News. BBC, 05 Apr. 2016. Web. 06 Apr. 2016.

Politi, Daniel. "The Latest From the Panama Papers: Details From the Largest Leak in History." Slate. Slate.com, 05 Apr. 2016. Web. 06 Apr. 2016.

Ryle, Gerard, Will Fitzgibbon, Mar Cabra, Rigoberto Carvajal, Marina Walker Guevera, Martha M. Hamilton, and Tom Stites. "Banking Giant HSBC Sheltered Murky Cash Linked to Dictators and Arms Dealers." International Consortium of Investigative Journalists. International Consortium of Investigative Journalists, 08 Feb. 2015. Web. 06 Apr. 2016.

Schmidt, Blake. "Panama Papers: A Conversation with Jurgen Mossack and Ramon Fonseca." The Sydney Morning Herald. The Sydney Morning Herald, 05 Apr. 2016. Web. 6 Apr. 2016.

Schmidt, Blake. "Panama Papers: Jurgen Mossack Says the Cat's Out of the Bag." Bloomberg.com. Bloomberg, 04 Apr. 2016. Web. 06 Apr. 2016.

Schmidt, Michael S., and Steven Lee Myers. "Panama Law Firm’s Leaked Files Detail Offshore Accounts Tied to World Leaders." The New York Times. The New York Times, 03 Apr. 2016. Web. 06 Apr. 2016.

"Tricks of the Trade." International Consortium of Investigative Journalists. International Consortium of Investigative Journalists, 05 Nov. 2014. Web. 06 Apr. 2016.

Wayne, Leslie, Kelly Carr, Marina Walker Guevera, Mar Cabra, and Michael Hudson. "Leaked Documents Expose Global Companies' Secret Tax Deals in Luxembourg." International Consortium of Investigative Journalists. International Consortium of Investigative Journalists, 5 Nov. 2014. Web. 06 Apr. 2016.