Simpler is better
IN THE LATEST CRACKDOWN on corporate accounting shenanigans, the Justice Department brought criminal charges against eight former executives at the accounting firm KPMG for developing and promoting abusive tax shelters that cost the U.S. Treasury a jaw-dropping $2.5 billion.
The Justice Department also cut a deal with KPMG, agreeing to defer and, if its terms are met, drop its case against the company. In return, KPMG agreed to admit responsibility, curtail or reform its tax-related services and pay the government at least $456 million in penalties.
The settlement thus fulfills important goals of both the government (punishment and deterrence) and KPMG (survival).
But the affair is merely symptomatic of a larger and more intractable problem, and the prosecution just a preamble to what the government ultimately must do. In a nutshell, the tax code is too complex. Unless it is simplified dramatically, there will continue to be opportunities for people and corporations to cheat, avoid detection and, if caught, befuddle a jury.
The KPMG shelters helped hundreds of American multimillionaires hide $11 billion in taxable income by creating bogus losses that could be used to offset taxable income or by converting income magically into long-term capital gains, which would be taxed at a lower rate. In each case, the accountants took advantage of wrinkles in the tax code that were designed to achieve some socially desirable goal.
Nobody likes to pay taxes. And some people are willing and able to fork over princely sums to cut their tax bills by an even larger amount. In one of the KPMG shelters, each customer paid $7 million in fees to conjure up a $100-million loss, saving $20 million in taxes. That’s why supposedly reputable firms such as KPMG are tempted to mine the tax code for shelters that push the boundaries of legality.
A simpler tax code won’t eliminate the temptation and incentives to cheat. What it will do, though, is provide fewer means to do so. Just as important, cutting some of the layers of intricacy will make it easier for the Internal Revenue Service to spot abuses.
The tax shelters at KPMG went unchallenged by the IRS until September 2001 -- five years after the first shelter was launched. That shelter and a slight variation were so egregious that at least 92% of the people who invested in them have agreed to pay the IRS penalties instead of defending the shelters in court.
If the IRS has trouble detecting schemes as blatant as these, just imagine what other abuses are still being hidden under the cover of the tax code.
