Business Adventures: Twelve Classic Tales from the World of Wall Street

by John Brooks

In the fall of 1963, the I.R.S. took a big step toward increasing the efficiency of its collections still further, and, by a feat worthy of the wolf in “Little Red Riding Hood,” it managed to present the step to the public as a grandmotherly move to help everybody out. The step was the establishment of a so-called national-identity file, involving the assignment to every taxpayer of an account number (usually his Social Security number), and its intention was to practically eliminate the problem created by people who fail to declare their income from corporate dividends or from interest on bank accounts or bonds—a form of evasion that was thought to have been costing the Treasury hundreds of millions a year. But that is not all. When the number is entered in the proper place on a return, “this will make certain that you are given immediate credit for taxes reported and paid by you, and that any refund will be promptly recorded in your favor”—so Commissioner Caplin commented brightly on the front cover of the 1964 tax-return forms. The I.R.S. then began taking another giant step—the adoption of a system for automating a large part of the tax-checking process, in which seven regional computers would collect and collate data that would be fed into a master data-processing center at Martinsburg, West Virginia.

Then he went on, “Looking over the sweep of years, I think we’ll come out well. Probably a point of crisis of some kind will make us begin to see beyond selfish interests. I’m optimistic that fifty years from now we’ll have a pretty good tax.”

Former tax commissioner, spoken in the late sixties. Oops.

“Perhaps we can move the rates down and get rid of some deductions,” he says, “but then we may find we need new deductions, in the interests of fairness. I suspect that a complex society requires a complex tax law. If we put in a simpler code, it would probably be complex again in a few years.”

The prior quoted commissioner’s successor, closer to the mark.

What this means to anyone whose income would normally put him in a very high tax bracket is obvious: he must find a way of getting as much as possible of that income in the form of capital gains. Consequently, the game of finding ways of converting ordinary income into capital gains has become very popular in the past decade or two.

This was written in the sixties. Only thing untrue at this point is that it’s many more decades now

By favoring capital gains over ordinary income, the Code seems to be putting forward two very dubious notions—that one form of unearned income is more deserving than any form of earned income, and that people with money to invest are more deserving than people without it. Hardly anyone contends that the favored treatment of capital gains can be justified on the ground of fairness; those who consider this aspect of the matter are apt to agree with Hellerstein, who has written, “From a sociological viewpoint, there is a good deal to be said for more severe taxation of profit from appreciation in the value of property than from personal-service income.”

Sounding Picketty-y here. But yeah, why is cap gains taxes at lower rate? We afraid people would be afraid to earn income on capital, and invest less?

For one, there is a respectable economic theory that supports a complete exemption of capital gains from income tax, the argument being that whereas wages and dividends or interest from investments are fruits of the capital tree, and are therefore taxable income, capital gains represent the growth of the tree itself, and are therefore not income at all.

I get a little lost in the metaphor here. Just saying that difference in value when buying something then selling something isn’t “income”? Ok, then why is it taxed at all? It’s a grand compromise? ;) Few more explanations coming though it’s not actually clear what was used in the original tax legislation (which stipulated that long-term cap gains be taxed at half the individual’s marginal rate, subject to 25% ceiling).

Another argument—this one purely pragmatic—has it that the capital-gains provision is necessary to encourage people to take risks with their capital.

Finally, nearly all tax authorities are agreed that taxing capital gains on exactly the same basis as other income, which is what most reformers say ought to be done, would involve formidable technical difficulties.

Really, why? It’s just a different percentage?

Of the whole array of loopholes in the Code, however, probably the most widely loathed is the percentage depletion allowance on oil. As the word “depletion” is used in the Code, it refers to the progressive exhaustion of irreplaceable natural resources, but as used on oilmen’s tax returns, it proves to mean a miraculously glorified form of what is ordinarily called depreciation. Whereas a manufacturer may claim depreciation on a piece of machinery as a tax deduction only until he has deducted the original cost of the machine—until, that is, the machine is theoretically worthless from wear—an individual or corporate oil investor, for reasons that defy logical explanation, may go on claiming percentage depletion on a producing well indefinitely, even if this means that the original cost of the well has been recovered many times over.

This is still in place, right?

The brains that go into tax avoidance, which are generally recognized as including some of the best legal brains extant, constitute a wasted national resource, it is widely contended—and this contention is cheerfully upheld by some leading tax lawyers, who seem only too glad to affirm, first, that their mental capacities are indeed exceptional, and, second, that these capacities are indeed being squandered on trivia.

I think this is the saddest part. Just a little worse than intellectual waste on hedge funds, just worse than ‘financial engineering’ a la synthetic CDOs, CDSs etc.

to enact a law permitting federal lotteries, like the lotteries that were permitted from colonial times up to 1895, which helped finance such projects as the building of Harvard, the fighting of the Revolutionary War, and the building of many schools, bridges, canals, and roads.

Didn’t know this

The ideal income tax envisioned for the far future by many reformers would be characterized by a short and simple Code with comparatively low rates and with a minimum of exceptions to them. In its main structural features, this ideal tax would bear a marked resemblance to the 1913 income tax—the first ever to be put in effect in the United States in peacetime. So if the unattainable visions of today should eventually materialize, the income tax would be just about back where it started.

Broad base, low rate.