Robin Hood In Reverse

The Enron scandal has plenty of dirt to go around, as the Harvard Corporation has already discovered. But what will always remain most shocking to me is that in four of the last five years, Enron paid no income taxes. What’s more, it was entirely legal. Through a variety of loopholes, including 800 subsidiaries in tax havens like the Cayman Islands, Enron managed to earn $1.8 billion without owing the government a cent. In fact, the company got a net rebate of $381 million, your tax dollars and mine.

Over the past few years, the U.S. tax system has started to play Robin Hood in reverse. The availability of new tax shelters, combined with lax enforcement by the Internal Revenue Service (IRS), has let the rich and dishonest evade their obligations and increase the burden on the American public. Without drastic reform, tax loopholes and outright evasion will create a vast paid subsidy for the wealthy—or, to put it another way, a huge hidden tax on everyone else.

While offshore tax havens may once have been the preserve of companies like Enron, they’re now available to the mass market. Americans who keep money in accounts overseas are required to pay taxes just as if the money were in a U.S. bank. But many countries have secrecy laws that keep these accounts hidden from the IRS. And companies like MasterCard, Visa and American Express make it easy to access offshore accounts, issuing overseas cards with million-dollar monthly credit limits.

In a Pulitzer Prize-winning article in October 2000, David Johnston of The New York Times reported that secret offshore accounts may cost the public more than $70 billion every year. At the time, this represented six cents of every income tax dollar—and the figure has likely gone up since. A follow-up article by Johnston revealed that as many as 2 million Americans may have unreported offshore accounts.

But most tax evasion isn’t nearly so elaborate. It’s as simple as lying on your tax returns. Most Americans’ returns are checked against records submitted by their employer. But Americans who are self-employed, or whose income derives from investments or partnerships—who tend to be wealthier than average—face no such scrutiny. The IRS, which has been kept on a shoestring budget for several years now, can only review one of every 400 partnerships. Well-off tax evaders have virtually no chance of getting caught.

Instead, since the Republican Revolution of 1995, Congress has only promoted enforcement against fraud by the working poor. According to Johnston’s reporting, the IRS employs 2,200 people to investigate fraud involving the Earned Income Tax Credit (EITC), a program that helps working Americans stay out of poverty. At most, such cheating amounts to $9 billion a year. Yet on a per-dollar basis, the IRS has only a quarter as many employees investigating more than $300 billion a year of other fraud. (The eyes tend to glaze over when faced with numbers like these, but $300 billion a year is more than we spend on Medicare). In all, EITC recipients are three times more likely to be audited than those with incomes above $100,000. Why would Congress put such a disproportionate burden on the working poor? Here’s a guess—the people pocketing the $300 billion tend to have more political influence.

How can we restore sanity to our tax system? The first step: refocus the agency’s enforcement efforts. The Senate is just starting to take the issue seriously, with Finance Committee hearings this week. Offshore accounts would be a good place to start; the same bank secrecy laws that protect tax cheats also keep al-Qaeda’s money safe. The U.S. should make financial transparency a condition of doing business with American companies.

Second, increase the penalties for evasion. If cheating no longer makes good business sense, good businessmen will stop cheating on their taxes.

Third, eliminate known tax shelters, closing the loopholes that let Enron enjoy a particularly generous form of corporate welfare.

Finally, investigate ways of fighting tax fraud that can withstand an IRS funding shortfall or a hostile Congress. One approach would be to make the tax laws self-enforcing. The False Claims Act already allows private individuals to file “qui tam” lawsuits against those defrauding the government. If they win, the government receives treble damages, and the plaintiffs take home a portion of the proceeds—normally around 25 percent. Originally designed to catch fraudulent military contractors during the Civil War, the act was revised in 1986 to increase rewards and to protect employee whistleblowers. Since then, the law has recovered more than $9 billion of public money.

Unfortunately, however, the law doesn’t cover tax fraud. The IRS offers rewards for information, but only if the tips lead to a successful enforcement action. Given that the agency is too cash-strapped for effective enforcement, Congress needs to amend the False Claims Act so that individual whistleblowers can stop tax cheats on their own.

Real enforcement will cost real money—but it will also bring the tax dollars rolling in. According to an expert quoted by the Times, $9 million spent investigating partnerships could bring in $1.8 billion every year, not counting interest and penalties. If we’re going to invest the Social Security trust fund, why not go for a 20,000 percent return?

Yet it isn’t just an issue of money. Unless the system is reformed, soon paying taxes will no longer be the responsibility of every citizen, only of the suckers who are too poor or too honest to cheat. By letting enforcement lapse, Congress has made sure that crime does pay, creating an immense new welfare program for the wealthy and unscrupulous. And that’s one kind of welfare America doesn’t need.

Stephen E. Sachs ’02 is a history concentrator in Quincy House. His column appears on alternate Tuesdays.