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A Labyrinth of Abuse

October 24, 2003

Criminals fearful of retribution by former mob associates often insist on being anonymous when testifying before Congress. But what does it mean when a former executive in the leasing industry sits behind a screen, his voice electronically scrambled "to protect my wife and children from certain retaliation," while testifying about tax shelter schemes before the Senate Finance Committee?

The Internal Revenue Service estimates that abusive shelters have cost as much as $85 billion since 1993 -- a near match for the supplemental Iraq aid that Congress is considering. The Byzantine tax avoidance schemes revealed Tuesday by "Mr. Janet," as he called himself, turn out to be more widespread than ordinary mortals had imagined.

Many law firms, investment bankers and accounting firms have a hand in schemes that rely on manipulating the tax code to create the appearance of great financial loss where there is none. Companies befuddle the IRS by burying questionable tax shelters in a blizzard of legal activities on their tax returns.

One shocking dodge revealed Tuesday was that U.S. corporations paid millions upfront to cash-starved municipal governments to "lease" a subway or dam. Then the corporation leased the subway or dam back to the public authority that owned it, threw in a maintenance clause and claimed a big tax deduction by depreciating the asset.

This sleight of hand is not confined to the U.S. According to Mr. Janet, "a minimum of $20 [billion] to $30 billion a year of foreign infrastructure is purportedly leased and sold in this manner." Bank of America, named in testimony, paid $25 million to deduct the value of Canada's air traffic control system on its tax bill. Bank of America says it was legal. If this is legal, the law is defective.

It's encouraging to see whistle-blowers stepping forward, something William J. McDonough, chairman of the new Public Company Accounting Oversight Board, hopes to see more of. McDonough warned Tuesday that he would relentlessly target accounting firms that abused tax shelters.

The IRS has increased its attention to tax shelters, but a new General Accounting Office report states that the IRS is struggling to bolster its enforcement staff and doesn't have a firm grasp on the extent of tax shelter abuse, in part because the IRS quit measuring noncompliance in 1988. An important step would be for Congress to approve legislation backed by Sens. Charles E. Grassley (R-Iowa) and Max Baucus (D-Mont.) that would force firms to disclose on their tax forms better information about tax shelters.

Congress needs to simplify an insanely complicated corporate tax code that constitutes an invitation to abuse. Sophisticated corporations should not operate in a different universe from family-owned businesses that pay a fair share to the government. Cleaning up abusive tax shelters might even ensure that former executives won't have to appear before Congress like mobsters afraid of being rubbed out.

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