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April 29, 2002
Civilization at a Discount: the Morality of Tax Avoidance
Joseph J. Thorndike

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Tax Notes historian Joe Thorndike examines President Franklin Roosevelt's approach to dealing with tax avoidance on a moral basis.


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If you still consider tax avoidance morally suspect, then it's time to get with the program. Asked recently about the controversial issue of corporate expatriations, House Ways and Means Chair William M. Thomas, R-Calif., gave American corporations a free pass.

"I'm less inclined to say 'you can't do it,'" Thomas explained, "than I am to treat it as a symptom, examine the underlying disease -- and it's the tax code and its failure to be even minimally useful to these folk -- and deal with the fact that the U.S. is out of sync with the rest of the world."

Thomas's medical imagery is helpful in decoding his thinking. If tax avoidance is the "symptom" of some "underlying disease," then we can hardly blame the stricken patients. And if an ailing company decamps to Bermuda, we should presumably treat it like a trip to the spa -- a tax-advantaged retreat to a corporate Baden-Baden.

Not everyone takes such a charitable view of tax avoidance. Indeed, critics have been quick to denounce corporate inversions. "These expatriations aren't illegal, but they're sure immoral," declared Senate Finance Committee ranking minority member Charles E. Grassley, R-Iowa. "During a war on terrorism, coming out of a recession, everyone ought to be pulling together. If companies don't have their hearts in America, they ought to get out."

Grassley's moral indignation recalls an earlier campaign against legal but unsavory tax avoidance. In 1937 Franklin Roosevelt launched a very public campaign against tax loopholes. With the New Deal threatening to run out of political steam, FDR energized his constituents by targeting the "clever little schemes" of rich Americans trying to reduce their tax bills.

Roosevelt believed deeply that most tax avoidance schemes were immoral. In fact, he considered the distinction between avoidance and evasion little more than a legal technicality.

Roosevelt's Treasury secretary, Henry Morgenthau Jr., crystallized the president's point of view when he warned that if taxes were the price of civilized society, then "too many citizens want the civilization at a discount."

Roosevelt's antiloophole crusade was intensely personal, focusing on a relatively small group of rich individuals. The president longed to vilify them in public, prodding the Treasury Department for a memo that not only outlined egregious avoidance schemes, but also identified the taxpayers using them.

In that memo, Morgenthau assured the president that vigorous enforcement and remedial legislation had already closed many loopholes. "But we still have too many cases of what I may call moral fraud," he warned, "that is, the defeat of taxes through doubtful legal devices which have no real business utility, and to which a downright honest man would not resort to reduce his taxes."

The Treasury memo described a variety of avoidance devices. Domestic and foreign holding companies were particularly popular, with taxpayers using them to manage personal assets including houses, yachts, and racehorses. Most of the foreign ones were incorporated in the Bahamas, although Newfoundland and Panama were also popular. Most of those arrangements were technically legal, at least barely. A few, however, seemed to cross the line into fraud.

Morgenthau, however, did not confine his criticism to legally suspect loopholes. In fact, he reserved his most damning criticism for well-established provisions of the tax law.

Percentage depletion drew much of his ire. "This is perhaps the best example of legalized theft from the United States Treasury which the revenue laws still permit," he complained. Similarly, he denounced the ability of married couples to divide income between husbands and wives, especially in community property states. "This is another legalized fraud on the revenue," he declared. Morgenthau even criticized the purchase of tax-exempt state and local bonds by wealthy taxpayers.

Clearly, the secure legal status of a loophole offered no protection from Morgenthau's rhetorical attack. Married couples in California were tarred with the same brush as expatriate industrialists.

"One of the most disheartening facts disclosed by our investigation," Morgenthau continued, "is that lawyers of high standing at the bar are advising their clients to utilize devious tax avoidance devices, and they are actively using them themselves." The secretary offered a roster of malefactors, including several prominent New York and Washington law firms. In later congressional testimony, he would complain that these lawyers had developed "what might be called the sporting theory of tax administration."

"Legalized avoidance or evasion by the so-called leaders of the business-community is not only demoralizing to the revenues," Morgenthau concluded, "it is demoralizing to those who practice it as well."

Like the president, Morgenthau conflated avoidance and evasion, recognizing no meaningful distinction between the two. His was a "hate the sinner" approach to tax minimization, although most of his solutions involved legislative attacks on the "sin" itself. After all, most of the avoidance techniques described in the memo were technically legal.

Roosevelt soon took his case to Congress, where a Joint Committee on Tax Evasion and Avoidance began hearings on the tax shenanigans of prominent taxpayers. And while FDR had refrained from naming names (after much pleading from his staff and the Justice Department), the hearing room brought identities to light. Among the targets were several members of the du Pont family, actor Charles Laughton, newspaper publisher Robert Scripps, top executives with U.S. Steel and General Motors, and violinist Fritz Kreisler.

The antiloophole campaign produced several modest reforms, but nothing particularly dramatic. The campaign was more significant for its debate over the moral status of tax avoidance. Critics of the administration complained that the difference between legal tax avoidance and criminal tax evasion was crucial. J.P. Morgan was the most celebrated critic of the president's position, dismissing FDR's moralistic crusade as misguided. Taxpayers had no moral responsibility to shun loopholes, he insisted. If political leaders didn't like the tax law, then they should change it.

In fact, changing the law was exactly what the president wanted to do, but he certainly enjoyed vilifying a few rich taxpayers along the way. And he was delighted to have the politically clumsy Morgan defending tax avoidance; he was the sort of enemy Roosevelt loved to engage.

When it comes to tax avoidance, Bill Thomas and Charles Grassley may be the ideological descendants of J.P. Morgan and Franklin Roosevelt. Their debate over corporate inversions reveals the tenacity of this dispute about morality and tax avoidance. It seems clear, however, that Grassley and his supporters have their work cut out for them. Almost a century of moral indignation has done little to convince taxpayers that they should shun aggressive tax schemes. Paying taxes has always been an adversarial process, pitting taxpayers against the fisc. It seems likely to stay that way.