David Cay Johnston Syracuse University College of Law Rochester, Syracuse and New York City ______

David Cay Johnston is in his seventh year as a distinguished visiting lecturer at Syracuse University College of Law. He teaches the tax, property and regulatory law of the ancient world.

He is a columnist for , Al Jazeera America, and National Memo, a Newsweek contributing editor, and a frequent commentator on various national broadcast shows.

Johnston is the immediate past president of the 5,000-member Investigative Reporters & Editors (IRE). He has lectured about tax policy, investigative reporting and ethics on four continents.

He was awarded a 2001 Pulitzer Prize for his coverage of taxes in . He was a finalist three other times.

Among his five books is a best-selling trilogy – Perfectly Legal, Free Lunch, and The Fine Print – on taxes. Perfectly Legal won the 2003 investigative book of the year award. Johnston has been called the “de facto chief tax enforcement officer of the United States.” The Oregonian says his work equals that of Lincoln Steffens, Upton Sinclair and Ida Tarbell. The Joint Committee on Taxation valued two tax deals his reporting thwarted at more than $250 billion. He is the only American journalist whose work caused a broadcaster to be forced off the air by the FCC.

At age 18 one of the nation’s largest newspapers, the San Jose Mercury, recruited him. At 19, Johnston joined as a staff writer. Over the next four decades Johnston was an investigative reporter for that paper, the Detroit Free Press, , Philadelphia Inquirer, and The New York Times. In 2011-12 he was the global tax and economics columnist for , where he revealed more tax games and that Singapore imposes stealth taxes that make it world’s most highly taxed country.

Johnston attended seven colleges, including the , and earned more than enough credits for a master’s degree. In Los Angeles he taught for eight years at USC and UCLA. He has eight grown children and five grandsons. Johnston has been married to Jennifer Leonard, CEO of the Rochester Area Community Foundation, for nearly 33 years, but not long enough.

Ronald D. Aucutt McGuireWoods LLP Tysons Corner, Virginia ______

Ronald D. Aucutt is a partner in the Tysons Corner, Virginia office of McGuireWoods LLP and is co-chair of the firm’s Private Wealth Services Group. Mr. Aucutt concentrates on planning and controversy matters involving the estate, gift, and generation-skipping transfer taxes, the income taxation of trusts and estates, and the rules regarding tax-exempt organizations and charitable contributions. He has extensive experience in assisting clients with the transfer of wealth from one generation to another, particularly including the orderly and tax- efficient succession of family-owned businesses. He also advises lawyers and other professionals on tax planning and controversy issues across the entire spectrum of estate planning and charitable giving, including the complex rules governing generation-skipping transfers under chapter 13 and the special valuation rules under chapter 14 of the Internal Revenue Code. He is experienced in resolving tax issues through rulings in the ’s National Office and in administrative appeals throughout the country. He has contributed to the formation of estate tax policy through legislation since 1976, as well as in Treasury regulations, has served as an expert witness in estate and gift tax matters, and was named in January 2014 to the Internal Revenue Service Advisory Council.

Ron was recognized as one of Washington’s 31 “Best Lawyers” in the December 2011 issue of Washingtonian and as one of the top 30 “Stars of the Bar” in the December 2009 issue of Washingtonian; he holds Chambers USA’s “Band 1” ranking for Wealth Management; and he was elected to the National Association of Estate Planners and Councils Estate Planning Hall of Fame and given the designation of Distinguished Accredited Estate Planner in 2009. He was awarded the 1995-1996 Estate Planner of the Year Award by the Washington, D.C. Estate Planning Council. His biography appears in Who’s Who in America, Who’s Who in American Law, Who’s Who in Finance and Industry, and Who’s Who in the World. He is also listed in the Best Lawyers in America.

Ron is a Fellow and former President (2003-04) of The American College of Trust and Estate Counsel (ACTEC), an academician of The International Academy of Estate and Trust Law and former member of its Council (2000-04), a former Vice Chair (Committee Operations) of the American Bar Association’s Section of Taxation (1998-2000), a Fellow of the American College of Tax Counsel and the American Bar Foundation, and a member of the Christian Legal Society. He is also a member of the Advisory Committee of the University of Miami Philip E. Heckerling Institute on Estate Planning, the Editorial Board of Estate Planning, the Board of Advisors of Business Entities, and Tax Management’s Advisory Board on Estates, Gifts, and Trusts.

Ron received a B.A. degree in 1967 and a J.D. degree in 1975, both from the University of Minnesota. He has been a lecturer in law at the University of Virginia School of Law. He has lectured on estate planning subjects at over 100 tax institutes and conferences nationwide and is the author of more than 150 published articles on estate planning and other tax subjects. Mr. Aucutt is co-author of Structuring Estate Freezes, published by Warren, Gorham & Lamont and supplemented twice a year.

Ron was in the U.S. Navy from 1970 to 1973. He served in Vietnam and achieved the rank of lieutenant.

Ron and his wife Bunny live in Falls Church, Virginia. They have two sons, David and Jamie, a daughter-in-law, David’s wife Evelyn, and a grandson Brayden, who all live in Chicago.

A Transfer Tax for the 21St Century Economy

___

The MOST Plan ___ Lifetime Investment Accounts

Syracuse University College of Law By David Cay Johnston

Heckerling Institute, Orlando, Florida, January 2015

The American transfer tax system is economically, intellectually and legally incoherent. It double taxes, under taxes and, far too often, fails to levy economic gains. It has become so porous that a gift worth 1 $100 million can be passed through a $1.2 million tax‐free hole.

Fortunately, we can design an economically, intellectually and legally coherent transfer tax system, one that flows from the new economic order of the Digital Age.

I propose a new transfer tax system that will:   Lower costs of tax administration and compliance  Accurately and predictably raise revenue to finance public  goods and services  Encourage savings and investment in productive assets  Eliminate the lock‐in effect of capital gains taxes  End the rampant cheating in valuing gifts  Levy all economic gains, inducing fairness  Eliminate discounts to ensure integrity  Make cheating impossible ‐ except by criminal conduct  Limit the estate tax to super‐fortunes Encourage gifts to public charities, including endowments Discourage gifts to private foundations

That may seem a tall order, but filling it is quite easy as we shall see, provided we do just one thing: change the way we regard our tax system, which in turn will allow us to see tax avoidance in a new light.

We must change our perception of tax from dread, fear and even violent hatred to an appreciation of what taxes make possible: wealth creation, property rights, social stability and individual liberty. our liberties and our wealth commonwealth Our goal should be to create a tax system that will enhance by financing the vast array of goods and services, without which there would be no liberty and no wealth.

10‐2

To change this attitude we must start with those who prosper by giving sophisticated advice on tax avoidance, a form of tilting the playing field, especially when this advice involves technically lawful ways to game the system. All gains must, and should, eventually be fully levied so that all who prosper share in the costs of the government that enabled their prosperity.

We can also encourage more saving and investment, creating an economically stable society in which older working class people2 like bus drivers commonly own their homes free and clear.

The core element of this plan is creating Lifetime Investment Accounts (LIA) in which taxes on capital can be deferred until death. Drawing on our experience with defined contribution retirement plans, we can create plans with fewer restrictions and much more flexibility.

Capital income would be taxed only upon withdrawal or at death. In the first case the capital is being consumed ‐‐ fruit taken from the tree. In the second the owner has ceased to exist, ending lifelong deferral on gains in her LIA.

At death these accounts must be emptied promptly, with taxes withheld before transfer. There would be a one‐time deferral for the surviving spouse, but not for any subsequent remarriage by that spouse.

A fiduciary, subject to strict liability, would stand guard to monitor deposits and withdrawals, as well as payment of taxes, ensuring integrity. The remarkably low costs charged by some of our biggest investment managers for the current defined contribution retirement plans tells us that the costs of having fiduciaries will be minor, so small they may not amount to a single basis point on large accounts. Some mutual funds charge retail investors as little as a nickel per $100 annually for all costs. st The 21 Century transfer tax system detailed below takes into account both liquid securities and assets that are either indivisible or hard to value, including objets d’art, buildings and privately owned businesses. These proposed rules are part of a larger proposal I am drafting to modernize the entire tax system so that it complements the

10‐3

st 21 Century economic order, strengthening both society and its system for financing the public goods and services on which private wealth creation is built and the defenses of liberties rely.

Tax systems must flow from the economic order of the day or fail. A Viking king can command part of the catch, the Pharaoh part of the harvest of emmer, but a Nordic king who tries to support his government on a grain harvest or an Egyptian ruler who relies on the fish will lack the resources to provide for his people what only governments can provide.

Today’s tax system was designed for the Industrial Age, an era of fixed assets, cash wages and a mostly domestic economy. Tax that steel mill – it’s not going anywhere. Withhold some of those cash wages. Worry little about what goes on beyond the national boundaries.

That economic order is receding. Today that system cuts against the economic order instead of flowing from it. The most valuable assets today are intangibles, which can be easily sent offshore, making it difficult to tax them. At the same time, we grant evermore tax abatements for immovable assets. Today compensation comes in many forms, not all so easy to value as cash in an envelope, paper or digital. And foreign rules shape decisions by multinational companies, which dominate the economy and also lobby and make campaign contributions, investing in government rules changes for their own benefit. The last is simply sophisticated rent‐seeking that corrupts our moral sentiments. st Our tax system needs updating for the 21 Century economy of intangibles, complex compensation and global competition.

We always need to encourage capital, not diminish it. Today we need a system that gives people maximum flexibility over their savings and spending decisions, encourages reinvestment of capital income and still makes sure that all gains ultimately are fully taxed. We all benefit from building a society with a broader distribution of capital. That would enhance social stability and reduce demands for government services.

10‐4

Unlimited deferral of taxes has powerful effects on behavior. Consider how adding just five words to IRC Section 531 in the 1986 Tax Reform Act sent trillions of dollars of untaxed corporate profits into 3 open‐ended tax deferral accounts offshore.

The original 1909 corporate income tax included a limitation on holdings of cash and near cash to prevent tax avoidance and to 4 keep money circulating to encourage economic activity. policy Since 1909 thousands of companies were hit with the penalty, asterisk currently 15 percent, for hoarding cash. The 1986 change – what I call a – drew hardly any notice. It retained the cash hoarding rules for domestic firms, but created an exemption for multinationals by adding Section 531(b)(3) which exempts “a passive foreign investment company”

The change exempted money held offshore from these rules, a powerful attractant for risk‐averse CEOs who could build a cushion of cash and near‐cash reserves to protect their companies (and their jobs) from economic buffets.

Nonfinancial firms have stashed more than $3 trillion (note the “t”) in offshore accounts – about $10,000 per American. Count d5 omestic cash and the hoard grows to more than $5 trillion.

We can learn lessons good and bad here. And we can apply that knowledge to enact a policy that strengthens society by creating those Lifetime Investment Accounts.

The problem with the 1986 change is that the very well‐advised multinationals converted taxable domestic profits into tax‐deductible expenses that are sent to offshore subsidiaries as fees, rents and royalties, demonstrating that the modern alchemy of turning ink on corporate tax returns from black to red is far more valuable than the imagined Philosopher’s Stone that could convert lead into gold.

We can induce a similar change in individual behavior, but without the negative consequences of corporate offshore cash hoarding, by creating LIAs. We can persuade people to save post‐tax and

10‐5 encourage them to leave the money there to compound. And we can protect the fisc by letting people withdraw as they need to without limits or penalties.

Government should be indifferent to capital income deferrals so long as they have a predictable and inescapable end point. LIAs have, for large numbers of people, predictable end points because barring some breakthrough in biological science death is inescapable. In contrast corporations are artificial persons who can be immortal and, thanks to Chapter 11, can even rise from the dead by shedding cancerous obligations and obtaining fresh infusions of money. Section 531(b)(3) corporate deferrals can last forever.

The overall rate of return in LIAs should exceed the government's borrowing costs. And having a broader range of people with investment accounts will provide personal financial cushions that will reduce demands for government welfare services.

Before we can understand the benefits and necessity of a new tax system, we need first to understand the principles underlying these issues, human insights going back thousands of years that have been tested, refined and either cast aside or continued. These historical perspectives can help us avoid morally ambiguous territory and the fiscal quicksand of the perpetual human desires for a free lunch and to stick the other guy with the tax bill.

“Principles first” makes the mechanics obvious, showing us how to grease the wheels of commerce and culture while seeing clearly who benefits by throwing sand in the gears.

Ancient Principles

Tax is, by far, the world’s largest economic activity. Among countries with modern economies,6 tax accounts for roughly 35 percent of gross product.

10‐6

The United States appears in the official data to be about a third below this average at 24 percent. But that is misleading because in America many public goods and services today are financed with fees, including tuition and tolls, in lieu of taxes. Many services that would be public in other countries, including health care and old age annuities, are largely privately financed – and typically at vastly larger expense due to that. Combine taxes with the fees and other private payments and the total cost of services for Americans equals or exceeds 7 the burdens in other modern countries.

Taxes, as Justice Oliver Wendell Holmes observed, buy us civilization. Without tax there is no civilization.

Without taxes there would be no laws to define personal rights or property, no mechanisms to adjudicate disputes and to enforce judgments. Without taxes there is no liberty, no wealth, no improvement to societies and living conditions.

Without taxes there are no governments, which set the rules and enforce them. But for taxes, mankind would live in its natural state ‐‐ the jungle. Animate life’s natural state involves both cooperation and conflict. Before civilization life humans existed in an endless war and There are no threat of war in which it was all‐against‐one or, at best, all‐rights, personal or property, without governments. against‐one‐ group. In this state there is no justice, only brute power. 8

There is no investment absent rights. But for taxes, neither incomes nor wealth would exist. Any goods would be at constant threat of being taken, along with life itself, with no recourse.

We forget, or ignore, these basics at our peril.

Once we develop a respect for tax as the foundation of civilization we can turn our attention to how to benefit the most from tax. We can first think about what we buy with our taxes. We need to discourage actions that undermine the system, especially respect for it and its integrity.

10‐7

Knowing that tax forms the foundation of all we hold dear should make us oppose chipping away at its granite base until it turns to sand, making everything built on the foundation unstable. We want to create many more sound and diversely owned economic structures so we can all live well. We need to let the human spirit flourish, which requires all the individual liberty we can imagine, and then we must defend that liberty. It is questioning man, the visionary artist, the challenger to dogma, who calls attention to our flaws, distilling their beauty and ugliness so we can perceive them and advance understanding of the human condition.

For civilization to endure requires a solid foundation that can withstand inevitable storms: economic, military, political and social. For civilization to help mankind be what we can be, we need rules that define rights and responsibilities, systems to protect liberty and property, and money to provide the education, infrastructure and basic research on which life now depends. We need abundant commonwealth goods and services if we are to live long and prosper as a society. And we need to finance all that with taxes.

All wealthy nations collect significant taxes ‐‐ and tax equivalents like tuition, fees and premiums ‐‐ because ensuring individual liberty, fostering wealth creation and maintaining tranquility require continual investments in a vast array of commonwealth goods and services. Democracy in particular requires not just literacy and numeracy, but critical thinking skills and awar9 eness of what sociologists call “The Other.”

Education, infrastructure, basic research, civil and criminal justice and safety regulation all underlie private wealth creation. Basic research also requires taxpayer funding (while applied research can be privately funded) to keep up with the rapid expansion of human knowledge that generates most of the modern world’s economic growth.

Achieving a modern tax system that can do all this begins with learning and honoring the surviving insights of the ancients. Any principle that survives for thousands of years is, by definition, classic and conservative. Appreciating these timeless principles will open our

10‐8 eyes to the deep faults in our current transfer tax system and they threat they pose to our liberty and our wealth.

When the ancient Athenians ended what we call the Tyranny by demos inventing self‐governance, they faced an immediate problem – how to square the idea of the , in which each male citizen had an equal vote, with the historic influence of the rich who traditionally wielded power. The Athenians came to the conclusion that wealth did not entitle one to extra votes or even more influence.

Instead, great wealth came with great obligations because such wealth could only be attained, and maintained, because one lived in Athens. This is a crucial part left out of our tax policy debates. We are not rich in America by divine right, but because of government policy that aligns the rules with human nature. Failing to adapt those rules to address changes in everything from technology to market manipulations will destroy our wordoliberalismealth. Just as Adam Smith taught that the benefits of markets require open, fair and honest competition, the German principle of seeks to generate competitive market incomes by responding to efforts to tilt the paying field.

The Athenian moral philosophers recognized that riches came from policies that enabled those riches. Its laws defined property rights. Its courts adjudicated disputes. Its military protected the great piles of gold and other treasure that wealthy Athenians kept in the basements of their palatial homes. Athens protected personal and property rbecause ights. But for Athens, these wealth holders would not have their riches. Thus the greater the wealth one managed to attain of the good fortune of living in Athens, the greater the burden one had a m10 oral obligation to bear so that Athens would endure.

Making Tax Our Ally

This is not to elevate tax, but to ground it. Once we recognize that without tax all of what we hold dear would go away we can think about this largest economic activity on our planet in ways that promote

10‐9 efficiency, effectiveness, equality and endurance. We can think about how tax can be our friend, not our enemy.

The first step in creating an entirely new approach to tax is, moral logically, to address the Athenian principle that the greater your gain, the greater the burden you must bear. This basis for progressive taxation that the ancient Athens devised has endured for 2,500 years and has been supported by Plato, Aristotle, Adam Smith, Jeremy Bentham, David Riccardo, Karl Marx, Alfred Marshall, John Maynard Keynes, Milton Friedman and, repeatedly, by George W. Bush. Even John Locke supported progressive taxation though in the mildest form possible. Locke held that the poor had nothing to tax and everyone else should be taxed as little as possible.

Instead of recognizing the moral basis for progressive taxation and the political benefits of taxation rules evenly enforced, we have created a vast machinery to wage war on tax. The trusts and estates bar and the accounting profession understandably employ their intellectual firepower to help clients avoid paying tax. That’s where the money is, after all.

Complexity favors those with the resources to pay for sophisticated advice. It also rewards the most aggressive about tax, those most willing to call impermissible black a shade of grey, especially when they wok to reduce the resources of tax law enforcement so they run little risk of civil liability and virtually no risk of criminal prosecution.

This is no way to run a tax system. We want a system with integrity.

We should develop a culture that looks on cheating and tax avoidance based on ignoring the spirit of the law with the same opprobrium we apply to pitchers who intentionally bean batters, to con artists who trick us out of our charitable dollars and to elected officials who rent out their votes or signatures. We should insist on integrity in taxes, which we all pay.

10‐10

We should be appalled that for more than three decades it has been well understood, especially by the trusts and estates bar and its 11 equals in accounting, that the estate tax is essentially a voluntary levy.

We should be troubled that limits on gifts are easily gotten around, as Mitt Romney’s campaign acknowledged in writing when I posed a single, carefully worded question about the $100 million trust fund for the five Romney sons. We should look upon “defective grantor trusts” as Orwellian because they serve no public purpose, but instead shift burdens from the wealthy and well advised with progeny to everyone else.

We should replace the transfer tax system we now have, more loophole than law, because it poses a long‐term danger to the endurance 12 of this, the Second American Republic.

A system with integrity will treat all taxpayers alike by taxing all gains. That will not eliminate the need for the trusts and estates bar, but merely redirect it from creative avoidance techniques to promoting lawful behavior and compliance.

With this philosophy of integrity in place, we can appreciate hst ow a transfer tax system designed for the 21 Century can be created, one that is economically sound, intellectually rigorous and legally clear while protecting both the fisc and the interests of all taxpayers.

This new system will bring economic, intellectual and legal coherence to transfer taxes. It will also offer a very large and juicy carrot to encourage savings and investment by janitors and plutocrats alike, because in a democracy they are, as the Athenians taught us so long ago, political equals.

Asset Ownership Narrows

Owning assets encourages social stability. People who own their own homes tend to be more financially secure, especially in old age if they paid off the mortgage. People who own income‐producing assets such as rental properties, stocks, bonds and savings accounts also tend 10‐11 to avoid socially destructive behaviors that would put their as13sets at risk. Paradoxically, reliance on assets also increases anxiety, 14 producing extreme fears of loss in some very large asset holders.

Early in the 2000 presidential campaign until the end of his second term, George W. Bush vowed to create an “ownership society” in which a growing share of the populace owns their homes, stocks, bonds and other investments. Congress reduced taxes on ordinary incomes, capital gains and most dividends, as well as enacting major reductions in estate and gift taxes. 15 Despite this, asset ownership did not expand. It contracted.

Enacting a 21st Century transfer tax system would help broaden ownership, which would strengthen the economy and the polity.

The share of the populace who own their homes fell in 2013 to its lowest level since 1995. It was expected to fall further in 2014 because of declining incomes and employment instability, forcing more people rent because they do not qualify for a mortgage or need the ability to move quickly to take advantage of limited job opportunities.

Receipt of dividends is a proxy for the breadth of stock ownership outside of retirement funds. From 2000 to 2012 the number of taxpayers reporting dividends fell by 6.2 million, to just under 28 million or about one in five taxpayers.

Capital gains, the most concentrated major form of income subject to tax, became dramatically more concentrated. Generally gains are only reported when assets are sold. In 2000, one in eight taxpayers reported capital gains; in 2012 only one in fifteen did. The number of taxpayers reporting capital gains plummeted over those years to fewer than 9.8 million, a 39 percent decline from the 16.2 million taxpayers with gains in 2000. Reported gains fell sharply in that period, down almost 23 percent, to $644.9 billion.

Even among those with adjusted gross incomes of more than $2 million a year, roughly the top one‐tenth of 1 percent of Americans, the number reporting gains fell almost 10 percent.

10‐12

Only the rapidly growing segment of people who report negative incomes – about one in in every 68 taxpayers – showed an increase in capital gains from 2000 to 2012. While business reversals may explain this, sophisticated tax planning and rules allowing unlimited depreciation write‐offs for landlords who work at least two days a week in real estate may also explain these figures.

During these years the receipt of capital gains and dividends became much more highly concentrated at the top.

In 2000, half of capital gains went to the top one‐tenth of 1 percent of Americans. In 2012, this very thin and very rich slice of Americans collected a much larger share: 62 percent of capital gains.

This high‐income group’s share of dividends grew over those years from 18 percent to 38 percent and the average amount soared from $246,000 to $1,169,600.

This data shows that far fewer people are benefitting from owning assets. But the numbers are somewhat misleading because these figures exclude retirement accounts, which are overwhelmingly invested in stocks and bonds whose increases in value are, when sold, taxed at wage rates.

At the end of 2012, Labor Department data showed that 63.1 million Americans held $3.5 trillion in 401(k) plans. That is just $55,500 per person with any such savings, my analysis of reports by the nonprofit and nonpartisan Employee Benefit Research Institute shows.

Gains in retirement plans are taxed at withdrawal at the higher rates for labor, except for Roth plans, which are tax‐free at withdrawal.

Significantly, contributions to retirement plans are severely restricted by Congress, though creative tax planning has allowed some very high net worth individuals to stuff them with hundreds of millions of dollars in assets.

10‐13

Early withdrawals, generally those made before the year when a taxpayer reaches age 59½ are subject to a 10 percent penalty, a burden which generally falls not on those best able to bear this burden, but those least able. In 2012, for example, people with incomes of $10,000 to $15,000 paid 18.4 percent of such penalties, many paid by people who were out of work and had no choice but to draw down their only reserves.

These trends tell us the extent to which most people who own securities hold them in tax‐deferred retirement accounts. We can improve on this model, encouraging more savings. In so doing, we can limit and remake the estate tax so that it affects only fortunes large enough that they pose a dynastic threat of economic stultification.

Perpetual trusts would be banned, with federal tax law ignoring any state law violating the traditional prohibition, which helps ensure th we do not end up like late 18 Century France where all valuable assets were tied up in trusts, blocking economic progress. One goal here should be to insure the transfer of assets in ways that discourage dynastic wealth, which inherently creates barriers to dynamic economic changes. Public policy should encourage new wealth based on merit, invention and progress, not luck by birth.

The most important element of this plan is to allow a lifetime deferral of taxes on capital income, while also requiring full taxation of such income at death with a temporary exception for one surviving spouse.

The Canadian federal government adopted a similar system in 1971. While those who believe capital income should be favored over labor income continue to argue against any tax on capital gains, there is no evidence that the Canadian system has damaged business or investment. Making the MOST

There is a simple and honest way to provide for a lifetime deferral of taxes on capital incomes, which would encourage more savings and

10‐14 investment. This change requires few rules. It would be dramatically less expensive to administer than today’s complex estate plans even for those with wealth below the current unified tax credit exemption level.

Current rules require extensive tax planning for the living to avoid incurring capital gains taxes and recapture levies on depreciated assets. These rules create a lot of very well paid jobs, but in doing so they divert intellectual firepower that society could put to much better use. By eliminating the need for a great deal of tax planning it would shrink the estate planning and tax avoidance field in numbers (or else cause incomes to drop), resulting in a more efficient deployment of human capital.

Current rules also discourage young people from saving in retirement plans. Little savings takes place outside of such plans, especially among those under 40.

Congress strictly limits how much can be saved in retirement funds, as little as $5,500 for a traditional IRA. More significantly, Congress generally imposes penalties for withdrawals before age 59 years and six months, while requiring withdrawals at specified levels after age 70 years and six months.

This penalty regime discourages younger savers because the decades between the day they get their first job until they reach retirement age is a horizon too far. Even for those in their 50s, unpredictable bumps in the road may force early withdrawals and, with them, a 10 percent penalty tax. We can do better.

Let’s create the Modern Optimal Savings Tax (MOST).

We can avoid the worst elements of retirement savings plans and take advantage of the best to get the MOST benefits for individuals, businesses and government.

We can also make sure that all gains are ultimately taxed. Under the MOST plan there would be no step‐up in basis and no exemption from taxes on capital incomes, only deferral until withdrawal or death, which would be a deemed withdrawal.

10‐15

The essential elements of the MOST plan are 1) trusteed investment accounts, partially patterned after those already required for defined contribution retirement plans, 2) a rigorous set of fiduciary obligations on the trustee, 3) an absolute prohibition on loans from the investment accounts, 4) unlimited deposits and withdrawals, the latter always subject to tax when there are gains in the LIA and 5) only allowing deposits and withdrawals in cash.

That last provision is to promote integrity. It is already required for retirement accounts. Requiring cash in, cash out with a fiduciary standing guard monitoring the flow of money in both directions Fiduciary Box will ensure honest reporting to the tax authorities and honest valuations. We can call this investment vessel the .

MOST accounts would allow unlimited deposits and withdrawals at any time. This removes the barrier to savings created by the long time span in IRAs and 401(k)‐type plans.

Because no taxes apply within the fiduciary box, owners can freely move their capital. They can buy and sell securities with no immediate tax consequences so long as the funds remain inside the fiduciary box.

Multiple virtues flow from this: 

Since there is no lock‐in effect, we can anticipate more  efficient deployment of capital.

This freedom should also encourage more people to invest  through a fiduciary box.

These features should, in turn, encourage more prudent  handling of income so that people save more.

In turn this should promote job creation, though reductions in consumption will tend to offset the benefits of increasing the amount of capital.

10‐16

Inside the fiduciary box, owners are free to invest in productive assets, but not property that diverts capital from active employment.

As with existing retirement accounts, funds could not be invested in collectibles. I would clarify the current vague definition, which is subject to change by the Commissioner, to include nonproductive assets: antiques (and antique cars), all objects d’art, gold, personal residences, yachts or anything else which may rise in value but is an unproductive asset. The reason? The purpose of the capital income tax deferral in these accounts is to increase our stock of capital, not personal toys.

Similarly, fiduciary‐box cash can be used to buy a meadow ‐‐ provided that it is not fallow land to enjoy as open space, but a part of a working farm or other income‐producing activity such as a resort.

Funds in the box could be used to buy investment real estate, from rental homes to skyscrapers, either through REITs and other securitized vehicles or directly. And it could be used to own a directly operated business, enhancing the benefits of reinvesting profits in a business rather than consuming their value, the macro effect of which results in fewer jobs when the societal goal is more jobs.

The fiduciary would be held accountable for making sure that any investment not in liquid, publicly traded securities is bought and sold at real arms‐length prices. Those who choose to make investments in real estate and direct operating businesses through their fiduciary box will entail added cost for documentation and other compliance compared to the cost of overseeing purchases of mutual funds, individual stocks and bonds.

Concerns that it will be hard to find fiduciaries lack merit. First, America is rich with fiduciaries (and workers in positions of trust who should be fiduciaries) today, including my wife. I asked her what risks and problems her fiduciary status as head of a large charitable endowment worth many multiples of our combined lifetime incomes and net worth created for us. “None,” Jennifer Leonard said. “The only time being a fiduciary gets in the way is if you want to do something you shouldn’t.”

10‐17

Fiduciary status is a virtue for investment because it promotes honest conduct at all times. With new rules we can make both occasional and chronic dishonesty not worth the risk.

The price of fiduciary services will reflect demand for them as well as the investment choices owners make. Fiduciaries would be required to post a large bond to ensure recovery and would be audited regularly by the government, with costs covered by their licensing fees. Since many millions of people would no doubt want to take advantage of the tax deferral benefits of the MOST plan’s fiduciary box, we can rest assured that when it comes to identifying competent and honest fiduciaries, the market will provide.

Fiduciaries who play fast and loose would, under the proposed rules to be listed below, ne held liable for their actions. They would stand to lose everything. per se Violations of fiduciary duty, including a lack of diligence, should be made crimes, requiring only proof of what the fiduciary did, or did not do, without consideration of intent. The civil penalty for first offenses should three times the amount of funds involved plus all costs of enforcement; the second offense, ten times plus costs and lifetime loss of fiduciary status. Giving prosecutors the discretion to file criminal charges would serve as a powerful deterrent. Since the crimes involved would be not those of passion, but calculated commercial decisions they can be curbed through rigorous enforcement.

As part of this integrity regime, the law should require public disclosure, in plain English, of all completed investigations and annual audits of fiduciaries, who would have to disclose their own enterprise’s audited financial statements. Auditors would be selected at random and changed every third audit to avoid collusion. A single set of books prepared under uniform accounting rules and uniform record keeping practices are essential.

Investigations not completed after 18 months would be subject to disclosure unless it would jeopardize an inquiry; a temporary waiver

10‐18 that could be sought from a U.S. District judge under rules ultimately requiring full disclosure.

By becoming a fiduciary for a MOST plan, one would also voluntarily accept these conditions.

As part of the strict liability for fiduciaries, a ban on self‐dealing by fiduciary‐box owners (as well as the fiduciary) is also required. Similar rules already exist for retirement accounts. For example, in retirement accounts the owner may invest in mortgages, but not those in which he or a list of disqualified persons has any interest.

One Property, Indivisible

Not everyone invests in securities. Government should do as little as possible to restrict investment choices other than insist that to gain the benefits of this deferral investments must be in productive assets. Money in the fiduciary box could be used to buy indivisible, but income‐ generating property, such as an apartment house, factory or office building.

What happens to such indivisible property when the fiduciary box owner dies and her estate plan leaves her only asset, a building, to her children? Are they entitled to discounts for minority interests and blockages? No.

That an investor chooses to invest in illiquid or hard‐to‐value or hard‐to‐divide assets is not the government’s concern. While no rule should bar such investments, because that would be inconsistent with maximizing individual liberty, no discount from the tax owed should be allowed.

Consider a fiduciary‐box owner who owns a $100 million building, her only asset, and whose will provides at death that it be divided equally among her eight children.

10‐19

If the building is all gain, having been fully depreciated, and the then‐current tax rate on gains is 30 percent then the estate would owe $30 million in tax. Once the tax is paid, and the building transferred to the eight inheritors, each would own a 12.5 percent in their own boxes of the jointly owned building.

In this way the deferred gain (and any recapture of depreciation) is fully taxed and the inheritors receive the after‐tax value of the investment. Under the MOST plan there would be no step‐up in basis.

And where would the $30 million of cash to pay the deferred taxes come from? In this case it could easily be borrowed in the market place. A 30 percent loan‐to‐value mortgage is as close to a risk‐free loan as the world has ever known.

Since no leverage is allowed on assets in the box, how could such a loan be obtained? Easy. The banking world will devise loans that solve the problem. We already have bridge loans. Bankers can create products such as a loan against the anticipated asset, funding it the moment before transfer. This would create a momentary lack of security for the bank, which would deposit the cash needed to pay taxes with the fiduciary, which would then instantly empty the fiduciary box. Banks would charge a fee for the momentary risk. The rule could also allow for simultaneous borrowing and box emptying, but only to pay taxes on illiquid box assets.

A strict rule to avoid gaming the system through such transactions may not be required because under strict liability, the fiduciary may be sufficiently on notice to protect the fisc.

Now imagine that this building throws off $8 million of cash annually. Once the children own their shares each can collect their $1 million in their individual boxes tax deferred. They are then free to withdraw it and pay tax on that rental income or to reinvest it tax‐ deferred inside the box.

What about siblings who wish to cash out? Sales between the inheritors must be closely examined by the fiduciary whose duty of loyalty is to the fisc, not the inheritors. Again, no discounts. One efficient

10‐20 way to establish market prices for minority shares is to require posting offers to sell in a public forum and requiring, as we do with charitable assets and with corporate assets in which shareholders are being forced out, acceptance of the highest bid.

These same principles could also put an end to rampant cheating on gift taxes, a problem known about for years and that continues to this 16 day.

What about an owner, aware death is near, who mortgages up the property and withdraws the cash, say $90 million? There is no gaming here. If the cash goes into the fiduciary box, it is untaxed anat withdrawald available only for investment in other assets inside the box. If this cash is withdrawn it is income, fully taxed by withholding .

Again, how people manage or mismanage their assets is not the government’s concern. Its interest in tax revenues – protecting the fisc – is the paramount concern.

Let’s assume for a moment that MOST plans allowed unproductive assets, say works of art. Now imagine that the only asset was a painting purchased for $1 million and now worth $101 million and that the owner’s will instructs the children they may not sell for 20 years. Should the value of the asset be discounted? No. Again, how people invest is their choice, but making specific choices never entitles the investor or her progeny to short the government.

If the owner has a surviving spouse, he or she can become the temporary owner of the fiduciary box in addition to his or her own box. Upon the death of the surviving spouse, even if he or she remarries, both boxes must be emptied and taxes paid on all gains.

Under a progressive income tax structure, this rule may encourage the surviving spouse to withdraw and pay the tax on some or the late partner’s fiduciary‐box gain in years when her own income is down, thus avoiding a higher bracket. (There is never any tax on basis because only post‐tax cash deposits are allowed.)

10‐21

Again, how the owner chooses to invest is a personal choice anyone is free to make. Other than limiting benefits to investments in productive assets, that is not the government’s concern. No tax reductions, or increases, should arise from such choices.

The proposed rules against self‐dealing cited above, including the harsh penalty regime for owner and fiduciary alike, should prevent manipulations, such as sale of the firm at a discount to siblings with a subsequent (and disguised) kickback.

To recap, under the MOST plan: o

There would be no restrictions of any kind on the frequency o or amount of fiduciary box deposits and withdrawals.

Securities inside the fiduciary box could be traded freely with no immediate tax consequences, just as we allow in individual retirement accounts. Dividends, interest and other income would flow into the account untaxed. All o incoming cash would be recorded as additions to basis.

All withdrawals would be fully taxable unless there are no gains and therefore basis is being withdrawn. o

There would be no offsets between deposits and withdrawals. A box owner who withdraws $1 million of her gains while, in the same year, depositing $2 million would be fully taxed on the $1 million while the $2 million flowing o into the account would add to basis.

All taxes would be fully withheld by the fiduciary, whose duty of loyalty is to the fisc. Fiduciaries would be subject to o strict liability and must be bonded.

As with IRAs, creditors could never attach MOST accounts. Owners would be prohibited from posting them as collateral. Doing so would void the loan contract and would make both the box owner and the fiduciary subject to

10‐22

per se

penalties for crimes. The lender could also be prosecuted, though that would require showing criminal intent.

Funds withdrawn from the fiduciary box, whether gain or basis, would lose their shield from new creditors. As a further safeguard, since loans against the box are prohibited any loan made in anticipation of payout at death would be void, again to prevent gaming the system.

At first blush, this ban on loans‐against‐the‐fiduciary‐box may seem to create problem for leveraged investments. It does not. Funds inside the fiduciary box could be used to buy securities that make use of leverage, just as investors can do in retirement accounts today. Real estate inside the box can be acquired with mortgages provided the lenders are unrelated to the box owner by blood, marriage or business interest. We already have well‐seasoned rules on who constitutes a disqualified person.

If this leverage magnifies gains, so much the better for the person who owns the contents of the box and their tax‐deferred increase in their wealth. Should leverage wipe out the security, the investor would have a nondeductible loss, as doAt death, all accumulated gains investors in their retirement are fully taxed. accounts.

The entire contents of the box must be promptly emptied unless there is a surviving spouse. In that case the survivor would have two boxes, both of which must be emptied upon his or her death. A time period of 180 days to empty any box should be adequate, but the exact length of time allowed is a matter of Congressional judgment. Any delays should require payment of tax and interest at the government’s blended average borrowing rate plus 10 percent, which as of this writing would be 2.016 percent plu17 s the surcharge for a total of 2.218 percent.

As for illiquid assets in fiduciary boxes: 

 It is not the government’s problem that the investor chose to invest in illiquid assets. Insurance can provide liquidity. 10‐23

A rule could allow for payments over time for illiquid small businesses that continue operating, but it should be at the government’s blended borrowing rate plus, say, 25 percent to encourage rapid pay down (currently 2.52 percent).

What of the estate tax?

We could eliminate it entirely if we taxed capital gains at death as Canada does or, as with the MOST plan, taxed capital income and gains at withdrawal or death. But there are instances of highly concentrated wealth that adversely affect the economy.

Large concentrated fortunes in one industry pose their own economic problems, giving rise to a reasonable public concern over perpetuating such concentrations. A fundamental tendency of capitalism is toward oligopoly, duopoly and monopoly as weaker competitors are acquired, culled or destroyed through competition. Society has a legitimate interest in promoting competition and breaking up private enterprises that inhibit economic growth. (st This issue will be explored in future papers on crafting a 21 Century tax system.)

The estate tax should be applied only to fortunes of $1 billion or more, of which evidence suggests there are now several thousand in the United States. Evidence that extreme concentrations of personal wealth destroy societies goes back to the rise of the first great commercial fortunes in Athens. More than 2,000 years ago the Greco‐Roman oldest and most fatal historian Plutarch observed (emphasis added) that “An imbalance between rich and poor is the ailment of all republics.”

Amounts above this threshold could be subject to a high rate of levy on both basis and gains, as with the current estate tax, that would effectively force dispersion of ownership and perhaps breaking up of the enterprise after the death of the owner and a surviving spouse. While such a move would offend many and perhaps nearly all huge wealth builders, it would also strengthen generational dynamism so that society endures. The purpose of the United States is not riches.

10‐24

Were that so America would fail when confronted by attack as few would die just to protect the fortunes of others. The preamble to our Constitution sets forth six noble purposes, among them domestic tranquility, justice, liberty and promoting the general welfare. The dead have no need of welfare. inter vivos Great wealth holders can avoid such an estate tax by making gifts, which would subject only their gains to taxation. Such large fortunes are primarily gains, not basis. Those great wealth holders unwilling to part during life with their fortune can avoid the tax by giving the money away. Here a simple change in rules could produce large public benefits.

Allowing a full deduction for gifts to public charities and private foundations over whose board the bequester has no influence would be maintained. (Disclosure: my spouse is CEO of a large public charity that relies primarily on bequests.)

A Half Deduction

But bequests to a private foundation that is controlled or even includes on its board, staff, or contractors people treated under our existing retirement plan rules as disqualified persons would receive only a half deduction because of the value of retaining power over the assets and their disposition.

The reason for the limitation is to discourage dynastic fortunes. A gift to a foundation that is under control or even the influence of friends and family is not a full disposition for public benefit. As such it should not qualify for a full tax deduction.

Under current rules an operating foundation could act as an employment agency only for heirs and business associates or their friends and family and still meet the annual payout requirements. One alternative to this would be requiring all private foundations to pay out their full corpus over a fixed term, say 25 years. The problem with such a time limit is that, absent other rules, the money could be granted to 10‐25

what amounts to a new private foundation or other entity effectively controlled by friends and family. The emphasis should be on the equivalent of disgorgement if a charitable gift is to qualify for a full tax deduction.

We can continue with the system we have, diverting resources from productive work to tax avoidance and ensuring a lot of well paid work for lawyers and accountants while encouraging tactics that sow disrespect for the United States of America. Or we can recognize that the reason the Framers placed almost no restrictions on the power we grant Congress to tax us stems from recognition that times change and how money is raised must change with it.

While it is important to always encourage more capital, we have no shortage of capital these days, only of useful employment for it. We also have a shortage of revenue compared with the vast unmet needs, including using up our commonwealth assets without replacing them. Requiring full payment of taxes on capital income and gains, but allowing lifetime deferral except for withdrawals, is still a favor compared to the system of withholding taxes on wages before payment. But the MOST plan has the offsetting virtue of encouraging more people to building up assets, even modest assets, which in turn promotes social stability and helps ensure that the United States of America and the liberties it enables will endure.

In short, we can take ideas from what the law already provides and devise a modern system to promote broader ownership of assets, encourage savings, maximize freedom to consume capital income or reinvest it, devote far fewer resources to tax avoidance and protect the fisc. st The first step to this 21 Century transfer tax system is to address what matters – integrity in tax.

______

David Cay Johnston has been a Distinguished Visiting Lecturer at Syracuse University College of Law since January 2009. He teaches the

10‐26 tax, property and regulatory law of the ancient world as a way for students to understand principles of modern law. The New York Times Johnston was awarded a Pulitzer Prize in 2001 for his coverage of tax policy in Newsweek, the last of five major newspapers he Tax served as an investigative reporter for 40 years beginning when he was Analysts National Memo Aljazeera America 19 years old. He now writes for and is a columnist for , and . New York Times Wall Street Journal He is the author or editor of five books, including a Perfectly Legal and, Free Lunch best‐selling The Finetrilogy exposing hidden Print Perfectly Legalaspects of the American tax and regulatory system: (taxes) (subsidies) and (regulation). won the 2003 Investigative Book of the Year award from Investigative Reporters and Editors (IRE).

Meghan A. Grattan and Cameron T. Bernard, Syracuse University College of Law 3Ls, provided invaluable research assistance.

Romney’s Gift from Congress 1 by David Cay Johnston, Reuters, January 31, 2012 http://blogs.reuters.com/david‐cay‐johnston/2012/01/31/romneys‐gift‐from‐congress/ The Prospering Swedes 2 by David Cay Johnston, Tax Notes Magazine, Sept 15, 2008, available at How the Accumulatedhttp://taxprof.typepad.com/taxprof_blog/files/120TN1085.pdf Earnings Tax Can Stimulate Growth 3 by David Cay Johnston, Tax Notes Magazine, March 11, 2013, 138 Tax Notes 265; Tax Analysts Document Number Doc 2013‐5206District Court Orders $10.9 Million Refund For Corporation That Contested Accumulated 4 Earnings Tax

, Tax Analysts, Feb. 18, 1993, Tax Analysts Electronic Citation 93 TNT 44‐25

10‐27

reprinting U.S. District (Minnesota) trial court decision in Network Systems Corp. v U.S.; Minnesota District No, 4‐91‐CV‐869. Idle Corporate Cash Piles Up 5 by David Cay Johnston, Reuters, July 16, 2012, available at http://blogs.reuters.com/david‐cay‐johnston/2012/07/16/idle‐corporate‐cash‐piles‐up/ and Reuters Decoder video at OECD Taxes as Share of GDP 1965https://www.youtube.com/watch?v=Ia4QwztEjxg‐2012 6 at Tax Policy Center Tax Facts, May 12, 2014, http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=307 from http://stats.oecd.org/InA Tale of Two Healthcaredex.aspx?DataSetCode=REV Plans 7 by David Cay Johnston, Reuters, Sept, 12, 2012, available at http://blogs.reuters.com/david‐cay‐johnston/2012/09/11/a‐tale‐of‐two‐ healthcare‐plans/ showing that the U.S. spent $2.64 per capita in 2010 for health care for each purchasing power‐equivalent dollar spent by other modern countries, all of which have universal care while 80 million Americans had no or only part‐year health care. Compared to the French system, widely regarded as the world’s best with universal care and virtually no out‐of‐pocket costs, the extra U.S. costs equaled all of the federal individual income taxes Americans paid that year. In other words, had America adopted the French system in 2010, we would have had universal health care with no out‐of‐pocket expenses and we could have eliminated the income tax for that year. You Can’t Take It With You 8 by David Cay Johnston, The New York Times Book Review, The Myth of Ownership: Taxes and Justice April 21, 2002, available at http://www.nytimes.com/2002/04/21/books/you‐can‐t‐take‐ it‐with‐you.html?pagewanted=print examining by Liam Murphy and Thomas Nagel, Oxford University Press, ISBN What Is Otherness 978‐0195176568 9 by Zuleyka Zevallos, undated, available at http://othersociologist.com/otherness‐resources/Democracy, Equality and Taxes 10 by Maureen B. Cavanaugh 54 Al. L. Rev 415 Winter 2002, available at SSRN: http://ssrn.com/abstract=325709. “Equal tax burdens characterize non‐ democratic political systems. Governments funded through generally applicable, flat taxes are uniformly those least devoted to political equality. Athenian democracy, with its complete commitment to political equality, allocated its tax burden to the wealthy and exempted ordinary citizens from tax, an exemption largely responsible for incorporation of ordinary (i.e., non‐wealthy) citiz A Voluntary Tax? New Perspectivesens in democratic government. on Sophisticated Estate Tax” Avoidance 11 Columbia Law Review by George Cooper, , Vol. 77, No. 2 (Mar., 1977), pp. 161‐247; published in book form in 1979 with th0e same title by the Brookings Institution ISBN: 081571551X

12 The First American Republic, under the Articles of Confederation, failed because it lacked two essential powers – the power to tax and to regulate commerce. See U.S. Constitution at Article I, Section 8, Clause 1 (tax) and Clause 3 (commerce).

10‐28

The Loss of Happiness in Market Democracies 13 by Robert F. Lane, Yale University Press, 2001, ISBN TALKING 978‐0300091069 MONEY WITH: SHERRY LANSING; Under a Mattress Will Be Fine, Thanks 14 , by Geraldine Fabrikant, The New York Times, Dec. 3, 1995, available at http://www.nytimes.com/1995/12/03/business/talking‐money‐with‐sherry‐lansing‐ under‐a‐mattress‐will‐be‐fine‐Americans’ Ownership of Assets thanks.html?pagewanted=allShrinks 15 by David Cay Johnston, Al Jazeera America [opinion], Nov. 6, 2014, analyzing IRS Statistics of Income Table 1.4 data, available at http://america.aljazeera.com/opinions/2014/11/inequality‐ capitalgainsdividendsgeorgebushownershipsociety.htmlI.R.S. Sees Increase in Evasion of Taxes on Gifts to Heirs

16 by David Cay Johnston, The New York Times, April 2, 2000, available at http://www.nytimes.com/2000/04/02/business/irs‐sees‐increase‐in‐evasion‐of‐taxes‐on‐ gifts‐to‐heirs.html?pagewanted=print 17 http://www.treasurydirect.gov/govt/rates/pd/avg/2014/2014_10.htm

10‐29