When It Comes to Taxes, It Might Be Legal But It Ain't Always Right

Tax avoidance is legal and tax evasion is not. Simple distinction, but not always relevant, at least not in politics. Consider the recent burst of outrage over corporate tax avoidance generally, and General Electric's tax bill in particular. In some years, GE's tax schemes might have escaped public notice. But in other years -- especially hard ones -- they get plenty of attention. And it was ever thus.

Consider the lessons of 1933. Wall Street investigator Ferdinand Pecora hauled J.P. Morgan, Jr. before the Senate banking committee. Pecora had been charged with uncovering malfeasance on Wall Street, but he focused much of his attention on tax issues. In particular, he forced Morgan to acknowledge from the witness chair that he had paid no income taxes in 1931 and 1932.

Morgan provided a reasonable explanation: stock trading losses in the great market crash had wiped out his other sources of taxable income (such losses were fully deductible in those days). Indeed, Morgan and his partners had seen their net worth plunge from $119 million to $53 million between 1929 and 1931. When all was said and done -- and all capital loss deductions had been taken -- there was simply no taxable income for any of the partners.

"I am not responsible for these figures," Morgan observed wryly. "I viewed them with great regret when they appeared."

From a legal perspective, Morgan had done nothing wrong. But the revelation of his non-payments still shocked the nation, and his explanation carried little weight with Pecora -- and pretty much none with the general public.

"The country, in 1933, was in no mood for nice distinctions between tax 'evasion' and tax 'avoidance,' " Pecora later recalled. "Approved by the existing tax authorities or not, the public could not see the justice or equity of financial giants paying nothing, while Tom, Dick, and Harry scraped the bottom of their modest purses to meet their tax obligations to the Government." (Ferdinand Pecora, Wall Street under Oath; the Story of Our Modern Money Changers,1939).

The Pecora investigation sparked a powerful drive to clamp down on tax avoidance, producing (among other things), new limits on the deductibility of capital losses. More generally, it kicked off a decade of high-profile campaigns to boost effective tax rates on the rich, including a remarkably ambitious effort to revamp corporate income taxation from the ground up.

Which just goes to show: it may be legal, but it ain't always right -- at least not in politics.