What Is a ‘Loophole’?

December 3, 1962

The Administration seems to be divided on whether it should recommend simply a tax “cut” in 1963 or whether it should also demand tax “reform.” Unfortunately it seems to have precisely the wrong idea of what constitutes true tax reform. True tax reform would make our tax system simpler, less vexatious, less inequitable, less discouraging to business growth. The “reforms” insisted on by the Administration at the last session of Congress were mainly in the opposite direction. It tried unsuccessfully to get interest and dividend withholding that would have created an accounting nightmare. It succeeded in getting punitive taxes on foreign investment, and stringent rulings on business expenses.

Here is The Wall Street Journal’s summary of the proposed application by the Internal Revenue Service of the new expense-account law:

“Anyone claiming deductions of $10 or more for travel would have to provide documentation of the cost of transportation, meals, lodgings, telephone expense; date and hour of departure and return; number of days away from home; number of days spent on business at each stop; location of each stop, and the business purpose of the trip, ‘including the nature of the business benefit expected to be derived by the taxpayer as a result of the travel to each place’.”

KILLING INCENTIVE

The requirements for entertainment deductions are even more inquisitorial. They would constitute what the Journal calls “a bookkeeping nightmare,” and a “blow to travel and entertainment and indeed all business.” In order to catch a few cheaters, must every taxpayer or businessman be treated as a potential crook?

In its November Survey, the Morgan Guaranty Trust Co. of New York describes the multitudinous ways in which the high corporate and individual income tax rates have distorted business practice, and twisted incentive into strange shapes where they haven’t killed it altogether. Many savings in corporate costs hardly seem worth the effort when it is pointed out that they really amount only to 48 cents on the dollar. “Beyond the dollars and cents,” concludes the bank, “enormous harm has been done to business by the colorful mythology that has grown up around practices designed to help the individual avoid losing the greater part of his pay to taxes. Externally, the exaggerated impression of rampant abuse has damaged public respect for, and confidence in, business. Internally, it has chipped away here and there at business morale and business ethics.”

CONFISCATORY RATES

The favorite demand of most tax “reformers” is that we must “close the loopholes.” But what is a loophole? Those who invoke the catchword never refer to the exemptions and deductions that apply to the low-bracket incomes. They use it only to stigmatize the deductions that those who earn high incomes are permitted to take, implicitly or explicitly, by the law. They do not stop to ask whether a deduction is fair or unfair. Do a few abuse it? Then it should be denied to everybody. Even President Kennedy, in his tax message to Congress on April 20, 1961, said: “The slogan—‘it’s deductible’—should pass from the scene.” He was talking of expense-account abuses; but if his statement were taken without qualification, no expense deduction, no matter how legitimate, would ever be allowed. Even a company that lost money would pay taxes on its gross. It is only because of expense deductions and “loopholes” that most businessmen are able to stay in business at all.

The kind of tax reform we most sorely need is not that proposed by the “loophole” closers. The most important tax reform is to stop confiscation. Any tax rate above 50 percent, on corporate or individual income, is prima facie confiscatory. We need to reduce the multitude of income brackets, to stop penalizing irregular incomes, to deal in a more balanced way with capital gains and losses. If we undertook this kind of reform we could at the same time reduce tax rates and increase revenues. More importantly, we would enormously stimulate income, production, employment, and national economic growth.