Taxes: Enter Balance Due Here

(See Cover)

The late great Albert Einstein once admitted that figuring out his U.S. income tax was beyond him—he had to go to a tax consultant. “This is too difficult for a mathematician,” said Einstein. “It takes a philosopher.”

Most U.S. taxpayers, being neither mathematicians nor philosophers, are baffled, too. by the intricacies of the income tax. Unless they take the straight and narrow path of the short form and the standard deduction, even conscientious taxpayers can never be really sure when they send off their returns whether they cheated themselves or their Government. A philosopher fares no better than an Einstein. If he were heroic enough to read all 929 pages of the tax code, he would not find in them what philosophers seek: order, coherence and principle amid the seeming chaos.

A Danger Point. Testifying before the House Ways and Means Committee in 1958, Law Professor Mortimer Caplin argued in favor of reforms to tidy up the tax mess. “We must recognize,” he said, “the hodgepodge fashion in which special relief has been granted to various groups and how favors to one have led to many balancing favors to others. Our tax laws have become unbelievably complex. They are riddled with exceptions and preferences.” Because of the complexities and inequities of the tax code, Caplin warned, “we have reached a danger point which strongly evidences an undermining of the tax morality of large numbers of people. They appear to be developing a lethargy over tax enforcement, reminiscent of the former widespread attitude under the Volstead Act.”

Last week President Kennedy sent his long and loudly heralded tax proposals to Congress, and they reflected Caplin’s thinking. The “preferences and special provisions” of the tax code, said the President, “discourage taxpayer cooperation and compliance by adding inequities and complexities that affect similarly situated taxpayers in wholly different ways. They divert energies from productive activities to tax avoidance. Taxpayers with equal incomes who are burdened with unequal tax liabilities are certain to seek still further preferences and exceptions.”

Kennedy’s proposals, even if fully adopted by Congress, would still leave the tax code exceedingly untidy. What he wants most urgently is tax reduction to stimulate the long-term growth of the economy and reduce the unemployment rate, thereby improving his prospects for re-election in 1964. But he included in his tax message to Congress a batch of proposed revisions designed to make at least a dent in the tax code’s melange of deductions and special-case provisions.

It was perhaps no coincidence that these revisions resemble proposals that Caplin put forward in earlier years. As a Senator, Kennedy talked taxes with Caplin. As a presidential candidate, he asked Caplin’s advice on tax issues. And as President, he named Caplin to be Internal Revenue Commissioner of the U.S.

“I Was Always Running.” The commissioner’s job is to administer the tax laws, not shape them. But Caplin, unlike his predecessors, attends the staff meetings of his boss, the Secretary of the Treasury, and as a highly respected tax expert, he works closely with Secretary Dillon’s top tax-policy aides, Under Secretary Henry Fowler and Assistant Secretary Stanley Surrey. “I am able to get some of my ideas across,” says Caplin.

Despite his lack of administrative experience, Caplin is notably better qualified than many of his predecessors. Under Franklin Roosevelt and Harry Truman, the post went to Democratic politicos. Among them: New York Politician Joseph D. Nunan Jr. (1944-47), who later served two years in prison for evading $91,086 in income taxes. Eisenhower’s first Internal Revenue Commissioner, T. Coleman Andrews, was at least a qualified accountant, but after leaving the Administration he went into right-wing politics and declared himself an enemy of the progressive income tax. Ike made sounder choices later on, and his last commissioner, Dana Latham, was a highly qualified tax lawyer.

Commissioner Caplin, 46, draws laughs by claiming that he got the IRS job because of his “good judgment—the good judgment to have both Bobby and Teddy Kennedy as students at the University of Virginia and to pass them both.”* But in fact, the way he got the job was by letting it be known that he wanted it.

Both the jest and the fact are typical of Mortimer Maxwell Caplin. He is a bouncy extravert who wears colorful bow ties and shows frequent flashes of humor (“There is one difference between a tax collector and a taxidermist—the taxidermist leaves the hide”). But beneath the relaxed surface seethes a fierce and driving desire for success. “There may be something in being a member of a minority that makes a man run,” he says. ”Anyway. I was always running.”

“Along Came Morty.” Caplin is two generations removed from Bialystok, Poland. His grandfather migrated to the U.S. in 1888. sold used shoes and paintbrushes from a pushcart in Brooklyn. In the second generation, Uncle Hymie managed boxers, including five champions, served four years in prison for his part in a card-game swindle. Wrote Sports Columnist Red Smith when Hymie Caplin died in 1949: “It is wrong to mark a guy no good simply because he got himself jammed up. I was fond of Hymie and he wasn’t a bad guy.” Referring to Hymie’s fighters, Smith added: “Not many managers have had so many good ones, or done so well with them.” By some accounts, another uncle, Nathan. known as “Kid Dropper” in New York rackets, was killed in a gangland fight in 1923.

Mortimer’s father Daniel was a white sheep, became a physical education teacher, eventually rising to assistant director of health education in the New York City school system. On the side, he managed a few professional fighters.

Early in life Mortimer displayed his urge to excel. He got top marks in school, became captain of his high school swimming team. When he went to the University of Virginia, he knew what he wanted. “I said to myself I wanted to be Phi Beta Kappa,” he recalls. A lawyer who was a fellow student of Caplin’s remembers how hard he ran: “Almost from the first day, we knew Morty would be first in the class. Nobody was willing, or had the energy, to compete with him.”

Caplin went out for boxing at the university and, lacking any special gifts of physique, he had to work at it. Since Virginia refused to subsidize football players, it got trounced regularly on the gridiron. Recalls Law School Dean Frederick Ribble: “The students were humiliated. They felt their manhood was in question. Then along came Morty, the boxer. He started knocking people down and became a hero.” Dogged Middleweight Caplin fought for a time with a broken bone in his right hand.

A Seven-Exemption Man. Besides being a campus hero and making Phi Beta Kappa. Caplin fulfilled predictions by finishing first in his law school class (average: 94.5). In addition, he won the Raven Award as an outstanding man in his class. As a youthful lawyer, Caplin found his way to the Wall Street firm of Paul. Weiss, Rifkind, Wharton & Garrison. In 1950, before getting a doctor-of-laws degree as a night student at New York University, he went back to the University of Virginia to teach. By the time President Kennedy tapped him to be the nation’s chief tax collector, Caplin was earning $15.000 a year as a professor and about $12.000 more as a consulting lawyer; taking his $20,3000-a-year post on the New Frontier meant a loss in income.

In Washington Caplin is still running hard. “His briefcase never leaves his side,” sighs his wife Ruth. But Caplin seldom misses his weekly Saturday workout in the Pentagon gym with his three sons. (He also has two daughters, giving him a total of seven exemptions on his income tax.) Only five pounds over his college fighting weight. Caplin often lunches on Metrecal at his desk, always bends and stretches through a strenuous course of calisthenics no matter how late he gets home. “I lie in bed and count for him.” says Ruth. “It does me a lot of good.”

Prophetic Exceptions. The tangled income tax laws that Commissioner Caplin is charged with enforcing were messy right from the beginning. Within a few years after the U.S. first imposed an income tax, to help finance the Civil War, President Lincoln apologized to the nation for the “inequities in the practical applications.” But he added: “If we should wait before collecting a tax, to adjust the taxes upon each man in exact proportion with every other, we should never collect any tax at all.”

That first income tax law (rates: 3% on income of $600 or more, 5% on $10,000 or more) included a prophetic batch of exceptions, including a provision permitting every taxpayer to deduct a house rent allowance, whether he was a renter or not—a forerunner of many anomalous provisions to come.

When the pressures of war eased, the principle of progressive tax rates came under heavy attack. “It is a punishment of the rich man because he is rich,” cried Ways and Means Chairman Thaddeus Stevens; and James Garfield, later President of the U.S., called progression “unethical, unsocial and unconstitutional.” The progressive aspect was removed in 1867, and in 1872 the income tax itself expired.

Bypassing the Court. Faced with dwindling federal revenues because of a recession, Grover Cleveland tried to revive the income tax in 1894. Rich New York Socialite Ward McAllister threatened to leave the country if the tax was enacted. Thundered Democrat William Jennings Bryan: “If ‘some of our best people’ prefer to leave the country rather than pay a tax of 2%, God pity the worst!” The bill passed—but the Supreme Court, by a vote of five to four, declared it unconstitutional.

To get around the conservative Supreme Court, Congress in 1909 lopsidedly passed a joint resolution calling for a constitutional amendment authorizing an income tax. When a new income tax law went into effect in 1913, the top effective rate was 7%, but it soared to 77% due to World War I. The rates fell steeply during the 1920s but rebounded during the Great Depression, and have remained high ever since.

But Not the Underwear. Back in 1913, rich Republican Senator Elihu Root complained that the new income tax statute, a mere dozen pages then, was too complex. “No one understands the income tax law,” he said, “except persons who have not sufficient intelligence to understand the questions that arise under it.” But the opponents of complexity had not seen anything yet. High tax rates inevitably brought incessant demands for ways of escaping them. Ignoring Lincoln’s implied warning that the task was inherently impossible, Congress over the years has kept trying to accommodate every pressure group of taxpayers with a claim to special relief.

Examined separately, many of the deductions and other types of exception seem fair and sensible. But each relief provision indirectly increases the taxes of those not covered by it, and every attempt to provide equity for a special group makes for new inequities elsewhere in the tax code. The double exemption for blind taxpayers is a humane provision, but it creates a special privilege not shared by taxpayers who suffer other kinds of disabilities. The deductibility of mortgage interest fosters socially desirable home ownership, but it gives the home owner a special advantage over the renter, whose rent includes a share of the land lord’s interest costs.

Enforcement of the tax laws constantly involves the IRS and the Tax Court in absurdities, contradictions and quibbles. The IRS ruled that a Hollywood actress could deduct the cost of her expensive wardrobe on the ground that a movie star is required to look well-dressed; but, added the taxmen, she could not deduct the cost of undergarments, because the public did not see them. The Tax Court ruled that a particular taxpayer could deduct termite damage (not ordinarily deductible) as a casualty loss because the infestation was sudden; the Court thereby created an absurd anomaly by which one man’s termite damage is deductible from his taxable income and another’s is not.

The Court has permitted a taxpayer to deduct the cost of clarinet lessons for a child whose orthodontist recommended them, and a psychiatric patient got away with deducting automobile expenses because his psychiatrist prescribed driving as therapy. But the Court disallowed the cost of dancing lessons for a surgery patient, although a doctor recommended dancing for postoperative therapy. A taxpayer is permitted to deduct educational expenses if they enable him to keep his job, but not if they enable him to get a better job. A specialist in internal medicine, for example, was allowed to deduct the cost of psychoanalysis (he said it would help him be a better internist), but a psychiatrist was not allowed to do so since analysis might help him become a psychoanalyst—and thereby make more money.

A Bet on a Horse. The IRS’s efforts to grapple with tax delinquents sometimes gets the agency into comically grotesque postures. The wife of a rich Texan got mad at her husband, told the IRS that he had been finagling on his tax returns. As an informer, she got a $50,000 payment —a portion of the extra tax the Government collected. Understandably, she did not want to tell her spouse about the payoff, so she failed to report it on their joint income return. The husband found out all about it when the IRS jumped on her for tax evasion.

A Hollywood actor got so far behind in his taxes that the Government put liens on all his property, including his race horses. When one of the horses won a $20,000 purse in California, IRS wanted to seize the money. But his lawyer persuaded the agents that if the actor used the money to ship the horse East and enter him in a $100,000 race, the Government might collect a lot more. In effect, IRS bet on the horse. It finished out of the money—and so, for the time being, did the IRS.

Roads of Avoidance. Of all the escape routes in the tax code, the one that rankles tax reformers most of all is the oil depletion allowance, which costs the Government well over a billion a year in taxes. The proprietor is permitted to deduct 27½% of the gross income from an oil property in figuring his tax—and he can keep doing that even after he has recovered his capital outlays. “It’s the only law I can think of,” says one Treasury source, “that allows a recovery in excess of the investment.” Similar allowances apply to natural gas and, at lower rates, to most kinds of mineral deposits. Last week a federal judge in Texas ruled that farmers who draw water from wells on their own land are entitled to a depletion allowance, too.

Another wide avenue of tax avoidance is the special tax treatment of capital gains—profits on sales of assets held for six months or more are taxed at half the normal income tax rate, up to a limit of 25%. It is greatly to the advantage of high bracket taxpayers to gather in money as capital gains rather than as fully taxable income, and figuring out ways of doing that is a principal preoccupation of high fee tax lawyers. Another heavily traveled road of avoidance is the use of taxexempt foundations to reduce tax liability. A businessman can set up a foundation in such a way that it remains under his own control, make fully deductible contributions to it, but retain some use of the money he donates—he may take it back in the form of an easy-term loan, for example.

The deductibility of charitable contributions has led to a colorful abuse: buying a painting, having it appraised later on at a much higher value, then donating it to charity and claiming a deduction at the full inflated figure. The IRS is currently battling the claim of an art patron who seems to have refined this device even further—by painting her own deductions. The revenuers claim that she was deducting up to $30,000 a year for contributing her own nonobjective paintings to art museums. The principal evidence of the market value of the paintings is that one was sold—to a business partner of her tax lawyer.

Helping Righteousness. Despite the tax code’s complexities and invitations to cheat, Commissioner Caplin thinks the U.S. taxpayer behaves remarkably well by world standards. “No other country in the world,” he says, “can approach the percentage of citizens who pay taxes promptly, report all their income, and take only the allowable deductions.” But Caplin is not a man to sit back and hope that righteousness will prevail unassisted by enforcement. He has warned taxpayers that the IRS would crack down, for example, on the art-donation loophole. And he has intensified IRS scrutiny of returns submitted by high income taxpayers. “We might not examine one out of 100—one out of 1,000—of the 1040-A returns,” he explains. “They are wage earners and take standard deduction, and we get income information from their employers. But we would examine nine out of ten returns in the $100,000 bracket, and we would really zero in on returns that claim travel and entertainment expense.”

Caplin has plenty of justification for looking hard at those “T. & E.” deductions. “It is impossible to delineate accurately between business and nonbusiness expenses,” he says, “and each decision must necessarily be arbitrary to some extent. But experience discloses widespread abuse of the tax law in this area—abuse which strikes at the heart of our self-assessment tax system.” Samples:

¶ The president of Sanitary Farms Dairy, Erie, Pa., and his wife took a six-month African safari in 1950, with stops in Paris, London and Rome. The Tax Court permitted the firm to deduct $16,443 for costs of the trip on the ground that it constituted legitimate “advertising.”

¶ Wisconsin’s Doughboy Industries paid out $10,000 to remodel the ground floor of a top executive’s home and $6,000 to construct a swimming pool on the grounds. A lenient court ruled that the company could deduct 95% of the outlays because the executive often entertained customers at home.

¶ A tax consultant claimed a deduction on the expenses of operating his yacht, explained that he ran up a pennant with the number 1040 on it every time his yacht reached port, thereby advertising the fact he was open for income tax business. (IRS disagreed.)

To curb such abuses. Congress last year knocked down the old “Cohan Rule.” named after Songwriter-Impresario George M. Cohan. Back in the 1920s Cohan told a court that he kept no records of his expenses, and the courts finally ruled that details were unnecessary and “skeleton” notes would suffice. Under the new law, the taxpayer has to provide documentation to show that claimed travel and entertainment expenses were “directly related to the active conduct of the taxpayer’s business.”

Armed with this definition, Caplin has proposed regulations that all T. & E. deductions be itemized if they amount to more than $25. At first he put the figure at $10, knowing that it was unreasonably low, so as to give himself room for strategic retreat when the protests boiled forth—so they did. Even after the switch to $25, the Caplin proposals bring grumbles from businessmen, already overburdened with tax paperwork. But Caplin is happy about the tightening up. “The hunting lodge, the yacht, the safari,” he says, “they’re going to be out. But I can see $24.95 specials developing all over the country.” A few restaurants already offer tape recordings and photographs to document diners’ expense accounts.

Loophole Closer. Another enforcement tool that Caplin wanted Congress refused to grant: tax withholding on dividends and interest. Caplin figures that unreported income from these sources results in a $1 billion revenue loss each year.

The IRS is rapidly setting up an electronic computer system to search out tax evasions, intentional and unintentional. Says Virginia’s Harry Byrd, chairman of the Senate Finance Committee: “It’s the biggest single loophole closer that has ever been enacted.” In one 30-ft. by 40-ft. room at the National Computer Center in Martinsburg, W. Va., some 400 miles of magnetic tape will store basic information about 82 million separate tax accounts—each taxpayer identified by a number. Fed into the computers will be information that the Government normally collects from some 120 various documents, such as employers’ reports of wages paid. The machines will compare this information with what the taxpayer reports on his return. Scheduled for full nationwide operation in 1966, the system has already begun handling returns from taxpayers in seven Southeastern states.

The Pragmatic Approach. No matter how ingenious or tough enforcement becomes, it cannot dent the complexities and inequities of the tax code—that task requires legislation. Some idealistic tax reformers would like to see the code com pletely rewritten, but pragmatic President Kennedy explicitly rejects that approach in his tax message. “An attempt to solve all tax problems at once by the inclusion of even more sweeping reforms,” he says, “might impair the effect of rate reduction. This program is designed to achieve broad acceptance and prompt enactment.”

Kennedy’s program calls for lowering individual income tax rates from the present 20-91% range to 14-65% over the course of three years—a tax cut of $11 billion (see table). For many taxpayers, notably those who itemize their deductions, the lower rates would be partly offset by Kennedy’s proposed revisions, but even so, every taxpayer would get at least some lightening of his load.

For corporations, Kennedy proposed to drop the tax rate from the present 52% to 47%—a cut of another $2.6 billion. This tax saving would at first be partially offset by a speedup Kennedy proposed in the scheduling of corporate tax payments.

Kennedy’s proposals for tax reforms were largely aimed at prodding taxpayers to take standard deductions rather than itemize—thus simplifying the returns for both taxpayers and tax collectors. Perhaps the most important revision of all in its impact on middle income taxpayers is the recommendation that itemized deductions be allowed only to the extent that the total exceeds 5% of adjusted gross income. Example (a salaried taxpayer who takes in $20,000 a year, has two children, files a joint return), including the differences due to Kennedy’s proposed rate reductions:

Total income Present $20,000 Proposed $20,000 Itemized deductions (charity, interest, local taxes, medical, etc.) Present 3,300 Proposed 3,300 Less 5% of income Present — Proposed 1,000 Total deductible Present 3,300 Proposed 2,300 Personal exemptions Present 2,400 Proposed 2,400 Taxable income Present 14,300 Proposed 15,300 TAX Present 3,410 Proposed 2,952

Minor Casualties. To help low income taxpayers, Kennedy proposes a new gimmick: an optional standard deduction that would entitle a taxpayer to deduct $300, plus $100 for each dependent (but not more than $1,000), even if this deduction amounted to more than 10% of his income—the present maximum percentage. For persons 65 or older, Kennedy would discard the extra $600 exemption and substitute a tax credit of $300. Since the $300 would be applied against the tax actually owed (while the $600 exemption merely reduces taxable income), the change would be a net benefit for taxpayers in low and middle brackets.

Kennedy recommends that deductions for casualty losses be confined to losses exceeding 4% of the taxpayer’s adjusted gross income (they can now be deducted in full). Says the President: “There is no reason why truly minor casualties—the inevitable dented fender, for example—should receive special treatment.”

His package would also revise medical and charitable deductions. All medical expenses, including drugs, would be lumped together (drugs are now a separate category), and would be deductible to the extent that they exceeded 4% of income. On deductions for charitable contributions a uniform limit of 30% of taxable income would be set for all taxpayers (it is now 20% for most, higher in special cases).

On capital gains, Kennedy’s package would trim the rates but stretch out the minimum holding period from the present six months to one year. He calls for outright repeal of some special-case provisions that presently clutter the income tax forms:

¶ SICK PAY. An employee may now exclude from taxable income up to $100 a week in salary paid him while he is sick and unable to work. Said Kennedy: “This sick pay exclusion is clearly unjustifiable. The taxpayer escapes tax on the salary he continues to receive, although his substantial medical expenses are deductible; and the employee who stays on the job, even though ill or injured, is in effect penalized for working.”

¶ DIVIDEND EXCLUSION AND CREDIT. A stockholder may now exclude from income the first $50 received in dividends. He can also subtract from his tax 4% of dividend income in excess of $50.

¶ RETIREMENT CREDIT. This complex provision—it takes up nearly two-thirds of a page in Form 1040—has permitted retired individuals to take a credit against their tax for part of their pension income. Income from social security and railroad retirement plans would still be excluded from taxation.

While they include something for everybody, Kennedy’s tax proposals fall far short of a serious assault on the tax code’s inequities and complexities. The package would give proportionately little relief to those who are most inequitably burdened by the present code—the upper-middle-income taxpayers. A big slice of their gains through rate reductions would be canceled out by the subtraction of 5% of income from their itemized deductions. To advocates of genuine tax reform, the Kennedy proposals are likely to seem inadequate. Deep reduction in tax rates would provide a rare chance to push for thorough reform—and Kennedy fails to do that. He not only leaves a lot of the old complexity, but here and there even adds a new gimmick. He makes only a timid stab at the oil depletion allowances, a longtime chief target of reformers. Indeed, the package suggests, upon close examination, that the reform proposals are included mainly to placate Arkansas’ Congressman Wilbur D. Mills, champion of tax reform and head of the tax-writing Ways and Means Committee (TIME Cover, Jan. 11).

“The Most Urgent Task.” Inadequate as they may look to real tax reformers, Kennedy’s proposed revisions may run up against strenuous opposition in Congress. The U.S. tax system, says one expert, is “a continuing struggle among conflicting interests for the privilege of paying the least.” Even the rate reductions will be eyed warily by congressional conservatives disturbed about the $11.9 billion deficit in the budget that the President recently announced. Says an Administration tax official: “It will take a lot of profiles in courage to pass this package.”

The President sounds as if he, at least, is going to push for his proposals. “Now is the time to act,” he said. “We cannot afford to be timid or slow. For this is the most urgent task confronting the Congress in 1963.”

* Actually, neither brother got high marks from Professor Caplin.