Five Questions with… David Cay Johnston
September 19, 2011
Welcome to a new feature exclusive to DylanRatigan.com, where we go through Dylan’s rolodex and call some of the smartest people he’s had on the show and Radio Free Dylan. Some days Five Questions will be based on the news, other days, it’ll just be people we feel like catching up with. (We do guarantee that you’ll learn something either way.)
Today’s guest, David Cay Johnston, is a little bit of both. David is a columnist for Reuters, a Pulitzer Prize-winning reporter and expert on U.S. tax policy. He is author of Free Lunch: How the Wealthiest Americans Enrich Themselves at Government Expense (and Stick You With the Bill).
We talked to him by phone just after President Obama unveiled his $3 trillion long-term deficit reduction plan based heavily on closing tax loopholes and raising taxes on wealthy Americans.
Q: So David, today President Obama mentioned in the Rose Garden something you’ve been arguing for for a long time — that the U.S. tax code is over 10,000 pages long, when it’s printed out in a stack it’s five feet tall, and is entirely too complex. He made a special point that with our tax code, “what you pay depends less on what you make, and more on how you game the system.”
DAVID: He’s actually been saying this for a long time — he said it during his campaign in 2007. And he’s quite right about it. We have a federal tax code where people with similar incomes — people who are roughly in the same position on the income ladder — pay radically different amounts of taxes, depending on the source of their income, depending on whether they qualify for rules that let you earn now and pay your taxes years, sometimes decades in the future. And here’s an important point to remember. If you can delay paying a dollar of tax for 30 years, and you invest it and earn 8% — which for a business person is something you can expect to do — at the end of that period you will have ten dollars. You will owe the government $1 — so you’ve made $9 off the deferral. And, for the government, that dollar is only worth 40 cents. In the meantime, the government’s been borrowing for 30 years — and even if it only pays 3% interest, it’s now spent, the whole dollar, in original terms 90 cents to capture the net value of the 40. This is a crazy system that we need to fix, and one of the keys to that is to radically simplify the tax code, particularly all these benefits for very narrow groups of people that have been slipped into the code since 1986, often with little or no news coverage.
Q: What do you consider to be some of the more egregious tax loopholes that are costing our country money?
DAVID: America has two tax systems, separate and unequal. One is for people’s salaries. Every dollar they make is independently reported, and the government is extremely efficient in collecting that money, which comes out of your paycheck before you get it. The second system is for business owners, landlords, investors, particularly people who operate multinationally. The government trusts them to fully report their income and properly pay their taxes, with little or no independent verification. We need to have a much more rigorous system of verification than we do today, and we need to have a significantly larger number of auditors to deal with people at the top.
Q: In our last conversation, you talked with Dylan specifically about hedge fund managers. Today, Obama brought up their tax rates versus what average Americans pay. You’ve said that “When you look at hedge fund managers… their current tax rate is zero.” So, is Obama missing the point on carried interest?
DAVID: The important point to understand about carried interest is that the partnership shares you receive are taxed not only at a 15% rate, but only when you cash out. So, if you’re a hedge fund manager in your 30′s, and you technically keep your fund open until you’re in your 80′s, you could go 50 years until you pay that 15%. This is an area that is so misunderstood by the public, and is so heavily lobbied that it’s very difficult to imagine getting real reform here. I mean, after all we have at least 25 people who are making $1 Billion or more a year — not a total fortune, a year. And they can afford to spend enormous amounts persuading Congress that it is not in their political interests to make them pay taxes the way everybody else does, even though they are not wealth creators. They are speculators and accumulators, not wealth creators.
Q: Republicans are kicking back against Obama’s plan, saying that tax rates for the top tier of taxpayers stimulate the economy and encourage spending and job creation. What’s your take on that?
DAVID: I am also chairman of the board of a small company I founded. I can’t imagine — nor can any of my friends, like my next-door neighbor who is a manufacturer with about 150 workers — hiring someone for a tax break. First of all, assuming you get a tax break of 35 cents, you’re going to spend a dollar on an employee to get back 35 cents? You invest more when you have customers who can buy your product or service, and especially when they can pay higher prices for your product or service. We do not have a significant problem in this country with taxes interfering with the ability of business to make money.
The vast majority of businesses, first of all, don’t pay taxes. They are either organized so they flow through to the owners, or they are organized like mine is to see to it that we don’t make a profit at the end of the year. If we have any money at the end of the year, we invest it back in the business. Or, we take the money out as bonuses or money into retirement plans. So, we need to recognize that the problem is demand. We need to have people earning money so that they can spend money. Labor and capital are a circulatory system. That’s a crucial thing we seem to have forgotten. And if your venal blood flow is tremendously more powerful than your arterial flow, you’re going to end up with blood pooling in some part of your body where eventually it will rot and it will kill you. We have to get back to an understanding that this is a circulatory system, as Adam Smith taught more than 200 years ago.
Q: Warren Buffett pointed out that he and other wealthy people shouldn’t be paying a smaller share of their income in federal taxes than middle-class taxpayers. He used his secretary as an example, who makes $60K a year but pays a higher tax rate than Buffett. I’ve heard a lot of responses to the tone of, “well, if Warren Buffet wants his secretary to make more money, he should cut her a bigger check.” What’s your take on that response to Buffett?
DAVID: Well, there’s an economic theory to what you pay people. And it’s being violated for one group in America and that is people at the very top of organizations. You pay people the lowest possible pay that will retain the talent you need to do the work. Whether people are assembly line workers, or they are sales people, that’s the economic theory. You pay people just enough to stay when you want them to stay. Now we violate this rule with people at the very very top where we seem to have a competition to figure out how we can pay them the most. Many companies say their policy is to pay their CEO in the top quartile. Well, that inherently raises everybody up! And we have numerous examples of where the value of shareholder investments is declining, and CEO pay keeps rising. Warren Buffett should pay his secretary whatever it takes to retain her if her regards her as a good secretary and valuable to his organization. This is a good example of the kind of sophistry that is polluting the debates about taxes today.
For more from David Cay Johnston, check out his prior podcast with Dylan on the tax and deficit debate.
- Megan Robertson is a digital producer for DylanRatigan.com.
I disagree with Mr Johnston's comment about paying people just enough to stay, etc. At the CEO level, in many cases you pay what it takes to lure IN a specific someone who has been searched out, screened and romanced to JOIN the organization, with (as backdrop) the mutual awareness that incoming CEOs have a very limited time in which to demonstrate they can move the needle in the right direction.
Personally, I was an executive and co-owner in a firm that never went "outside" to hire a top executive (that has changed now that the company has gone public) but if we HAD, we would have recognized that we were in a different market altogether.
This is far less straightforward that Mr Johnston has implied here. Wall Street doesn't like your corporate performance, so you decide to replace the CEO — with someone that Wall Street thinks (rightly or wrongly) will juice up corporate performance. Some are "rock stars" already, and some are viewed as budding superheroes. Mostly that's nonsense, because what Wall Street wants is often not attainable in the short term, but that's the way the game is played. All that razzmatazz about paying the exec in the 75th percentile is just eyewash to justify what has already happened. If you were hiring an NFL coach or GM to do a herculean task, you wouldn't bother with justifying it. In the corporate world you have to go through that exercise, as flawed as it is.
And realize that the average tenure of a CEO is something less than 4 years, from what I have read. It's no wonder that golden parachutes abound. The candidate has the leverage to get one, and that's all that matters.
There ARE other problems as well, having to do with Board members taking care of those whom they have bet on (or know and like) — but it all adds up to an irrational prescription for excess.