Justice Department’s Unethical Tax Evasion Case against KPMG Is Falling Apart

Thanks in large part to a punitive corporate tax rate and mind-numbing complexity in the tax code, a lot of accountants and lawyers get rich by figuring out ways to protect shareholder money. This irritates politicians and bureaucrats, who constantly tinker with the law in an attempt to grab more tax revenue (though this effort is offset by politicians looking for campaign cash, which leads to the endless creation of new loopholes). This is business-as-usual in Washington, but the Justice Department added a bizarre twist to the game by launching a legal attack on some partners from an accounting firm, even though the tax shelters they were peddling were not illegal. The Justice Department’s actions were reprehensible, rather akin to the totalitarian tactics of the tax authorities in Russia. If tax lawyers at the Department of Justice think that some people are taking advantage of tax loopholes, they certainly have every right to inform lawmakers and to ask them to change the law. In an ideal world, they would even recommend lower tax rates to remove the incentive to seek out new shelters. But they should never have the right or the ability to arbitrarily declare – by bureaucratic fiat – that tax planning is a criminal act. The Wall Street Journal condemns the Justice Department for its unethical behavior:

The Justice Department’s case against 16 former KPMG partners for tax evasion continues to unravel, with prosecutors themselves conceding late last week that federal Judge Lewis Kaplan has little choice but to dismiss the charges against most of the defendants. Judge Kaplan ruled last year that Justice had violated the defendants’ Constitutional rights by pressuring KPMG not to pay their legal fees. He is now considering a defense motion to dismiss. Prosecutors continue to protest the judge’s ruling but on Friday they admitted in a court filing that dismissal is the only remedy for the rights violations. The more honorable route would have been for prosecutors to acknowledge their mistakes and dismiss the charges themselves. The truth is that this tax shelter case should never have been brought. Both KPMG and its partners believed the shelters they marketed were legal, and no tax court had ruled against the shelters before Justice brought its criminal charges. Then prosecutors used the threat of criminal indictment against all of KPMG to extort an admission of guilt from the firm and force it to stop paying the legal bills of individual partners.

Enough is Enough

Three years ago the U.S. Supreme Court handed down McConnell v. FEC, a decision that upheld McCain-Feingold’s restrictions on political speech. The future seemed bleak for any limits on government regulation of speech and association.

But things are looking up. Today the Supreme Court handed down its decision in Federal Election Commission v. Wisconsin Right to Life.

McCain-Feingold made it a federal crime for any corporation to broadcast, 30 to 60 days before an election, any communication that mentions a federal candidate for elected office and is aimed relevant voters.  Wisconsin Right to Life (WRTL) is an ideological corporation that accepted funding from other corporations. Its members wanted to run ads in 2004 urging citizens of their state to contact its two senators and urge them to oppose a filibuster of judicial nominees. Sen. Russ Feingold, one of the senators and a co-author of the law in question, was running for re-election. Wisconsin Right to Life’s advertising plans thus constituted a federal crime. At least, they were a crime if the relevant part of McCain-Feingold was constitutional as applied to WRTL. In fact, McCain-Feingold was constitutionally invalid in this case and probably many others.

To understand why requires a quick summary of campaign finance law. Congress long ago prohibited contributions to candidates from the general treasuries of corporations and labor unions. But corporations could fund ads commenting on the issues of the day. However, if those ads directly advocated the election or defeat of a candidate, they became an attempt to circumvent the ban on corporate contributions and thus a federal crime. In Buckley v. Valeo, the Court said such “express advocacy” contained words like “elect” and “defeat.” If an ad did not use the words, it was not express advocacy and hence, not subject to campaign finance regulation.

In the 1990s some businesses and labor unions started funding advertising that met the legal standards for issue advocacy. The ads were legal and often highly critical of vulnerable members of Congress in the run up to an election. McCain-Feingold made such speech illegal. It said corporations could not fund ads that mentioned a candidate for federal office with 30 to 60 days of an election. The McConnell Court went along arguing that the ads in question were the “functional equivalent of express advocacy.” In the WRTL decision, the author of the majority opinion, Justice Roberts, has contracted rather than expanded the scope of government regulation. He has done so by redefining the meaning of express advocacy: “a court should find that an ad is the functional equivalent of express advocacy only if the ad is susceptible of no reasonable interpretation other than as an appeal to vote for or against a specific candidate.” The WRTL ad seemed to a reasonable person to be attempt at grassroots organizing. Hence, WRTL wins.

But this standard implicates more than this case. Many of the ads in the 1990s that were the target of McCain-Feingold might have been free of regulation under this standard. Reasonable people could have believed that the ads were attempts to persuade voters to contact their representatives. The political space free of government regulation seems to have expanded. Indeed, it seems possible that many fewer ads will be judged the “functional equivalent of express advocacy” in the future.

So, the good guys won one at last. “Enough is enough,” as Justice Roberts writes in considering efforts to further expand government control of politics.

But still there is reason to worry. The majority did not declare the relevant part of McCain-Feingold unconstitutional. Justice Alito did suggest a willingness to hear constitutional challenges to the McConnell decision (and hence, to McCain-Feingold). Justice Roberts also set out some criteria for the “express advocacy” that are fairly broad. An ad that mentions “an election, candidacy, political party, or challenger; or [that takes] a position on a candidate’s character, qualifications, or fitness for office” could become express advocacy depending on future judgments by the Court and perhaps, by the Federal Election Commission.

An important battle has been won. The war continues.

Americans Are Far More Generous than Europeans

USA Today reports on a new study showing that charitable contributions are at an all-time high in America. Most interesting, the report also revealed that Americans are far more generous than supposedly compassionate Europeans. Indeed, no nation gives even half as much (as a share of income) as the United States. The French are among the worst misers, giving less than one-twelfth of what Americans donate, though it is unclear whether this is because they are taxed so much that there is no money left in their wallets or whether they assume that it is now the role of government to solve every social problem:

Americans gave nearly $300 billion to charitable causes last year, setting a record and besting the 2005 total that had been boosted by a surge in aid to victims of hurricanes Katrina, Rita and Wilma and the Asian tsunami. …Individuals gave a combined 75.6% of the total. With bequests, that rises to 83.4%. …the willingness of Americans to give cuts across income levels, and their investments go to developing ideas, inventions and people to the benefit of the overall economy. Gaudiani said Americans give twice as much as the next most charitable country, according to a November 2006 comparison done by the Charities Aid Foundation. In philanthropic giving as a percentage of gross domestic product, the U.S. ranked first at 1.7%. No. 2 Britain gave 0.73%, while France, with a 0.14% rate, trailed such countries as South Africa, Singapore, Turkey and Germany.

Calling All Conservatives

The most important thing to happen to health care reform this year is not Michael Moore’s film SiCKO. It is an editorial in the July 9 issue of National Review.

National Review’s editors declared that conservatives and other free-market advocates should reject the goal of “universal coverage” that has seduced health care reformers left, right, and center. The editors write:

[T]o achieve universal coverage would require either having the government provide it to everyone or forcing everyone to buy it…

The health-care debate has centered on the uninsured. That so many people do not have health insurance is a consequence of foolish government policies…

Republicans should go in a different direction, proposing market reforms that make insurance more affordable and portable. If such reforms are implemented, more people will have insurance…

Some people, especially young and healthy people, may choose not to buy health insurance even when it is cheaper…Forcing them to get insurance would…lead to a worse health-care system for everyone because it would necessitate so much more government intervention. So what should the government do about the holdouts? Leave them alone. It’s a free country.

Libertarians and conservatives have fought a decades-old war over the direction the conservative movement should take on health care reform. One such skirmish will take place at a Cato Institute Capitol Hill briefing this Thursday on the Massachusetts health plan.

The editors of National Review have planted their flag on the side of less government and more freedom. Kudos to them. That should help conservatives coalesce around health care reforms that explicitly reduce the role of government, thereby enabling markets to make health care of ever-increasing quality available to an ever-increasing number of people.

An Almost-Ideal Plan to Fix the AMT

Kevin Hassett’s column proposes to solve the problem of the alternative minimum tax by dramatically lowering the top tax rate, a step that could be financed by eliminating the state and local tax deduction and ending the exclusion for municipal bond interest. While a very attractive proposal, the plan has a couple of less-than-perfect features, primarily the fact that it assumes the aggregate tax burden should rise. Admittedly, this already is going to happen if the AMT is allowed to fester (which will happen if current law is not changed), but acquiescing to a higher tax burden should never be an option. Moreover, his approach to municipal bond interest also is appealing since current law creates an advantage for debt-happy state and local governments over other interest-bearing investments, but eliminating the double tax on all forms of interest is the ideal way of fixing this inequity:

…the AMT problem is easy to fix in a way that should have bipartisan appeal. The key observation is this: most of the special items, such as the state and local tax deductions, that put taxpayers on the AMT mostly benefit wealthy people. After all, most ordinary folks don’t even itemize. Thus, if Congress is raising marginal tax rates to preserve the current system, they are effectively giving rich taxpayers money with one hand, when they allow them deductions, then taking the money back with the other, by raising marginal rates. Talk about needless complexity. It is a fool’s game, and it’s not all that hard to stop. Just eliminate or cap the deductions. To illustrate how beneficial that would be, the Tax Foundation recently estimated how big a revenue-neutral tax reduction you could fund by eliminating the big-ticket deductions and exclusions in the tax code. That is, they imagined a world with no state and local income deduction and no tax exclusion for municipal bond interest. They found that eliminating those items would allow a proportional tax-rate reduction of about 31 percent. That would take the top tax rate down from 35 percent to 24 percent. They also found that eliminating the deductions took just about everyone off the AMT. That was scored to raise the same revenue as the current code. In the real world, it would surely raise more as the low rates spurred economic activity. Such a reform is too bold to be considered bipartisan, but the key observation is this: It’s not difficult to conceive of a revenue-neutral reform that eliminates the AMT, drops tax rates by almost a third, and improves the overall efficiency of the economy. In that case, it is child’s play to conceive of half- measures necessary to eliminate the AMT and leave tax rates where they are today. Instead of eliminating the state and local tax deduction, for example, you could cap it at $10,000. The revenue gained from that could help you fix the AMT, without requiring marginal tax-rate increases.

At Least Somebody’s Listening (If Only It Were U.S. Policymakers)

Today’s Wall Street Journal reports (sub. req.) that the European Union is considering implementing a change that I have long advocated the United States implement: graduating China to market economy status for purposes of antidumping proceedings.  Among the reasons given in the article for the prospective change is that doing so might make it easier for Europe to “extract a range of concessions” from the Chinese on other issues deemed crucial to the trade relationship.

Though they have been stubbornly resistant, U.S. policymakers should be doing the same thing for the same reasons.  When we hear about the issues that define the U.S.-China trade relationship, those issues read like a litany of U.S. gripes.  The Chinese should: stop subsidizing industry; stop manipulating the currency; stop engaging in unfair labor practices; stop dumping; stop stealing intellectual property; stop imposing behind-the-border barriers; start opening services markets; start allowing uninhibited foreign ownership, start being a responsible stakeholder, and on and on.  (The presumption being that fulfillment of American objectives is the chief aim of Chinese policy.)

Can you name a single Chinese demand of the United States?  Well, there are several, but none of them are really “demands.”  They are requests, pursued diplomatically through ongoing dialogue and without a lot of political grandstanding. The single most important wish of the Chinese on the trade front is that they be given market economy status.  More than anything else, I believe, China’s interest in achieving that status is driven by a desire to be treated respectfully by the international community.  The non-market economy label carries a Cold War stigma and, in any event, is misapplied in the case of China, where the economy is increasingly market-oriented, if not market-based, by most metrics.

Under current European and American antidumping practices, China’s NME status means its rates of duty are not based on a comparison of prices.  Instead, they are based on a comparison of the Chinese company’s export prices to a fictitious guestimate of what the price would be in China if prices were in fact determined by market forces.  Got it?  Right!  NME rates tend to be higher than ME rates, but in any event are totally divorced from commercial reality.

Graduating China to ME status does not mean that Chinese exporters would be immune from antidumping allegations and actions by U.S. industries.  No, they would still be subject to a law that routinely produces high, and sometime prohibitive, tariffs.  But graduating China to that more respectable status would engender much good will and would likely inspire greater willingness among the Chinese to work with U.S. negotiators to resolve outstanding differences.

Ironically, the U.S. interests that are opposed to changing China’s status are the same interests that endorse the litany of gripes against China.  Eventually, they may smarten up like their European brethren and do the right thing.

Free Speech, Loophole, or Partisan Politics?

One of the things I find striking about today’s Supreme Court rulings is the extent to which the free-speech angle is downplayed in media coverage of the Wisconsin Right to Life decision. Consider the LA Times write-up of today’s decisions:

The Supreme Court gave President Bush and Republican leaders two important victories today by clearing the way for corporate-funded broadcast ads before next year’s election and by shielding the White House’s “faith-based initiative” from challenge in the courts.

The term “speech” only appears twice in the coverage of the decision, and in both cases they’re in quotes of the majority decision. The reporter never describes the case as a free-speech case himself. And let’s be clear here: “corporate funded” doesn’t mean ads funded by Exxon-Mobil or Microsoft. In this particular case, it was a pro-life organization—a grassroots non-profit—that was being prevented from promoting its views on television. The NRA, the ACLU, the Sierra Club, and dozens of other genuine issue advocacy organizations had their free speech rights curtailed by BCRA. Now check out the coverage of the “Bong Hits 4 Jesus” case later in the same story:

In a third ruling, the court gave school principals the authority to discipline students who advocate the use of illegal drugs at schools. Roberts said the court was not rejecting the notion that high school students had free-speech rights, but rather making clear that these rights were limited, especially when students advocated in favor of illegal drugs.

The decision reversed a free-speech ruling in favor of a high school student from Juneau, Alaska, who had been suspended for holding up a banner that read “Bong hits for Jesus.”

So the right to unfurl a “Bong Hits 4 Jesus” banner is a free-speech issue, but the right to air television ads critical of elected officials is just partisan politics.

You see the same sort of bias in the New York Times coverage of the ruling. The word “speech” doesn’t appear in the story until the fifth paragraph, at which point it’s used in the following sentence: “Its detractors see it as interference with free speech.” In contrast, in the second paragraph, the article states that “the high court opened a significant loophole in the Bipartisan Campaign Reform Act of 2002.”

On the other hand, the headline in the Times write-up of the “Bong Hits” case is: “Supreme Court Limits Students’ Speech Rights.” The article starts off by saying ” The Supreme Court tightened limits on student speech Monday.”

So when a high school principal prohibits a student from displaying a nonsensical “Bong hits 4 Jesus” sign, that’s a restriction on the student’s speech. However, when Congress tells Wisconsin Right-to-Life and the ACLU that they’re not allowed to buy ads criticizing elected officials in the month before an election, that’s merely closing a loophole in campaign finance law.