by John Brooks
But to enact an unsatisfactory law and then try to compensate for its shortcomings by good administration is, clearly, an absurd procedure. One solution that is more logical—to abolish the income tax—is proposed chiefly by some members of the radical right, who consider any income tax Socialistic or Communistic, and who would have the federal government simply stop spending money, though abolition is also advanced, as a theoretical ideal rather than as a practical possibility, by certain economists who are looking around for alternative ways of raising at least a significant fraction of the sums now produced by the income tax. One such alternative is a value-added tax, under which manufacturers, wholesalers, and retailers would be taxed on the difference between the value of the goods they bought and that of the goods they sold; among the advantages claimed for it are that it would spread the tax burden more evenly through the productive process than a business-income tax does, and that it would enable the government to get its money sooner. Several countries, including France and Germany, have value-added taxes, though as supplements rather than alternatives to income taxes, but no federal tax of the sort is more than remotely in prospect in this country. Other suggested means of lightening the burden of the income tax are to increase the number of items subject to excise taxes, and apply a uniform rate to them, so as to create what would amount to a federal sales tax; to increase user taxes, such as tolls on federally owned bridges and recreation facilities; and to enact a law permitting federal lotteries, like the lotteries that were permitted from colonial times up to 1895, which helped finance such projects as the building of Harvard, the fighting of the Revolutionary War, and the building of many schools, bridges, canals, and roads. One obvious disadvantage of all these schemes is that they would collect revenue with relatively little regard to ability to pay, and for this reason or others none of them stand a chance of being enacted in the foreseeable future.
A special favorite of theoreticians, but of hardly anyone else, is something called the expenditure tax—the taxing of individuals on the basis of their total annual expenditures rather than on their income. The proponents of this tax—diehard adherents of the economics of scarcity—argue that it would have the primary virtue of simplicity; that it would have the beneficial effect of encouraging savings; that it would be fairer than the income tax, because it would tax what people took out of the economy rather than what they put into it; and that it would give the government a particularly handy control instrument with which to keep the national economy on an even keel. Its opponents contend that it wouldn’t really be simple at all, and would be ridiculously easy to evade; that it would cause the rich to become richer, and doubtless stingier as well; and, finally, that by putting a penalty on spending it would promote depression. In any event, both sides concede that its enactment in the United States is not now politically practicable. An expenditure tax was seriously proposed for the United States by Secretary of the Treasury Henry Morgenthau, Jr., in 1942, and for Britain by a Cambridge economist (later a special adviser to the National Treasury) named Nicholas Kaldor, in 1951, though neither proponent asked for repeal of the income tax. Both proposals were all but unanimously hooted down. “The expenditure tax is a beautiful thing to contemplate,” one of its admirers said recently. “It would avoid almost all the pitfalls of the income tax. But it’s a dream.” And so it is, in the Western world; such a tax has been put in effect only in India and Ceylon.
With no feasible substitute in sight, then, the income tax seems to be here to stay, and any hope for better taxation seems to lie in its reform. Since one of the Code’s chief flaws is its complexity, reform might well start with that. Efforts at simplification have been made with regularity since 1943, when Secretary Morgenthau set up a committee to study the subject, and there have been occasional small successes; simplified instructions, for example, and a shortened form for taxpayers who wish to itemize deductions but whose affairs are relatively uncomplicated were both introduced during the Kennedy administration. Obviously, though, these were mere guerrilla-skirmish victories. One obstacle to any victory more sweeping is the fact that many of the Code’s complexities were introduced in no interest other than that of fairness to all, and apparently cannot be removed without sacrificing fairness. The evolution of the special family-support provisions provides a striking example of how the quest for equity sometimes leads straight to complexity. Up to 1948, the fact that some states had and some didn’t have community-property laws resulted in an advantage to married couples in the community-property states; those couples, and those couples only, were allowed to be taxed as if their total income were divided equally between them, even though one spouse might actually have a high income and the other none at all. To correct this clear-cut inequity, the federal Code was modified to extend the income-dividing privilege to all married persons. Even apart from the resulting discrimination against single persons without dependents—which remains enshrined and unchallenged in the Code today—this correction of one inequity led to the creation of another, the correction of which led to still another; before the Chinese-box sequence was played out, account had been taken of the legitimate special problems of persons who had family responsibilities although they were not married, then of working wives with expenses for child care during business hours, and then of widows and widowers. And each change made the Code more complex.
The loopholes are another matter. In their case, complexity serves not equity but its opposite, and their persistent survival constitutes a puzzling paradox; in a system under which the majority presumably makes the laws, tax provisions that blatantly favor tiny minorities over everybody else would seem to represent the civil-rights principle run wild—a kind of anti-discrimination program for the protection of millionaires. The process by which new tax legislation comes into being—an original proposal from the Treasury Department or some other source, passage in turn by the House Ways and Means Committee, the whole House, the Senate Finance Committee, and the whole Senate, followed by the working out of a House-Senate compromise by a conference committee, followed by repassage by the House and the Senate and, finally, followed by signing by the President—is indeed a tortuous one, at any stage of which a bill may be killed or shelved. However, though the public has plenty of opportunity to protest special-interest provisions, what public pressure there is is apt to be greater in favor of them than against them. In the book on tax loopholes called “The Great Treasury Raid,” Philip M. Stern points out several forces that seem to him to work against the enactment of tax-reform measures, among them the skill, power, and organization of the anti-reform lobbies; the diffuseness and political impotence of the pro-reform forces within the government; and the indifference of the general public, which expresses practically no enthusiasm for tax reform through letters to congressmen or by any other means, perhaps in large part because it is stunned into incomprehension and consequent silence by the mind-boggling technicality of the whole subject. In this sense, the Code’s complexity is its impenetrable elephant hide. Thus the Treasury Department, which, as the agency charged with collecting federal revenues, has a natural interest in tax reform, is often left, along with a handful of reform-minded legislators, like Senators Paul H. Douglas of Illinois, Albert Gore of Tennessee, and Eugene J. McCarthy of Minnesota, on a lonely and indefensible salient.
OPTIMISTS believe that some “point of crisis” will eventually cause specially favored groups to look beyond their selfish interests, and the rest of the country to overcome its passivity, to such an extent that the income tax will come to give back a more flattering picture of the country than it does now. When this will happen, if ever, they do not specify. But the general shape of the picture hoped for by some of those who care most about it is known. The ideal income tax envisioned for the far future by many reformers would be characterized by a short and simple Code with comparatively low rates and with a minimum of exceptions to them. In its main structural features, this ideal tax would bear a marked resemblance to the 191
3 income tax—the first ever to be put in effect in the United States in peacetime. So if the unattainable visions of today should eventually materialize, the income tax would be just about back where it started.
4
A Reasonable Amount of Time
PRIVATE INFORMATION, whether of distant public events, impending business developments, or even the health of political figures, has always been a valuable commodity to traders in securities—so valuable that some commentators have suggested that stock exchanges are markets for such information just as much as for stocks. The money value that a market puts on information is often precisely measurable in terms of the change in stock prices that it brings about, and the information is almost as readily convertible into money as any other commodity; indeed, to the extent that it is used for barter between traders, it is a kind of money. Moreover, until quite recently, the propriety of the use of inside dope for their own enrichment by those fortunate enough to possess it went largely unquestioned. Nathan Rothschild’s judicious use of advance news of Wellington’s victory at Waterloo was the chief basis of the Rothschild fortune in England, and no Royal commission or enraged public rose to protest; similarly, and almost simultaneously, on this side of the Atlantic John Jacob Astor made an unchallenged bundle on advance news of the Ghent treaty ending the War of 1812. In the post-Civil War era in the United States the members of the investing public, such as it was, still docilely accepted the right of the insider to trade on his privileged knowledge, and were content to pick up any crumbs that he might drop along the way. (Daniel Drew, a vintage insider, cruelly denied them even this consolation by dropping poisoned crumbs in the form of misleading memoranda as to his investment plans, which he would elaborately strew in public places.) Most nineteenth-century American fortunes were enlarged by, if they were not actually founded on, the practice of insider trading, and just how different our present social and economic order would be if such trading had been effectively forbidden in those days provides a subject for fascinating, if bootless, speculation. Not until 1910 did anyone publicly question the morality of corporate officers, directors, and employees trading in the shares of their own companies, not until the nineteen twenties did it come to be widely thought of as outrageous that such persons should be permitted to play the market game with what amounts to a stacked deck, and not until 1934 did Congress pass legislation intended to restore equity. The legislation, the Securities Exchange Act, requires corporate insiders to forfeit to their corporations any profits they may realize on short-term trades in their own firms’ stock, and provides further, in a section that was implemented in 1942 by a rule designated as 10B-5, that no stock trader may use any scheme to defraud or “make any untrue statement of a material fact or … omit to state a material fact.”
Since omitting to state material facts is the essence of using inside information, the law—while it does not forbid insiders to buy their own stock, nor to keep the profits provided they hold onto the stock more than six months—would seem to outlaw the stacked deck. In practice, though, until very recently the 1942 rule was treated almost as if it didn’t exist; it was invoked by the Securities and Exchange Commission, the federal enforcement body set up under the Securities Exchange Act, only rarely and in cases so flagrant as to be probably prosecutable even without it, under common law. And there were apparent reasons for this laxity. For one thing, it has been widely argued that the privilege of cashing in on their corporate secrets is a necessary incentive to business executives to goad them to their best efforts, and it is coolly contended by a few authorities that the uninhibited presence of insiders in the market, however offensive to the spirit of fair play, is essential to a smooth, orderly flow of trading. Moreover, it is contended that the majority of all stock traders, whether or not they are technically insiders, possess and conceal inside information of one sort or another, or at least hope and believe that they do, and that therefore an even-handed application of Rule 10B-5 would result in nothing less than chaos on Wall Street. So in letting the rule rest largely untroubled in the rulebook for twenty years, the S.E.C. seemed to be consciously refraining from hitting Wall Street in one of its most vulnerable spots. But then, after a couple of preliminary jabs, it went for the spot with a vengeance. The lawsuit in which it did so was a civil complaint against the Texas Gulf Sulphur Company and thirteen men who were directors or employees of that company; it was tried without a jury in the United States District Court in Foley Square on May 9th through June 21st, 1966, and as the presiding judge, Dudley J. Bonsal, remarked mildly at one point during the trial, “I guess we all agree that we are plowing new ground here to some extent.” Plowing, and perhaps sowing too; Henry G. Manne, in a recent book entitled “Insider Trading and the Stock Market,” says that the case presents in almost classic terms the whole problem of insider trading, and expresses the opinion that its resolution “may determine the law in this field for many years to come.”
THE events that led to the S.E.C.’s action began in March, 1959, when Texas Gulf, a New York City-based company that was the world’s leading producer of sulphur, began conducting aerial geophysical surveys over the Canadian Shield, a vast, barren, forbidding area of eastern Canada that in the distant but not forgotten past had proved to be a fertile source of gold. What the Texas Gulf airmen were looking for was neither sulphur nor gold. Rather, it was sulphides—deposits of sulphur occurring in chemical combination with other useful minerals, such as zinc and copper. What they had in mind was discovering mineable veins of such minerals so that Texas Gulf could diversify its activities and be less dependent upon sulphur, the market price of which had been slipping. From time to time during the two years that the surveys went on intermittently, the geophysical instruments in the scanning planes would behave strangely, their needles jiggling in such a way as to indicate the presence of electrically conductive material in the earth. The areas where such things happened, called “anomalies” by geophysicists, were duly logged and mapped by the surveyors. All told, several thousand anomalies were found. It’s a long way from an anomaly to a workable mine, as must be evident to anyone who knows that while most sulphides are electrically conductive, so are many other things, including graphite, the worthless pyrites called fool’s gold, and even water; nevertheless, several hundred of the anomalies that the Texas Gulf men had found were considered to be worthy of ground investigation, and among the most promising-looking of all was one situated at a place designated on their maps as the Kidd-55 segment—one square mile of muskeg marsh, lightly wooded and almost devoid of outcropping rocks, about fifteen miles north of Timmins, Ontario, an old gold-mining town that is itself some three hundred and fifty miles northwest of Toronto. Since Kidd-55 was privately owned, the company’s first problem was to get title to it, or to enough of it to make possible exploratory ground operations; for a large company to acquire land in an area where it is known to be engaged in mining exploration obviously involves delicacy in the extreme, and it was not until June, 1963, that Texas Gulf was able to get an option permitting it to drill on the northeast quarter section of Kidd-55. On October 29th and 30th of that year a Texas Gulf engineer, Richard H. Clayton, conducted a ground electromagnetic survey of the northeast quarter, and was satisfied with what he found. A drill rig was moved to the site, and on November 8th, the first test drill hole was begun.
There followed a thrilling, if uncomfortable, several days at Kidd-55. The man in charge of the drilling crew was a young Texas Gulf geologist named Kenneth Darke, a cigar smoker with a rakish gleam in his eye, who looked a good deal more like the traditional notion of a mining prospector than that of the organization man he was. For three days the drilling went on, bringing out of the earth a cylindrical core of material an inch and a quarter in diameter, which served as the first actual sample of what the rock under Kidd-55 contained. As the core came up, Darke studied it critically, inch by inch and foot by foot, using no instruments but only his eyes and his knowledge of what various mineral deposits l
ook like in their natural state. On the evening of Sunday, November 10th, by which time the drill was down one hundred and fifty feet, Darke telephoned his immediate superior, Walter Holyk, Texas Gulf’s chief geologist, at his home in Stamford, Conn. to report on his findings so far. (He made the call from Timmins, since there was no telephone at the Kidd-55 drill site.) Darke, Holyk has since said, was “excited.” And so, apparently, was Holyk after he had heard what Darke had to say, because he immediately set in motion quite a corporate flap for a Sunday night. That same evening, Holyk called his superior, Richard D. Mollison, a Texas Gulf vice president who lived near Holyk in Greenwich, and—still the same evening—Mollison called his boss, Charles F. Fogarty, executive vice president and the company’s No. 2 man, in nearby Rye, to pass Darke’s report on up the line. Further reports were made the next day through the same labyrinth of command—Darke to Holyk to Mollison to Fogarty. As a result of them, Holyk, Mollison, and Fogarty all decided to go to Kidd-55 to see for themselves.
Holyk got there first; he arrived at Timmins on November 12th, checked in at the Bon Air Motel, and got out to Kidd-55 by jeep and muskeg tractor in time to see the completion of the drill hole and to help Darke visually estimate and log the core. By this time the weather, which had hitherto been passable for Timmins in mid-November, had turned nasty. In fact, it was “quite inclement,” Holyk, a Canadian in his forties with a doctorate in geology from Massachusetts Institute of Technology, has since said. “It was cold, windy, threatening snow and rain, and … we were much more concerned with personal comfort than we were with the details of the core hole. Ken Darke was writing, and I was looking at the core, trying to make estimates of the mineral content.” To add to the difficulty of working outdoors under such conditions, some of the core had come out of the ground covered with dirt and grease, and had to be washed with gasoline before its contents could even be guessed at. Despite all difficulties, Holyk succeeded in making an appraisal of the core that was, to say the least, startling. Over the six hundred or so feet of its final length, he estimated, there appeared to be an average copper content of 1.15% and an average zinc content of 8.64%. A Canadian stockbroker with special knowledge of the mining industry was to say later that a drill core of such length and such mineral content “is just beyond your wildest imagination.”