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David Cay Johnston
David Cay Johnston
Perfectly Legal
ISBN: 1591840198
Perfectly Legal
—from the publisher's website

One of the country's top investigative reporters reveals how the richest people within the top 1 percent of the country has rigged the tax code and other laws in its favor.

Pulitzer Prize-winning investigative reporter David Cay Johnston has been breaking pieces of this story on the front page of The New York Times for nine years, work for which one business school professor calls him ìthe de facto chief tax enforcement officer of the United Statesî. With Perfectly Legal, he puts the whole shocking narrative together in a way that will stir up media attention and make readers angry about the state of our country. And he has sound advice on what to do.

Since the mid-1970s, there has been a dramatic shift in who benefits from the American economy and bears the burden of taxes. CEOs, big investors and business owners can delay paying their taxes for years and sometimes escape them almost entirely, while wage earners have their taken from each paycheck. Discreet lobbying by the political donor class has made tax policies and enforcement a disaster. Because of obligations to these donors Washington has been unable, or unwilling, to fix these problems. The news media have largely ignored official favors to those who are supposed to pay the corporate income tax, the estate tax, and the gift tax. Millions of families expecting tax cuts are losing some or all of them to a stealth tax that was originally enacted only to apply to the tax-avoiding rich, but that now stings single mothers making as little as $28,000. But the cumulative results are remarkable: the 400 richest Americans pay a smaller share of their income in taxes than someone making $100,000. The 400 richest pay less and less of their income in taxes while the middle class pays more and more. And while the incomes of the very rich skyrocketed over three decades, the average income for the bottom 90 percent fell.

Johnston exposes exactly how the middle class is being squeezed to create a widening income gap that threatens the stability of the country. By relating the compelling tales of real people across all areas of society, he reveals the truth behind: * "middle class" tax cuts and exactly whom they benefit * how workers are being cheated out of their retirement plans while disgraced CEOs walk away with hundreds of millions * how some corporations avoid paying any federal income tax * how CEOs fly on vacation in corporate jets for less than you pay for a middle seat in coach ñ and stick you with most of the cost * why the working poor are seven times more likely to be audited by the IRS than everyone else * how the IRS became so weak that even when it was handed complete banking records detailing massive cheating by 1,600 people, it prosecuted only 4 percent of them

Perfectly Legal
Program Air Date: April 18, 2004

BRIAN LAMB, HOST: David Cay Johnston, author of "Perfectly Legal," on this March the 30th, when we`re taping this, I picked up "The Washington Post." And I`ll read you the following first paragraph on a story by Jonathan Weisman. "President Bush`s 2004 (SIC) budget request for the Internal Revenue Service would seriously shortchange the agency`s tax collection activities, leaving a half million delinquent tax accounts uncollected, 15 million service calls unanswered and nearly 46,000 audits unscheduled, according to the president`s own IRS oversight board."

And as I read the rest of the article, your whole book is in this story.
DAVID CAY JOHNSTON, AUTHOR, "PERFECTLY LEGAL": Well, in fact, the report actually quotes my book. And I have the same story in "The New York Times" this morning, although, frankly, my lead is not quite as compelling as that one.
LAMB: So what is this book about?
JOHNSTON: This book is about the reality of how our tax system actually operates after the politicians pass the laws. The news media do a good job of telling you the official version of events and what politicians in Washington say about taxes. But I spent a lot of my career covering Washington without being there by paying attention to what actually government does, as opposed to what the politicians say that it does. And I show in this book that our tax system is not what most people think.

Most people believe that the higher your income, the greater the share of your income you pay in taxes, and that those who are the most successful provide benefits for those who don`t do as well. And what I show in the book is something it was astonishing to me to learn. In fact, I hired a graduate student in economics to double-check all of the findings. And that is that the middle class and the upper middle class, people making $50,000 to $500,000 a year, actually subsidize the richest people in America now. This was not historically true, but they do now.

The IRS just today came out this morning with new statistical tables on income for the year 2001. And on the way over here, I was calculating, and the 6,800 American who make more than $10 million a year pay a smaller percentage of their income, 25 percent, in federal income taxes, than people who make $400,000 to $500,000 a year. And when you add in Social Security taxes, people making $70,000 to $80,000 a year are paying a larger share of their income to the federal government than people who make $10 million a year or more.
LAMB: Whose fault is that? And is there anything wrong with it?
JOHNSTON: Well, "fault" I`m not sure is quite the word I would use. The responsibility for it is Congress. Article I Section A of the Constitution says that "Congress shall have the power to lay and collect taxes," and it`s a virtually unlimited power. It`s a political issue in America, what taxes are.

What`s wrong with it? I don`t think most Americans, if they knew that they are subsidizing people who make as much in a year or a month as they will in a lifetime, would be very happy about that. But it is not what most Americans understand because our national myth is something quite different. Our national myth is, as I described before, the highest-income Americans subsidize the rest of us. And it`s just not true. And this is the change that`s taken place over the last 30 years. Both Democrats and Republicans brought it about.
LAMB: Let me get into some of the names in your book. At one point -- and I don`t remember exactly what you said, you might even have thanked Suzy Wetlaufer for helping us better understand something about Jack Welch. Now, most people know that whole story.
LAMB: It`s gotten far -- it`s gotten very personal. But what was it you were talking about in the book?
JOHNSTON: Well, I didn`t thank her, but I described that unintentionally, in her role as editor of "The Harvard Business Review," she had brought to life in a way that people could understand one of what I think are the abusive practices in the tax system. And that is, the subsidy that you and I provide to senior executive who fly around in the company jet. They pay about a penny a mile, as a practical matter, to fly in the luxury of the company jet. The real cost of that flight is several dollars a mile, in many cases, $5 or $6 a mile. And that cost is charged to the shareholders and then taken as a deduction.

So when a CEO travels coast to coast in the company jet, he pays $260. The real cost is more in the neighborhood of $15,000 to $17,000. And so you and I, as taxpayers, foot $5,000 of that money. And this was done under the guise of middle class tax relief in 1985. It`s just a perfect example of how Congress says, you know, We`re out here to help ordinary Americans, and in fact, they weren`t. They were out helping CEOs.
LAMB: You get into some detail about the kind of plane that is at Jack Welch`s call I guess, a 737 business jet.
JOHNSTON: You and I probably have often flown in Boeing 737s. Many viewers have. They seat typically about 120 people. General Electric`s has a bedroom suite with a shower and a sitting room and a board room and seating for a small number of people. And when Jack Welch was running General Electric and being extraordinarily well paid -- he put together a fortune during those years of more than a half a billion dollars -- he had the unbridled use of those airplanes, including for personal use. And because the company took the position that his security required that he fly in company transportation -- he never flied commercial, like you and I -- there`s a special tax break for that.

In the last year that he had a contract negotiated with the company, there was a single line in the contract, in a footnote, that said something like, Upon his retirement, he shall continue to enjoy the benefits he had while in office. Well, it turns out that those benefits were, according to the wife who divorced him over his affair with Suzy Wetlaufer, about $2.7 million a year in value just for the jet. And there were other perks that went along with this.

After I explained the economics of this in an article in "The New York Times," Mr. Welch, the next day, had said that he decided that he would pay for these perks. He then wrote an op-ed piece for "The Wall Street Journal" about it. He then appeared on all sorts of TV shows and spoke to lots of reporters, but not to me, not that I blame him. I cost him a lot of money.
LAMB: If she hadn`t done the interview and written the article in "The Harvard Business Review," would we have ever known this?
JOHNSTON: Well, we knew it because I had reported previously in "The New York Times," but it didn`t have any impact or mean anything to people. I mean, that`s one of the important issues here about tax. You can tell people all day long about dry public policy issues. And to some people, people who watch C-SPAN, it may resonate. But to millions of Americans, it doesn`t. It`s when you can bring things to life through the example of an individual and his case and what that individual did or a group of people and give a human face to it, that you can bring meaning to public policy. And that`s why in "Perfectly Legal," much of the book is told through the lives of individual Americans who, for good or bad, encountered the tax system.
LAMB: But on the corporate jet thing -- who pays? Who ends up paying, for Jack Welch who`s retired, to have a jet at his disposal, go all over the world all year long?
JOHNSTON: The shareholders of General Electric pay, and then they get to deduct that on the corporate tax return. So you and, I as taxpayers, share in the cost of that.
LAMB: Why is this happening?
LAMB: And how much of it goes on?
JOHNSTON: Well, great deal of it goes on. There are 9,000 corporate jets in this country, and there have been lots of news stories that I have read, and some which I`ve written, about executives who use the company jet as a personal taxi. And we know that Ken Lay`s daughter used one of the Enron jets to fly her bed across the North Atlantic because it wouldn`t fit in baggage on a commercial jetliner. We know that during the RJR Nabisco matter, there was a flight on one of the company planes where the manifest said the passenger was G. Shepherd, as in German shepherd dog.
LAMB: We also learn in the Adelphia trial that the Rigas family had a Christmas tree flown to New York from Coudersport, Pennsylvania, if I remember right.
JOHNSTON: Coudersport. Well, if it doesn`t cost anything to do something, of course, you use it. I mean, that`s one of the fundamentals of economics. If something is virtually a free good, you`ll make a great deal of use of it. If C-SPAN put at your disposal tomorrow, Brian, a corporate jet and said, Here, we have a Gulfstream 5 for you, you can stand up and walk around in it, my guess is you would be off to Florida or Los Angeles more, even if you weren`t inclined to do so, just because it`s there and it`s virtually free.

And you know, originally, it wasn`t even in the law that this was the case. In 1985, there was a debate, which I recount in "Perfectly Legal," on the floor of the Senate, where Senator Packwood from Oregon came here and said, I have here this bill, there`s nothing else in it except relief for the poor middle class taxpayer who has to keep excessive amounts of records if he uses for personal use a company car. And it`s just an outrage, and people are rightly upset about this, and we`re going to fix this.

And Senator Metzenbaum from Ohio, a man wealthy enough to own his own personal jet -- maybe he does, I don`t know -- came onto the floor and said, Well, wait a second. That`s not quite true. Attached to this bill is a report that tells the IRS to value the personal use of company jets by executives not at the first class or charter rate that were in effect, but at these artificially low rates that work out now to be about a penny a mile for a jet you can stand up and walk around in on a long trip.

And it`s indicative of what`s happened to the tax code, that there are -- it is just larded with all of these provisions that benefit a very narrow range of people and that you and I are forced, in part, to share in the cost of.
LAMB: Is there any connection with all of this that politicians who are running for office and all, or not even running for office, get the corporate jets at the cost of a first class ticket to go from Washington to all over the country?
JOHNSTON: Well, they get it for a lot less than the cost of that. But yes, in fact, many members of Congress routinely get ferried around the country in corporate jets by people who are seeking favors from Washington. And I don`t have a jet to provide a congressman with that kind of a benefit and inure his good favor.

But there`s a secondary benefit to this, which is that, you know, most Americans, if they ever meet a member of Congress or a senator, it`s, Hi, I`m running for office and I`d like your vote. That`s the end of the discussion. But now, think about it. You`re pressing some piece of legislation, or your friends are, and you`re flying a member of Congress out for the weekend so he can give a speech to some group on the other end of the country. You`ve got five or six hours with him, or somebody on your staff does. You have an opportunity to explain and petition the government for your redress of grievances.

And that, together with the direct campaign contributions, are resulting in a government that is focused on and thinking about the concerns of the very best-off people in America. And we keep seeing legislation introduced, and if you listen carefully to the remarks of congressmen and senators, they`re not focused on ordinary Americans. Those are sort of throwaway lines. They are focused on, and the laws they are passing are focused on relief for the already best off.
LAMB: I`m not sure about this, but I`ll bet somebody`s watching this right now saying, That reporter from "The New York Times" is a screaming socialist.
JOHNSTON: Well, in fact, in my book, I inveigh against the danger that our tax system will turn us into socialists, if we were to adopt a flat tax. And I`m sure that will find -- many people find jarring. One of the things about my book -- I have sat on panels with left and right-wing tax economists, experts in the field, and all they do is sit there and agree with what`s in the book. The book is not ideological, it is descriptive of what is happening. And I have no antipathy to wealth. I have no antipathy to high incomes. I think we would be a better country if we had more wealth and we had more people with high incomes.

You know, on another show, somebody asked me a matter -- it`s a matter of public record, and I`ll go to that, which is, you know, I`m a registered Republican. So the -- my book is not about promoting any ideology. I don`t propose a solution to our tax problem, except that people become actively involved in the job of being citizens, so that we have a government that reflects the interests of all of us, not a narrow group of us.

And one of the things that isn`t in the book but maybe is an important historical point -- because I`ve studied taxes all the way back to the pharaohs. And it`s the pharaohs from whom we get the phrase, What are they going to do, beat it out of you? Yes. If you couldn`t pay your taxes to the pharaoh, you could go to his priests, and they would give you a beating. It`s because of a grant of tax relief by a pharaoh that we understand the hieroglyphics because that`s what the Rosetta stone is. When you read the text of it, it is a grant of tax relief.

Athens, at one time, had a flat tax. And when it did, it was a tyranny. Then the Athenians went to taxing based on ability to pay, and democracy flourished. The father of capitalism, Adam Smith, said taxes should be based on ability to pay, and he said that before Karl Marx was born. Every classic conservative economic thinker that I have read -- and I have read more than 100 books on the history of taxation, and histories related to taxation, has come to, it`s clear to me, the same conclusion: Taxes should be based on ability to pay.

And what we`re seeing going on now in this country is not classic, well-founded conservative thinking about taxes. We are seeing radical ideas that are being passed off that are ahistorical.
LAMB: The phrase that I read most often in your book is "political donor class."
LAMB: Political donor class -- what is it?
JOHNSTON: Well, that`s the 1 in about 850 Americans who are very important campaign contributors. These are the people who get real access. And you and I get the hello in the mall from the lawmaker. These are people who they themselves are donors, and they bring a lot of other money with them. And they get to sit down and in detail present the government, through Congress, with what their concerns are.

After I finished the book, I got off the plane one day at La Guardia, and a former state senator from a very wealthy family was there. And there was a shortage of cabs, so we shared a cab in. And I was articulating to him on the way into Manhattan my political donor class theory. And he said to me, Oh, David, you`re being much too kind to people like me. I go, What? And he says, You know, all the years I was in office, I knew every day who my 10 biggest donors were and that I had to be demonstrating to them every day that I was working on their behalf. Now, I might never get what they want. In some cases, I don`t think you could ever get what they wanted. But I had to show them that, or they were going to take their money and all the other money they represented and go to the other guy.

And then he said, You know, I don`t think I ever once looked in the mirror when I was shaving and said, What am I doing today for the average person I represent?

Well, the proof of that enormous influence that this group has because of the campaign donor system I think is shown in what happened after 9/11. Two days after 9/11, Congress came back into session, and there were 10 big bills introduced to deal with 9/11, and one of them was a tax bill. Now, what kind of tax benefit do the firefighters and the police officers who went into the World Trade Center and who now have left widows and orphans need? What about the busboy who was in the top of the World Trade Center at the Windows on the World restaurant or the Army sergeants and majors sitting at their desks over here at the Pentagon? Well, Congress thought that what they needed was estate tax relief because that`s what Congress is thinking about.

You know, every politician will say, You can`t buy my vote. I accept that. What you can buy is access. And if the only people with real, meaningful access are the political donor class, and particularly within that, a group of people who do not want to pay taxes, who are virulently anti-tax, then over time, that`s what members of Congress are going to think about.

And we`re seeing in the laws the results of that, that a family that makes $70,000, $80,000, people in that range on average pay as much or more of their income to the federal government as people who make an average of $25 million a year. That`s the new data that came out this morning. That`s -- I think that`s an outrage. And I think most Americans would not approve of that system, if they understood it.
LAMB: When you said estate tax, the name Frank Luntz jumped right out in front of me.
JOHNSTON: Yes. Frank Luntz is a strategist. He`s a hired gun. He works for the Republicans. He worked for Pat Buchanan and Ross Perot and Rudy Giuliani and he worked for Newt Gingrich.
LAMB: And he does MSNBC now.
JOHNSTON: He does -- oh, does he? All right. And he is the one who`s popularized the term "the death tax." And it`s astonishing. I mean, I`ve heard ordinary reporters, you know, refer to "the death tax" in their news accounts. There`s no death tax in America. There`s an estate tax. It is a tax on the right to transfer wealth from your pocket after you`ve died to someone else. There`s also a gift tax, if you do it while you`re alive. It is similar to the system of -- if you own stock in company A and you sell it and there`s been a gain, you have to pay capital gains taxes on it.

It only applies to a narrow segment of the public. It`s a segment that has grown somewhat because Congress has, as it often does, seen it as a money manager and has not adjusted it to reflect the fact that millions of people now own their retirement assets instead of getting a pension, so that gets counted in their estate, and the enormous run-up in housing values in America.

But if you -- right now, if you`re married couple and you have $2 million, you don`t pay the estate tax. I have interviewed people who believe, especially new immigrants, that in America, when you die, the government comes into your home and takes half of what you have. It`s been very successful. Now, when we interviewed Frank Luntz about this and he explained how he sold this and how to ask questions in a way that gets people to go for this, one of the questions that was asked in the survey is something like, Since the estate tax represents second and third and fourth and even fifth taxation of the same dollar, and since it discourages economic activity and it`s unfairly applied, are you in favor of it or against it? And shockingly, only about 79 percent of the Americans were against it. I mean, based on that question, 100 percent of Americans, you would think, would be against it.

He also, however, told us that if he was working for the Democrats or for those Republicans who want to retain the estate tax, he would have labeled it "the billionaire`s tax," and would have said, Hey, it`s only the Ted Turners of the world who pay this tax. He would have said, Let`s raise the exemption to $10 million because it`s a nice round figure and only apply it to people above that because most Americans can envision having a million dollars, but $10 million is certainly beyond their ken and a billion certainly is.
LAMB: When you talk about an inheritance or estate tax and the tax bill that President Bush pushed through Congress -- you discuss all this in here and go up to -- what year is it? What`s the optimum year of all this that it -- when does it die? When does the...
JOHNSTON: Well, the estate tax goes out for a single year, 2010. And you know, Paul Krugman has referred to it as the "throw Mama from the train bill." And I have no doubt, and I`ve talked to many estate tax lawyers who agree that they`ve had clients who will be plotting, if that`s the way the law remains, to figure out how to get rid of an ailing parent in December instead of January of the next year, when there will be estate taxes.

Interestingly, in the year 2000, there was a bill introduced in Congress that would have given immediate estate tax relief, would have reduced the number of people paying estate tax by probably 75 percent. It got almost no coverage. Neither the National Federation of Independent Businesses or the American Farm Bureau told their members about it.

I called up the NFIB and asked them for the names of five or six businessmen who they thought were well informed on this issue. And when I told each one of them that there was an offer of immediate estate tax relief, $4 million for a couple, every single one of these guys said, We`d go for that in a minute. And I said, Well, wait a minute. What about the principle here that we shouldn`t have an estate tax? And they all said, I don`t -- what -- principle? You know, this is a very practical matter. They didn`t see it as a principle matter, they saw it as a practical matter. So a bird in the hand was turned down.

However, let me point out that from now until 2010, what a terrific money maker for those politicians who want to exploit this issue. What a way to raise funds!
LAMB: What is -- and I read your chapter on this. I need to talk through this. What is the Alternative Minimum Tax? And how does it -- I mean, how can we understand when it applies to us? And who`s in danger of having to pay that?
JOHNSTON: Well, I paid it this year. If you look on line 43 of your tax return, you may have paid it. If you`re a married couple with two or more children, you make $75,000 to $100,000 a year, there`s a 97 percent chance you`re going to be paying it within the next two years. And 42 percent of the people in that group are going to lose all of their Bush tax cuts.

The Alternative Minimum Tax is a parallel universe. It`s kind of like a "Star Trek" episode. You know, there`s the good Captain Kirk over here, and there`s the evil Captain Kirk over here. And if you fall into the Alternative Minimum Tax, you lose various deductions because it is designed to make sure that you have to pay some income tax.

When it was enacted in 1969 in its original form, it was to make sure that 155 high-income Americans, people who made the equivalent of $1 million a year in today`s dollars, couldn`t get away with paying zero income tax. Well, it`s failed because now the number`s up to more than 300, but it has certainly caused a lot of people in that group to pay more tax than they would.

In 1986, when we had bipartisan tax reform that broadened the base and lowered the tax rates, the Alternative Minimum Tax was changed to plug a little hole. They were about $1 billion short of having revenue from the old system match revenue from the new one. So it was changed to make as things you lose because they`re tax shelters your exemption for yourself, for your spouse, for your children, your deduction for your state income taxes, your deduction for your local property taxes, the standard deduction, the most passive thing you can do.

Under this law, Congress will even tax you if you have a seriously ill child or you yourself are seriously ill. If you spend 10 percent or more of your income on medical bills, you will pay additional taxes because that`s what Congress has decided to do. And in the book, I tell about the Klaassen family and how because they have a son with cancer, they have been taxed. And Mr. Klaassen, who`s a lawyer, is just - he says, How could this possibly be? How could Congress do this? And I`ve got dozens of statements from congressmen and senators in my desk drawer saying this is an outrage, but nobody`s fixed it.

Well, because of the way the Bush tax cuts interact with the Alternative Minimum Tax and because there was no reform of the Alternative Minimum Tax when the Bush tax cuts were passed, more and more Americans are going to shift over into the alternative tax universe. By 2010 -- and maybe as early as 2008 because we`ve speeded up the cuts -- about 35 million Americans out of the 130 million households that file tax returns are going to fall into the Alternative Minimum Tax.

Basically, if you make $50,000 to $500,000, it will become the de facto tax system for you. And all of the money that that raises, a half trillion dollars of increased Alternative Minimum Tax -- and by President Bush`s standards, this is a half trillion dollar tax increase -- is being used by the government to finance the tax cuts for the super-rich, for those people who are making $3 million a year or more, so that they can pay a 35 percent rate instead of a 39.6 percent rate.

So you know, if you`re one of those people who thinks you should be having money taken out of your pocket by the government to help the super-rich, it`s a great system.
LAMB: Who doesn`t have to worry about it? Is there any way to -- I mean, what`s -- and what`s the percentage of tax under the Alternative Minimum Tax?
JOHNSTON: Well, it has two rates, 26 percent and 28 percent, but the tax base is different. The rate on which you pay is different. So line 43 will tell you how much additional tax you`re paying because of it. I think one year, my wife and I, because we sold a little rental property, we had, I think we paid $16,000 that wiped out -- more than wiped out any chance we had of making any profit on the investment.

Interestingly, while there`s a lot of talk about family-friendly tax policy in Washington, you are about 30 times more likely to pay the Alternative Minimum Tax if you have two or more children than if you`re single or have no children. So that`s who it hits. It hits families very hard because you lose the exemption for yourself, your spouse and your children. And if you`re like me -- I have eight children, although only two of them are still tax deductions -- if I had all eight of my children, I would be paying lots of Alternative Minimum Tax.
LAMB: And the age range on those eight children?
JOHNSTON: Thirteen to thirty-seven.
LAMB: And your wife -- what`s her name?
JOHNSTON: Jennifer Leonard.
LAMB: Where did you meet her?
JOHNSTON: Jennifer and I -- Jennifer is not my first wife. She`s the mother of my two younger children. And we`ve been married -- let`s see, this is March 30 -- 21 years, 10 months and 30 days today. We were fixed up on a blind date by United Way in Los Angeles.
LAMB: And why?
JOHNSTON: In 1980. I had a friend who worked there. I was an investigative reporter at "The Los Angeles Times." I was covering the Los Angeles Police Department. I was the first reporter to seriously examine the Los Angeles Police Department and was -- my stories essentially changed its image from this badge 714 efficient, honest, straightforward police department to show how it actually was operating. And as we now know, it`s now run under the aegis of the federal government.
LAMB: How long have you been with "The New York Times"?
JOHNSTON: Nine years.
LAMB: And why do you live in Rochester, New York?
JOHNSTON: Well, my wife, Jennifer Leonard, to whom the book is dedicated, is the president of the Community Foundation in Rochester. There are 600 Community Foundations around the country. They are -- as opposed to United Ways, where you give your money and it immediately gets out to social services, these are endowments. And I think 800-and-some families in Rochester have funds -- including my wife and I have a little, tiny fund -- to provide permanent charitable capital for the welfare of that community.
LAMB: And where did you grow up?
JOHNSTON: Well, I grew up in California. I was born in San Francisco, grew up in various towns up and down the coast. My grandmother had a little, tiny orange ranch in Orange, California. We moved to Santa Cruz on the coast when I was 12, and I guess I regard that as home.
LAMB: When did you leave it?
JOHNSTON: California?
LAMB: No, Santa Cruz.
JOHNSTON: Santa Cruz. Well, I left in 1968, when I was hired at the age of 19 by the "San Jose Mercury" as a reporter. I moved over to Silicon Valley. I lived there for the five years that I was on their staff, and I was the youngest reporter when I was hired and I was the youngest when I left. And then I went to the University of Chicago on a fellowship, went to Michigan, to the state capital, where I was "The Detroit Free Press`s" investigative reporter there. And then "The Los Angeles Times" hired me as a national investigative reporter based in San Francisco, and we moved back to Santa Cruz. And I commuted 75 miles to work on the days that I actually had to drive to the office.
LAMB: Did you get a degree in there?
JOHNSTON: No. I went into a college on the GI Bill because my dad was a 100 percent disabled veteran. And after the first quarter of college, a guy sitting next to me said, Hey, you know, they`ve got these things called 300 level classes. You just have to talk your way into them. And so I did six years of college work, six years of college credits, but they were all junior, senior and graduate school. And when I went in at Michigan State, when my GI Bill money ran out, and asked for a degree, they said, Oh, you have to go back and take all these freshman and sophomore courses, and I said, The heck with it. I got a very good education.
LAMB: Well, when did you get interested in tax?
JOHNSTON: Well, you know, we all pay taxes, first of all. I mean, the very time I paid any attention to taxes was after I went to work for the "San Jose Mercury." Ronald Reagan had been elected governor of California and said, we`re not going to have withholding, because taxes should hurt. And I hadn`t had to pay state income tax until I went to work. And I had this guy to do my taxes, and he told me that I owed the state of California $108. That was my take home for the week, $108. And that hurt. Let me tell you, a guy with two kids, that hurt.

Over the years, I had to write as a reporter about property taxes and disputes about them. And then in 1983, after I finished my coverage of the LAPD, I began writing about charities. That`s when C-SPAN first had me on, to talk about big foundations and things. And I began writing about estate tax things. When I went to the -- left the "L.A. Times" and went to "The Philadelphia Inquirer" to write about the casino industry, Gene Roberts, the legendary editor of "The Inquirer," and I talked a lot about taxes and how he`d like to have a different kind of coverage of taxes. And when he was brought back by "The New York Times," he was the first outsider brought back in a senior post since Carr Van Anda, which I think was is in 1912 or 1904. He brought me, along with a number of other investigative reporters into "The New York Times," and we had this idea, that we were going to do a running investigation of the tax system. And we were going to look at how the tax system actually operates, as opposed to what the politicians say about them.
LAMB: In the story I read in the -- your competitor, "The Washington Post," it said there`s something close to 100,000 employees at the IRS with a budget of over $10 million, but yet people say -- and the other thing I wanted to ask you about in this story was that this oversight board -- it`s the first time they`ve ever had a report like this, issued such a critique. What is the oversight board?
JOHNSTON: Well, it`s not the first time. In 1997 and 1998, Congress held hearings staged by the late Senator Roth that asserted that the IRS was an out of control agency. Senators Nickles and Murkowski and Lott referred to the IRS as, you know, Gestapo-like, and out of control. And there was this talk of jack-booted thugs. And you recall, there were IRS people who appeared behind screens.

And it turned out when "The Wall Street Journal," "Tax Notes" magazine, the paper in Richmond, "The New York Times," and some other journalists dug into these cases, that, in fact, things were not at all as they appeared. Most of the people who appeared with testimony was not to be believed, and the congressional investigating agency, the General Accounting Office, came to the same conclusion.

But as part of the outcome of those hearings, Congress passed a law, and it created this independent oversight board. And the oversight board has several times in the past said to Congress that the IRS does not have enough money to do the job.

Now, $10 billion sounds like a lot of money, except they`re collecting over $2 trillion. The IRS has about 12,000 auditors today. Well, back in 1988, it had over 16,000 and almost 17,000 auditors, and there were a lot more taxpayers and there was a lot bigger economy. Just to bring enforcement back to where it was in 1988, you`d have to more than double the number of auditors at the IRS, you would have to more than double the number of criminal investigative agents. There are fewer than 3,000 criminal investigative agents, and you`d need to dramatically increase the number of tax collectors, or called revenue officers.

Because we have essentially cut in half our commitment to collecting taxes fairly, and because of changes that have taken place in the economy among the better-off Americans, those who rather than depending on wages, own their own businesses, they`re investors and partnerships, they`re landlords, especially those who operate in the international arena. There`s been a collapse of law enforcement. And throughout the book, I name people who don`t pay taxes or who were caught, in some cases criminally caught by the IRS, and they weren`t even made to pay. Seventy-eight percent of known cheaters in partnerships are not made to pay.

There`s a man I write about in the book, Jerry Curnutt, who is a bureaucrat, was a bureaucrat at the IRS. His job was to find cheating in partnerships. He couldn`t find any. And one day, somebody shows him a tax return, and he looks at it and he realizes that a $10 investment was going to cost the government I think it`s $300 million or $500 million in taxes. It`s an enormous amount of money. And he figures out a solution. And it`s going to cost less than $100,000 a year. Jerry says maybe less than $20,000 a year.

Nobody has the money in their budget. And so for want of that little bit of money and changing one question on one tax form, the government is giving up $6, $7 billion, $10 billion a year in revenue from the highest income people in America, all of whom are cheating and they`re just not being caught. Fundamentally, the IRS is a completely out of date agency.

When I started writing about the IRS and -- in the mid `50s, IRS agents were using MS-DOS. They didn`t have Windows on their laptop computers. I have talked to the IRS agents whose desks are literally propped up with law books. There`s almost no money for training, and database searches and other tools that you need to identify tax cheats.
LAMB: What`s the DIF score?
JOHNSTON: The DIF score is a simple, crude analytical tool to find likely candidates for audit. It simply looks at your income class, it looks at the averages of deductions for those people who itemize on their tax return, and it picks the outliers. It`s based on data from surveys the IRS used to do until Congress prohibited them. The data is now from the 1980`s, so it`s way out of date. And the economy is much different now than it was 20 years ago, and today, if you get called in for an audit, there`s a two-thirds chance you`ll pay more money; there`s a one-third chance that you`ll either have your return approved as submitted, or you`ll get money back. Unbelievably inefficient, and it`s because the data on which this score is based is out of tune.

In the new technology the IRS is supposed to get, they should be designing very sophisticated statistical tools to catch all sorts of cheating that involve high degree of reliability in the ability to identify patterns of tax cheating. But I`m not at all confident that we`re going to see that, because Congress has been so tight fisted with money for new technology.
LAMB: If you could get all the cheaters and all those people who avoid tax, either legally or whatever, what`s the gap?
JOHNSTON: Well, the official number in the oversight board report is $311 billion. And since the income tax system brings in less than $1.5 trillion, it brings in about I think $1.3 trillion last year, that`s an enormous amount of money. That`s both corporate and individual income taxes.

I think that number is a conservative number. And historically, we thought of the tax gap as being people at the bottom. You know, the guy who cuts lawns and gets paid in cash. That underground cash economy. But one of the things that I show in "Perfectly Legal" is that a lot of the underground economy is at the top. It involves people with enormous incomes, who are not reporting these incomes, or are underreporting them.

I have talked to IRS criminal agents who told me about tax returns for guys that showed $90,000, $100,000 incomes, they look absolutely as clean as can be. And in fact, these guys are spending millions of dollars a year on their lifestyle by using offshore debit cards and credit cards and other devices.
LAMB: Let me ask you about -- bipartisan here, you have got two names that you write about in the book, John Snow, the current treasury secretary, and Terry McAuliffe, the current head of the Democratic National Committee.
JOHNSTON: I don`t think I mention McAuliffe in the book. Do I?
LAMB: Yeah, it`s in relationship to Gary Winnick and Global Crossing.
JOHNSTON: Oh, yes, yes.
LAMB: $18 million.
JOHNSTON: Yes. That`s right. Now I remember, I`m sorry, yes.
LAMB: But what were you getting at with John Snow or Terry McAuliffe? What`s the story there behind those ...
JOHNSTON: Well, the last substantive chapter in the book is about what`s happening to retirement plans, and Global Crossing is very much caught up in that. Global Crossing existed for three years. It had total revenues during that period of about $200 million, which were essentially advanced payments for services to be provided later for this worldwide network of undersea cables that they were laying.

The stock market valued the company at $52 billion at the peak. That`s more than Ford Motor Company, more than General Motors. And this tiny amount of revenue.

The insiders at that company cashed out $5.2 billion. That`s $200 million of revenue, we took $5.2 billion in stock profits. That`s astonishing.

Global Crossing had lots of friends in high places, and because it existed as long as it did, I don`t think there will ever be any prosecutions in Global Crossing, unlike many of the other companies we have seen.

But as part of the strategy of Global Crossing, they bought the telephone company in Rochester, and the workers in Rochester were then offered one of these, quote/unquote, "modern pension plans," 401(k) type pension plans. And they were told again and again and again, you are all going to be millionaires. These linemen who come to your house and install phones and stuff, you`re all going to be millionaires.
LAMB: That`s where you live.
JOHNSTON: That`s where I live.
LAMB: The Rochester Telephone Company was how big?
JOHNSTON: Oh, the union had maybe 1,400 people, and from 1,000 more on the payroll, and the rest are retired.
LAMB: Did you know some of these people yourself?
JOHNSTON: Not until I started writing about it.
JOHNSTON: I tell about a young man named John Pusloski, who is the first person in his family to graduate from college. And after graduating from college, he decides, with a finance degree, to go to work for the phone company, as a lineman, just like dad did. Because even though he`s young, he says, gee, I`m going to have this pension, I can retire at 55, I can go hunting and fishing and take whatever kids I have when I get married, and have time with them, and have a pretty nice life.

And this -- under the company`s pension plan, if you went to work for Global Crossing, as a lineman, in 1960 and retired in 1995, 35-year career, you`d get about $19,000 a year for the rest of your life. Under the modern plan, had it been in effect, this one was supposed to make you a millionaire, and assuming that they had earned the average returns for the stock market over that time, not the actual suppressed returns of a regular utility company, you would have left with a maximum of $120,000. So you would have gotten -- gross money. So you would have collected your -- the equivalent of your pension for six years and been broke.

And the point about companies like Global Crossing is that these new modern pension plans are a prescription for disaster. They impose an expectation that ordinary workers can manage their money very well. If managing money was easy, everybody would be rich. Everybody would own a yacht. It`s not. The average job on Wall Street, even when you count the clerks and janitors, pays four times the average salary in New York. What does that tell you about how hard it is to manage money?
LAMB: And Terry McAuliffe`s $18 million, how did he earn it?
JOHNSTON: He received stock in the company for some work he did for them. It went up in value. He`s disputed whether he sold at the peak, when it was worth $18 million, but he`s never been willing to tell people exactly what it was that he did. But it is one of the few sorts of deals like that that got into the public record and that we know about. There are lots of these deals where people in the political life are feeding off the business community, and they`re taking care of each other. And we are not seeing either of the political parties worrying about the ordinary people in this country.

And after all, what does our Constitution say is the reason we created this country? In the preamble, it says "to promote the general welfare," and both that document and the Declaration of Independence talk about freedom. We created America so that we would have freedom, to choose what we want to do. Wealth turns out to be a byproduct of freedom, and it`s terrific we have wealth. But the reason we created the company wasn`t to manipulate it, to make money and to shift burdens onto people who are not well equipped to deal with them.
LAMB: What was the story about our treasury secretary, John Snow, who used to be at CSX? Do you remember that one?
JOHNSTON: Yeah, I do not...
LAMB: It`s a retirement story. It`s one of these, you know, what`s the goodies at the end of the road?
JOHNSTON: Well, Snow is one of many executives I have written about who built up these unbelievable, untaxed fortunes in their systems.
LAMB: By the way, just to interrupt you, all of this is perfectly legal, as the title of your book.
JOHNSTON: That`s correct. I mean, there are things obviously I talk about that are illegal, people who have offshore accounts that are undeclared, which makes them tax crimes. But many of the devices that I describe are perfectly legal.

And while I don`t remember with the details of Snow`s account, let me deal with fellows who I know much better. Roberto Goizueta was the head of the Coca-Cola Company. And during the first dozen years he ran that company, stockholders did fabulously wealthy. Average annual return was more than 30 percent, when the long term average return for big companies is around 11.

But he amassed $1 billion untaxed fortune, through one of these executive deferred compensation plans. And in fact, when we originally first reported that in "The New York Times," there were members of the board of directors of the company who didn`t realize that he had $1 billion. There are lots of executives out there who have $400,000, $500,000 million untaxed fortunes, which means they`re deferring the taxes into the future.

That matter to ordinary Americans for this reason. Imagine that, Brian, you`re running C-SPAN, and it`s a publicly traded company instead of the non-profit cooperative that it is, and the cable company has decided to pay you $105 million next year. You take $5 million in cash to live on, and you pay the taxes on it. And after your state and local taxes, you have about $3 million left. And you should be able to have a pretty good life on that, especially with the kind of expense account that goes with that job.

The other $100 million you leave on deposit with the company. You don`t pay taxes on it. The company invests it on your behalf. Now, if they use it as working capital for the company, that`s different. But in most cases, that`s not what happens. They put it in an account on your behalf.

The company doesn`t get to deduct that money. It has to pay income taxes on it, $35 million. So to pay you $105 million, costs the company $140 million.

Well, you do that, and the number two guy does that, and the number seven guy, and all the way down to maybe the 50th or if it`s a really big company the 3,000th guy in the company.

The company has this huge tax bill. It can only pay that bill by doing one of two things. One thing is to buy illegal tax shelters. That`s part of the reason there`s this market and companies are willing to do things that they know they shouldn`t be doing, that are improper. We`ll pay Ernst & Young, KPMG, PriceWaterhouse, Deloitte & Touche, Arthur Andersen $5 million, and then we don`t have to pay the $35 million in taxes. All these companies now say they`re getting out of that business.

Then they go to the workers, and they say, gee, guys, you know, we just can`t afford your health care plan anymore, we can`t afford your retirement plan anymore. We`re going to have to get rid of that defined benefit pension plan that you have been working on, and we`re going to give you one of these modern pension plans that is going to make you rich. And which will cost us 10 cents on the dollar or maybe 30 cents on the dollar compared to the old plan.

It`s not competition from the company down the street that`s making the company take away your fringe benefits, it`s competition from guys in the executive office, and from the way that the tax system works that`s taking those benefits away from you.

And ordinary Americans do not know that. They don`t understand it. I have talked to union leaders who have been negotiating contracts who didn`t have a clue that this was what was going on, until they read my book. Now they understand much better how executive compensation is much larger than it appears in the published reports. It`s tax-driven, and it`s having a devastating effect on middle class Americans.
LAMB: You said before we started that John Kerry has read this book.
JOHNSTON: Well, Kerry told Knight-Ridder newspapers in February that he was stopping campaigning for a weekend so that he could, as he said, veg out and read two books. And one of them was "Perfectly Legal." And then on March 12, when he was at home in Boston, Kerry went to a Borders bookstore and he bought seven books, including "Perfectly Legal," which he had the store manager go get for him off the shelf.
LAMB: What do you think somebody like him would learn in this book that would make a difference? He`s been in the Senate for like 19 years.
JOHNSTON: Yes, but he`s not a tax specialist, and I think his understanding of the tax system is the same as every other member of Congress who isn`t a tax specialist, and most Americans.

We all live in the same society, and the societal myths that shape our lives are all the same. And as someone who`s married to a woman of great wealth and who is himself a wealthy man, though not in her league, he`s paid substantial taxes. And most of us believe that whoever is better off and further up the income ladder than we are pays more than we do. And so one shocking thing he certainly would learn is that that`s not true.

Secondly, I think he would learn how our government`s practices on the way we tax businesses favor multinational companies, the General Motors of the world, against domestic companies. If you are purely domestic companies, and that`s what most big entrepreneurial businesses are in America, you`re getting clobbered by the tax system compared to your multinational competitors.
LAMB: Why?
JOHNSTON: Because we have something called the foreign tax credit. You know, you`ll hear companies say, well, there`s double taxation, they tax us overseas and they tax us here. That`s not true. You get a dollar for dollar deduction on taxes paid to a foreign government. So every time an American company pays the communist government in China $1 in taxes, they don`t get a dollar deduction here. They get a dollar reduction in their taxes.

If we eliminated that system and went to a pure territorial tax system, just what profits did you earn inside the United States, corporate taxes would rise $6 or $7 billion a year. None of the big companies want to end that system, the multinational companies, because it`s a subsidy program for them in which they foist it on -- just as with individuals -- they foist it onto the people further down the chain.

Secondly, we have a system that encourages companies to move capital out of the United States. If you`re a chemist and you come up with a formula and suddenly say, gee, you know, we put -- one of the people rubbed this on their face yesterday and suddenly they were beautiful. I mean, imagine what you could get for that drug.

The drug company would sit you down with lawyers right that moment, they would put everything that you know about that drug into a letter, they would send it off to a company subsidiary in Switzerland or some other tax haven. They would pay for the value of that letter. Maybe they`d pay $1 million for it. Imagine the real value if you could come up with that, you know, face cream.

And then every time a jar of that face cream is sold, a royalty will be paid. It will be an expense on the U.S. tax system, it will take the profits outside of the United States, it will put them in a place where they`ll never be taxed. And the company will build up this huge offshore reservoir of untaxed money. And wherever the capital goes, the jobs ultimately have to go.
LAMB: So Republicans, Democrats, one party or the other do better with this?
JOHNSTON: No. The Democrats -- and we haven`t talked much about them -- but the Democrats started this practice of overtaxing the middle class to benefit the super rich with what they did to Social Security. And the Republicans have simply taken that ball and run with it.
LAMB: What did they do to Social Security?
JOHNSTON: Well, we used to pay as you go. We paid as much each year as was paid out in benefits. In the beginning of 1983, when the Democrats were in control of Congress, we have been overpaying. We have overpaid $1.8 trillion so far, and it will get much bigger. That money was used to finance tax cuts for the wealthiest people in America. They will eventually have to borrow -- pay back that money by redeeming treasury notes that are in the so-called lock box.

Paul O`Neill, by the way, the treasury secretary, is my authority on this, among others.

But what the wealthy got was a 30-year delay in paying those taxes before they have to pay them back. Well, a dollar I can pay 30 years from now is not very expensive. I and you pay the dollar today, and then we get the benefit 30 years from now. We are transferring the time value to that money to the very wealthiest people in America, and that`s why their incomes are exploding like this as I show in the book and ordinary Americans` incomes are stagnant.
LAMB: You talk about a woman named Kate Barton of the Ernst & Young Boston office. What did Kate Barton do?
JOHNSTON: Well, the fires are still burning at ground zero. The stock market is in the dump, and Kate Barton of Ernst & Young in a webcast to a big corporate client says we have a solution for you, we have a get-rich plan that only works because the stock market is down. All you have to do is move your company headquarters on paper to Bermuda. And you can stop paying U.S. corporate income taxes, and you just pay the Bermudians about $27,000 a year. And by the way, she says, now, some people might not like this idea because of what just happened, 9/11, shortly before. But she says, perhaps patriotism should take a back seat to profits.

I mean, that`s just a perfect example of people who want to take advantage of all the benefits that we have by having our free society that people fought and died to have and to sustain. And they don`t care about anything but their pocketbook. And I want America to endure. I don`t want my children or my grandchildren or people who won`t know about me 500 years from now who are my descendants to ever sit in a classroom in high school and pick up a book that says, "the United States of America was."

But if we don`t keep in mind that we have to promote the general welfare, we will see more and more people giving up on democracy, not caring, caring more about who Jennifer Lopez is sleeping with than who their congressman is, we will see more incidents like -- although hopefully not as horrific -- as Oklahoma City. We will see more and more people expressing the view that the federal government is a criminal organization, and I have written many stories in "The New York Times" about people who were expressing these views.
LAMB: But go back to Kate Barton for a moment.
LAMB: Did she succeed?
JOHNSTON: Well, a number of companies have gone to Bermuda. Generally not...
LAMB: Is it legal?
JOHNSTON: It`s perfectly legal. They`re generally not household names. They`re industrial companies, with a few exceptions. Stanley Works tried to go, but to do it they had to rig the election. They got caught, they didn`t get to go.
LAMB: Who`s Stanley Works?
JOHNSTON: You probably have their tools in your home. They make hand tools and hinges and automatic door openers. And their competitor, Ingersoll-Rand, went. So in the areas where they compete with each other, like automatic door openers, Ingersoll-Rand now has a tax advantage against Stanley Works.
LAMB: How does it work?
JOHNSTON: You turn what were profits in the United States into tax-deductible expenses that you send overseas in the form of interest on debt, royalties for intellectual property, as when I discussed the face cream, and you take the company logo and other properties and put them offshore. And if you have existing ones, you create new ones to imbue them with value. Management fees, and other devices. So that you basically remove from the U.S. what would be taxable profits, and reduce -- and if you`re really good at it, completely eliminate -- your corporate income tax.
LAMB: Panama, the Cayman Islands, a lot of other places you mention.
JOHNSTON: Bermuda, Barbados.
LAMB: All do the same thing?
JOHNSTON: Yes. Although Bermuda is the place of choice for two reasons. It has a set of laws and a legal practice that is one-sided and benefits corporations. You basically can`t sue a company successfully in Bermuda as you can here. And secondly, we have a treaty with Barbados. So these companies that go to Bermuda become resident in Barbados. They`re Bermuda companies resident in Barbados. That`s what Ingersoll-Rand is. They have one guy down there. They hold one meeting a year in Barbados. And under a U.S. tax treaty, they can suck all these profits out of the U.S. as tax-deductible expenses.
LAMB: Explain this, if I understand it correctly. If the IRS sues you, that can`t be public. If you sue the IRS, it is public.
JOHNSTON: That`s exactly right.
LAMB: What does that mean?
JOHNSTON: Well, it`s -- what is meant in practice is that it`s turned out to be a huge benefit, both for the IRS covering up its mistakes, but I think much more importantly for serious tax cheats. An IRS guy named Bradley Herbert figured out from an audit in the `90`s that Enron had become a fraud, and he wanted to stick by an audit that disallowed all sorts of deductions to Enron, which would have forced them to sue the IRS in court, and would have made this public, and everyone would have known well in advance it was a fraud. The national office of the IRS shut him down, ordered that Enron get the tax breaks that it wanted, and as a result, Enron went on its merry way until the disaster strike in 2001, 2000.

We used to have a system in which tax returns were public record. I have clips from the 1920s. Julius L. Rosenwald, founder of the Sears & Roebuck chain, went to the Internal Revenue Bureau in Chicago and paid his tax of $1.11 million yesterday.

Up until the Nixon era, it was public record whether you`d filed your tax return. Now, that`s all secret. And one of the few specific reforms I do recommend is that we create a public register that tells whether or not you filed a tax return, and we pay serious rewards for people -- for turning in those who haven`t filed. The police, after all -- the IRS is the tax police -- pay informants all the time. Lots of people would be added to the tax rolls if we did that.
LAMB: Just a couple of minutes. You also talk about the ability for somebody who is very rich to go into a lawyer, the lawyer writes -- may charge him $1 million for some kind of a letter that gets him a tax scheme.
LAMB: What`s that?
JOHNSTON: Well, when you buy a tax shelter, especially if you know it is not going to work if the government finds out about it, it`s a bad tax shelter, you pay for one of these opinion letters. And they`re like a treasure map where X marks the untaxed spot. They`re often 50 to 80 pages long. I`ve read a number of them. And they have enough caveats in them to sink a galleon. After all, a caveat doesn`t weigh anything. But you use that letter if your tax shelter gets demolished, to say, well, don`t charge me penalties. Don`t charge me any penalties.

And so if that happens, what happens if you get caught? All you do is pay the taxes and the interest. You`re in the same position you would have been, except for the fee you paid for the letter. It is a system that encourages tax cheating. And the administration just proposed a rule to shut down tax shelters by saying, we`re going to charge the promoters half of their fees. Want to shut them down? Let`s charge them three times their fees if they promote an illegal tax shelter. That will put them out of business.
LAMB: When all is said and done, this "Perfectly Legal" book will sell how many copies, do you think? How long has it been on the market?
JOHNSTON: It`s been out since January 4. It has been on "The Wall Street Journal" best seller list for two months, "The New York Times" list for six weeks, and the extended list for another three or four.

I don`t know how many it will sell. What I hope it does is cause enough Americans to understand how our tax system really works, that Congress has to pay attention to ordinary Americans, to what`s happening to them in our tax system, so that we get a tax system that greases the wheels of commerce, rewards strivers, promotes social stability and makes America endure.
LAMB: As we near April the 15th, there`s the cover of the book, "Perfectly Legal," David Cay Johnston of "The New York Times." Thank you very much.
JOHNSTON: Thank you.

Copyright National Cable Satellite Corporation 2004. Personal, noncommercial use of this transcript is permitted. No commercial, political or other use may be made of this transcript without the express permission of National Cable Satellite Corporation.