Regular readers know that we often challenge financial reporting participants to "tell the truth, the whole truth, and nothing but the truth."This ancient oath covers all the bases by binding witnesses to tell what they know to be true, not diminished by leaving something out and not augmented by adding something extraneous. One or even two out of three simply isn't good enough.
Our topic is a bit out of our usual domain, but it was triggered by a lengthy letter (Accounting Today, Sept. 10-23, 2007, page 6) titled, "No place for politics."
It was written by Harry Bose of Pendleton, Ore., apparently to vent a couple of understandable frustrations. First, he was upset that an earlier article (not our column) made political statements he didn't agree with. Second, he was upset that the political system passed a law that produced a situation he considers to be intolerable. We appreciate a good vent, and he certainly is entitled to express his dissatisfaction.
From one angle, we were bemused that he used his complaint about politics in the magazine to put politics in the magazine. However, we want to focus on his letter to illustrate the value of pursuing the whole truth without just stopping when you've said enough to rationalize your position or decision.
THE TAX ISSUE
Bose argues that recent cuts in federal taxes produced deleterious effects. We agree that he could be right. He tries to prove his point by contrasting the taxes paid by two hypothetical taxpayers, one a mid-income CPA and the other a hyper-wealthy investor who also collects a salary. After observing that they would have different degrees of tax savings, he concluded the cuts were "disproportionate" and presumably unfair.
That may be true, but Bose did not present, and perhaps did not consider, additional factors that could support different conclusions. He also did not acknowledge that other people have other values and might look at the same data and reach different yet legitimate conclusions. For example, his conclusion that the cuts were unfairly disproportionate is based on his notion of what is fair.
OUR REAL POINT
We will momentarily offer some additional points that should be considered in assessing the fairness of these and any other tax cuts - or tax increases, for that matter. We hope to give you some new insight on that issue.
However, our real point is that argumentation of political points, whether it's about tax policy, foreign policy or financial reporting standards, should follow efforts to uncover the whole truth, not just the part you like.
TAX EQUITY?
The issue of equity in taxation is complex. After all, taxation imposes involuntary payments of various kinds on all of us, sometimes in exchange for benefits and other times not. As an extreme, monarchs taxed everyone for their own benefit. In a democracy, a 50.1 percent majority could conceivably tax the other 49.9 percent into poverty. With our progressive system, the majority consisting of lower- and middle-income citizens imposes higher rates on the wealthier minority. Whether that imposition is "fair" clearly depends on one's point of view, perhaps driven by one's own income level.
WHAT'S FAIR?
Bose's sole argument implicitly assumes that the pre-cut rates were fair and that the after-cut rates were unfair because they were cut more for higher-income taxpayers. This view is simplistic, to say the least. Perhaps the old rates were grossly unfair and the tax cut made them more fair. This is a value judgment that cannot be supported solely by comparing before and after rates. We don't know the answer, but it takes more work to find it than he did.
COSTS AND BENEFITS
It can be argued that it's fair to link costs imposed on citizens with the benefits they receive, such that inequity exists if some pay higher taxes but don't get greater returns.
Take highways, police protection and national security, for example. Couldn't it be true that every citizen has essentially equal benefits from these services? If that were so, then would it be fair to impose higher costs on some than on others?
Perhaps, then, the recent cuts were a move toward greater fairness by reducing the excessive burden on some taxpayers.
We used Bose's numbers and discovered more of the truth than he put in his letter. What he didn't say was that his wealthy taxpayer's pre-cut tax bill was $1.2 million, which was nearly 59 times greater than his middle-income taxpayer's bill of just over $20,000. The ratio dropped to 33 times greater after the cut.
We don't know whether it's fair for people with higher income to pay that much more than others, but this point needs to be considered as part of the whole truth.
MULTIPLIER EFFECTS
Bose's point was that middle-class professionals, such as CPAs like him (and us), were left out of the tax cuts. We noted that his assumption that the hypothetical wealthy taxpayer had $2 million in capital gains skewed his results to the low side because of their low marginal rate. He also assumed $1.8 million in dividends, which could happen only with a very large portfolio. If the dividend number represents a generous 2 percent yield, then this person would have $90 million in stock. But few companies pay that much, which means this person could have a huge estate, say $500 million. Even if it's only $250 million, CPAs and money managers would surely be collecting fees in the range of $1 million every year to keep it safe and profitable.
If so, this person would be creating employment for the kinds of professionals that Bose says he is worried about, and a higher tax rate would cause them to lose some income.
Furthermore, if that portfolio is invested in the capital market, it is being used to support hundreds or thousands of other people's employment. Would it be fair - or wise, for that matter - to threaten their job security for the satisfaction of imposing higher rates on wealthier taxpayers? We don't know, but these points should be considered before reaching a conclusion.
DOUBLE TAXATION
Another point that Bose neglected is that many corporations don't pay dividends to avoid double taxation. It should be noted that $969,000 of corporate income tax would have already been paid on the income that produced $1.8 million in dividends. Considering the whole truth usually makes issues harder to resolve.
ESTATE TAXES
Bose also failed to mention estate taxes. For an estate of $250 million, this tax could be $100 million or more, greatly outweighing the half-million in savings produced by the cut. Meanwhile, the middle-income CPA probably won't pay any death taxes because of the $2 million exclusion. Is any of this arrangement fair? We don't know, but the point is relevant.
INCENTIVES TO SUCCEED
Another effect of higher tax rates is the reduction of wealthy taxpayers' marginal utility of additional disposable income, which could lead them to take fewer risks by making fewer investments and thereby create fewer jobs. Is this a sound public policy? We don't know, but the question is part of the search for the whole truth.
INCOME REDISTRIBUTION
Most believe that the real political reason for progressive rates is to redistribute income by confiscating wealth from some to give to others, or to at least keep others from paying as much. Those who advocate this argument need to be absolutely sure of their motive, which could be altruistic, envious or simply populist. Or it could be tyranny. We don't know the answer, but the question needs to be asked.
BACK TO REPORTING
As we stated, our real point is that the whole truth needs to be known if rational decisions are to be reached. That is just another reason why we call so frequently for voluntary reporting of more information that's useful to the capital markets to promote their efficiency and a more productive economy.
Our point also applies to those who present arguments to the Financial Accounting Standards Board and others that may be self-serving. Their tendencies to stretch or withhold the truth have to be ignored for everyone's good. Too many people look only at their own preparation costs and fail to see the bigger picture, including their benefits from providing more complete financial reports.
That's our point. We hope it will make you think differently and increase your respect for the truth, the whole truth, and nothing but.
Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at paulandpaul@qfr.biz.
