The Fine Print: How Big Companies Use Plain English to Rob You Blind

by David Cay Johnston

  Film studios can also sell their tax credits to companies that do owe Michigan taxes. Because these tax credits can be traded, when you buy a ticket to see a film that gets these deals, you are helping companies with no relationship to the movie industry escape taxes.

  The producers with tax credits to sell go to brokers, who typically charge a fee of about 4 percent. The buyers of these tax credits then bid for them. The amounts the tax credits are sold for are not disclosed. But let’s assume a million dollars of tax credits is sold for eighty cents on the dollar. The moviemakers collect $800,000, less the $30,000 or so in commissions to the tax credit brokers. The company that buys the Hollywood tax credits then gets to pay a million-dollar tax bill with a piece of paper that only cost $800,000. The only losers here are the taxpayers.

  The trading of state tax credits is now a growing corner of business. It creates no wealth—arguably it destroys wealth, by helping the Hollywood rich collect welfare from you.

  Next time you go to a movie with location shots, stick around when the action ends and watch the credits roll. Somewhere after the names of the stars, perhaps down where they list the chauffeurs and the caterers, you may see a list of people being thanked. One of the firms cited in the screen credits will probably be Tax Credits LLC, a New Jersey firm that specializes in helping studios sell their tax credits in fifteen states.

  Hollywood is far from alone in arranging these deals buried deep in the fine print. A whole industry has arisen to soak the taxpayers on behalf of the rich through tradable tax credits and subsidies that put money in the pockets of filmmakers, factory owners, hotel developers, shopping mall owners and anyone else among the very rich who has no shame about being on the dole. Not having any shame is, of course, a lot easier when hardly anyone knows you are on welfare.

  21…

  Silly Software

  Reform is bad for Intuit’s business.

  —Professor Joe Bankman

  21. Joe Bankman is a Stanford University professor of tax law with a really smart idea. He knows how to end what, for many people, is the single most aggravating aspect of being an American and, in doing so, may save taxpayers billions of dollars per year, free up billions of hours of people’s time and cut the cost of government.

  Bankman’s brainstorm? Get rid of income tax returns for most people by having government calculate their income taxes for them.

  If adopted by Congress, Bankman’s modest proposal could eliminate about 100 million of the more than 140 million tax returns filed annually. Plus Bankman’s idea has been tried and tested. It not only works, but people who have tried it love it, with a 98 percent positive rating in surveys. “Best government program ever!” is a common response.

  Think of mandatory income tax return filing for most people in the twenty-first century as the equivalent of Congress passing a law in 1908, when the first Ford Model T was sold, that every one of those newfangled automobiles come with a buggy whip. The buggy whip makers would want such a law in effect, just as the tax preparation industry likes mandatory tax returns; in both cases, one theoretical and one real, only the self-interest of an industry argues for being mired in an unnecessarily costly past.

  Bankman calls his idea ReadyReturn. If embraced by Congress and the legislatures in the forty-four states with income taxes, it could eliminate the aggravation of tax return filing for most Americans. With minor tweaks in tax law, as many as 120 million federal tax returns and almost the same number of state returns could be eliminated. If Congress streamlined the tax code, only sole proprietors and people with trusts and complex international investments would have to file tax returns.

  Most modern countries have already eliminated tax return filing for the vast majority of their people. The Organization for Economic Cooperation and Development, which represents thirty-four countries with modern economies, has documented how these programs are being expanded, easing burdens on taxpayers while saving money spent processing tax returns.

  Taxpayer savings result because ReadyReturns are prepared automatically using the same data that government collects from employers (as well as payers of pensions, interest and dividends). Such returns by definition do not contain the kind of mistakes by taxpayers and tax return preparers that require costly review by tax agency workers. Errors, both innocent and deliberate, cost money because of the cost of audits and other enforcement actions. ReadyReturns would also eliminate the cost of keypunching data into computers.

  The use of such returns could be optional. If the government makes a mistake or the taxpayer disagrees with the record sent, the taxpayer is free to file his or her own tax return. But ending tax return filing as we know it would be immensely popular, a means of ending the tortuous annual process of filling out tax forms, begun in 1943 as an emergency measure to restrain domestic spending and raise money to finance World War II. Back then, filling out paper forms was the only practical way to collect information on how much people made. Thanks to digital technology, this annual drudgery could be swept into the dustbin of history for most Americans.

  People dislike filling out tax forms so much that they routinely pay to outsource the pain. Accountants and others signed as preparers on 82 million of the more than 140 million American tax returns filed in 2010. The average fee charged by accountants and tax preparers in 2009 was about $220, while tax preparers at firms such as H&R Block and Jackson-Hewitt charged an average of about $181. The software company Intuit, which specializes in tax preparation (Quicken and TurboTax are two of its products), told its shareholders in 2011 that Americans spent $22 billion for tax preparation services. That was close to double the total IRS budget of about $12 billion that year.

  Americans pay others to prepare their tax returns because they find the IRS forms confusing, they do not trust their knowledge of the tax law, and for many other reasons. They worry a mistake will mean they’ll be hounded or even prosecuted by the IRS. That fear is encouraged by television ads from tax services and superficial stories by journalists, but it’s greatly overblown. In 2010 the government prosecuted only 1,430 cases listing any tax crimes, even as part of prosecutions for drug dealing or official corruption. An analysis of Justice Department data by the Transactional Access Records Clearinghouse at Syracuse University shows that fewer than 600 of those cases cited a tax crime as the primary offense.

  As a matter of written government policy, mere mistakes are not prosecuted nor are one-time violations, unless there is compelling evidence of a plot to hide a huge income, say millions of dollars from the sale of a business.

  The simplest tax return, Form 1040EZ, is so daunting that 11 million Americans, half of those who use this one-page tax return, pay an average of $50 each to have someone else fill it out for them. That cost is more than half a day’s take-home pay for a worker earning the median wage of slightly more than $26,000 per year, a significant burden that would be eliminated if the IRS used ReadyReturn for most taxpayers.

  WHY NOT READYRETURN?

  Most of the 58 million returns completed by taxpayers were prepared using tax software like Intuit’s TurboTax, the overwhelming favorite with more than 70 percent of the market. Such a large market share gives Intuit monopoly pricing power. More significant, Intuit exerts influence with government, which has been a very good friend to Intuit shareholders.

  Intuit is one of the most profitable companies in America. Overall, the fourteen thousand biggest corporations, which account for 85 percent of revenues, keep about a dime out of each dollar as profit before income taxes. Intuit kept twenty-five cents out of each dollar in 2011. For Intuit, your aggravation is money in the bank.

  For more than a decade, TurboTax sales have been mushrooming. Intuit sold 24 million TurboTax subscriptions on disc and online in 2011, many of which were used to prepare multiple returns. On average Intuit collected $54 for each copy of TurboTax, a total of $1.3 billion of revenue.

  Sales of TurboTax have been growing much faster than the number of taxpayers. From
1998 through 2011, the number of taxpayers grew about 13 percent, but Intuit’s sales increased 390 percent. TurboTax sales grew thirty times more than the number of taxpayers, partly because the software works well and gets better each year. But there was also another factor.

  TurboTax sales got a significant boost from the hidden hand of government. Policies in Washington and most state capitals steered customers toward TurboTax and the other much smaller tax software firms through a host of subtle policies. Intuit will offer free state-level filing to lower-income taxpayers, but only if states promise not to prepare returns in advance (such as California’s ReadyReturn) or let people fill out their forms online at a state-run Web site. And to reinforce this, when a state tax agency gets its budget cut, Intuit sometimes offers free software help in return for renewing those promises.

  Because of the economics of software, as Intuit’s sales grow, its profits on each copy of TurboTax should grow much faster. And TurboTax is already an exceptionally profitable product. Had you invested a dollar in the overall stock market in 1998 and another dollar in shares of Intuit, your returns would be dramatically different. By late 2011 your investment in the total stock market would have lost a bit of value, even after collecting dividends, while the dollar you put into Intuit would have grown to almost $7. For that investment to remain so lucrative, the law must continue to require people to file tax returns, even though that is a necessity whose time passed with the arrival of the digital age.

  Much of the $22 million Americans paid for income tax preparation in 2011 was wasted, a drag on the economy that enriches only tax preparers and tax companies like Intuit. Intuit has told its shareholders to expect future growth of 10 percent to 15 percent annually, even though the number of taxpayers grows at only about 1 percent per year. This suggests that the more sand Intuit throws into the gears of the economy, the more it profits, an issue similar to how the telecommunications companies profit by making sure America has an Internet that is slow and serves only densely populated, higher-income areas. Policies that create profits by working against the national economy need to be replaced yesterday.

  The key to understanding how to eliminate time and money wasted in preparing taxes is to remember that taxpayers fall into two broad groups: those who itemize deductions and those who do not. About one in three taxpayers, generally the more affluent and rich, fills out lengthy tax returns in which they get to deduct charitable gifts, mortgage interest, property taxes, exceptionally large medical bills and, in some cases, a wide array of other expenses, down to dry cleaning of uniforms. The majority of taxpayers only get the standard deduction plus an exemption for themselves, their spouses and any dependents. It’s the two-thirds for whom the make-work of filing tax returns could easily be eliminated.

  A ReadyReturn experiment began in 2005 when the state of California sent completed tax returns to fifty thousand people. All of these people were wage-earning singles. All they had to do to file their state income tax returns was sign the forms and mail them back.

  These completed tax returns were sent with no public announcement, no campaign to alert people and no advance letters that the finished forms would be arriving. Some of those who got the completed tax forms thought it was a scam and threw them away. Half of those who received the completed California tax returns did not even respond, which at first suggested they were not interested. Research later showed that most of these people had already filed their tax returns.

  Among those who had not yet filed, more than half signed the returns and sent them in. It involved no cost, no aggravation and only the time required to sign and date the form, then pop it into an envelope.

  How did the state know how to fill out the forms? Therein lies the reason why, for most people, completing a tax return is make-work. Federal and state law already requires employers to report how much they pay workers and how much tax is withheld from paychecks. For the two-thirds of taxpayers who do not itemize, all the government needs from taxpayers is their marital status, dependents’ names, and Social Security numbers. They already have the rest of the data.

  California ReadyReturn was limited at the start in 2005 to singles. That made the pilot as simple as possible to both execute and evaluate. Those chosen to get prepared returns had only wage income and listed themselves as unmarried on their previous tax return. Excluding married couples and heads of households eliminated the need for any adjustments for newborn children or those no longer dependent.

  ReadyReturn also allowed people to adjust their income up or down in case they made some money that was not reported or was less than their employers told the state. How many people used this feature indicated how accurate the ReadyReturns were. Just 4 percent of ReadyReturn users made adjustments. That low number suggests strongly that the returns were highly accurate. Further, it indicated that, as time passes and the system is refined, the tiny number of ReadyReturns requiring adjustments would shrink even more.

  The advent of ReadyReturn made some interested parties very nervous. Intuit, for example, wanted to kill ReadyReturn, and spent at least $3.4 million making its case in lobbying expenses and in campaign donations to more than a hundred politicians just in California. It has also worked hard against such ideas in other states, including Virginia, where it persuaded lawmakers to vote for Intuit and against the constituents by keeping mandatory tax return filing.

  But the best measure of its determination to get rid of ReadyReturn came in 2006, when Intuit gave a million dollars to support a single California state legislator who pledged eternal fealty to forced tax filing, which meant to Intuit’s profits. The huge donation went not to the candidate, but to a group supporting Republican state senator Tony Strickland. The indirect contribution helped obscure support for Strickland, who was running in 2010 for state controller against the incumbent, Democrat John Chiang. Strickland’s campaign spokesman, Michael Levoff, wrote to Tax Notes magazine, “Tony has been against it from day one, and always will” be against ReadyReturn.

  Strickland, who lost that race, was at the time the California leader of the Club for Growth, a Washington antitax group that says it favors significantly reducing tax burdens (though, obviously, not the burden of filing or the cost savings it would produce). The Club for Growth raises money to defeat Republicans it considers weak on fighting for lower taxes, especially on investors and business owners.

  ReadyReturn is also opposed by the National Taxpayers Union, which poses as a friend of taxpayers but, in this case, has befriended the tax preparation industry. The National Taxpayers Union dismissed ReadyReturn as “fools’ gold for the taxpayers.” Later it voiced strong support for a proposed federal law that would protect the tax-preparation industry. The bill’s title was dubbed, in classic Washington doublespeak, the Taxpayer Freedom to File Protection Act.

  Opponents rely on false statements to make their case against ReadyReturn. Intuit has made nine claims, all of which Dennis Ventry, another professor of tax law, has shown to be untrue. He calls them Intuit’s Nine Lies.

  The silliest attack, though, comes from Grover Norquist, president of Americans for Tax Reform. He says ReadyReturn and its online twin, CalFile, violate taxpayer confidentiality. In fact, as Norquist knows, all of the wage, interest, dividend, pension and other income is already reported to the authorities and, since the users are not itemizing deductions, there is no privacy to violate, only pockets to be picked by the tax-preparation industry. Norquist’s group also pressures Republican politicians and Democrats in swing districts to sign pledges to never raise taxes, a pledge that violates the oath of office taken by members of Congress to make decisions unfettered by any allegiance other than to the Constitution. In 2012, Norquist promoted a new way to replace taxes: universal gambling. He urged Texas lawmakers to expand gambling, ignoring the fact that money government gets from gambling comes from taxing money that the casinos win when players lose.

  Instead of ReadyReturn, Intuit has pushed for a system where it and other
tax-software companies offer free tax return preparation online for some people. In theory this system covers seven out of ten taxpayers based on income, but that figure depends on the mix of offerings by all of the software firms. Each firm need only cover a smaller portion so long as together their different rules, known as “free file,” are available to 70 percent of taxpayers. Not surprisingly, Intuit’s offering covers a much smaller share than 70 percent of taxpayers.

  Anyone who uses Intuit’s free service is bombarded with ads to buy its products, many of which literally offer no value to people filing the simplest tax return, Form 1040EZ. If you thought you might save more than the cost of software by buying it, would you? Many people do. And once people buy TurboTax they are more likely to buy it again and again, as well as the company’s related software, including Quicken electronic banking, and Intuit’s accounting for small businesses, QuickBooks.

  Professor Bankman’s idea makes a great deal of sense, both for you and for efficient government. As voters, we should remind Congress that, when it passed the 1998 Taxpayer Protection Act, one of its promises was to make the tax system simpler and to make it easier to pay your income taxes. A national ReadyReturn would accomplish exactly that.

  22…

  Pilfering Your Paycheck

  Our current governor [Pat Quinn]…is allowing Navistar to fire up to 25 percent of their workforce and still get millions from the state…. People should be outraged.

  —Illinois state representative Jack Franks

  22. Take a look at your pay stub. In all but six states, workers will see a deduction for state income taxes. You probably expect that money to finance public schools, the state university and college system, law enforcement and the other services that businesses and individuals rely on. Mostly it does, but in a growing number of states, your state income taxes will also be increasing the profits of your employer.