Why tax shelters exist.

Like most Washington lobbyists, Ken Kies has filled his office with photographs of himself in the presence of political luminaries. There is one of him embracing House Speaker Dennis Hastert; another depicts him with President Clinton in the Oval Office, Kies's mouth forming a thin, slightly crooked smile. But, among the dozens of photos, one stands out.

It shows Kies next to Senate Majority Leader Trent Lott. As in the other photos, both men are smiling. But, in this one, Lott's hand is wrapped around Kies's neck, as if to strangle him. Kies explains that this is simply a good-natured joke: During budget negotiations a few years ago, when Kies was still chief of staff of the Joint Tax Committee, Lott sought desperately to insert some small measure into a final bill, and Kies stymied him. So the mock strangulation, which would appear to be the gesture of a powerful man joshingly lording over his subordinate, is, in fact, the opposite. Kies is the victor, and Lott's pose is an expression of impotent frustration.

Kies has since moved from Capitol Hill to K Street, where he is chief lobbyist for the accounting firm PricewaterhouseCoopers. But he is still winning power struggles against politicians who nominally outrank him--and now even more so. Kies's current mission is to protect the thriving tax-shelter industry, of which his employer is a prominent member. The people pushing to curtail those shelters include such ideologically diverse heavyweights as Larry Summers, secretary of the Treasury, and William Roth, chairman of the Senate Finance Committee. "The other side," says one reform advocate, "is a one-man industry called Ken Kies." And Kies, even his most bitter foes admit, is probably going to win.

Kies's likely success is all the more remarkable because he is defending a practice that, not long ago, would have been thought indefensible. Tax-sheltering is far more disreputable than the normal game of finding advantage through tax loopholes. A loophole is a special exemption that Congress deliberately writes into law--say, a tax break for certain kinds of oil companies. That's bad enough, but a tax shelter is worse: a way for companies to reduce their tax burden by finding some mechanism Congress never intended. Typically, an accounting firm such as Kies's will offer to sell a shelter to a corporation in return for a hefty chunk of the savings. The shelters cooked up by such firms are usually fantastically complex schemes that involve economically meaningless transactions designed solely to avoid taxes. In one famous case, for instance, an American company leased a town hall in Europe in order to claim a rent deduction; it then leased the hall right back to the town.

In addition to being borderline--if not outright--illegal and depriving the Treasury of revenue, tax shelters are massively inefficient. Companies devote brilliant minds and billions of dollars to sophisticated paper-shuffling. Economists call this "deadweight loss"--corporations wasting resources trying to get around the law rather than following the invisible hand. Of course, a dollop of economic inefficiency might be acceptable if the beneficiaries were, say, minimum-wage workers. But tax-sheltering creates the worst of all economic worlds. It combines the maldistribution of laissez-faire capitalism--the beneficiaries of tax shelters are owners of capital and their ethically challenged but well-compensated hirelings--with the inefficiency of a planned economy.

Nobody knows precisely how much corporate tax-sheltering goes on. (Offending companies tend not to put out press releases on the topic.) But evidence suggests it has shot up in recent years. Corporations always report more income to their stockholders than to the IRS, but the gap between the two groups' information has widened. Moreover, in the last five years, corporate tax receipts have grown at less than one-fifth the rate of individual tax receipts. Last year, during an economic boom, corporate tax revenues actually fell.

How can this happen? One reason is the mismatch between the cops and the robbers. Clever tax lawyers can make much more money dreaming up tax shelters for accounting firms than they can rooting them out for the government. The schemes, by design, are intricate enough to escape detection by the IRS. They work like viruses: when the tax man ferrets out a scheme, accountants mutate it, and the game begins again. Articles in Forbes and The American Lawyer on the tax-shelter boom suggest that this has created a vicious cycle. As more companies realize they are not likely to get caught, more try tax-sheltering. Meanwhile, the more the practice expands, the thinner the IRS's resources are stretched, making tax shelters safer still.

Tax-shelter proliferation has reached such epidemic proportions that it has actually spurred a backlash among the more conscientious members of the tax profession. A few scrupulous tax lawyers have anonymously leaked details of shelter schemes to the IRS. The tax division of the American Bar Association has begun to crusade publicly against tax-sheltering. Opposition to tax shelters has taken hold in both houses of Congress. The main proponents of reform are the Treasury Department and House Democrat Lloyd Doggett of Texas, but even Roth, normally a slavish ally of business, has announced his support for at least modest reform.

Roth, alas, is an exception among congressional Republicans, who, while avoiding rousing pronouncements in defense of tax shelters, don't want to eliminate them, either. After all, while tax-sheltering may not make sense in terms of economic theory, most Washington Republicans are not free-market purists--they are defenders of business, interested in protecting the interests of the well-to-do above all else.

This can be seen most clearly in the support prominent Republicans exhibit for economically useless practices that benefit the affluent. A new book detailing offshore money havens, for instance, carries blurbs by the Cato Institute's Stephen Moore, the leading supply-sider in Washington, and Republican Representative Billy Tauzin of Louisiana, a proponent of abolishing the progressive income tax. Last February, House Majority Leader Dick Armey obliquely defended tax shelters as well, saying: "The business of a corporation is ... to maximize its earnings for its shareholders. Since tax is a very large part of their costs, anything they can do to minimize that share of their costs would be a legitimate thing." Armey does not claim tax shelters make the economy more efficient; he simply assumes that the interests of corporations are synonymous with the public good.

The job of turning this generalized prejudice into a credible-sounding public argument has fallen upon Kies,and he is perfectly trained for it. Kies began his career with the Cleveland law firm Baker & Hostetler. After Ronald Reagan's election, Kies left for Washington, where he worked for Texas Republican Bill Archer on the Ways and Means Committee. In 1987 he returned to his old firm, this time as a Washington lobbyist. When the GOP took control of Congress in 1994, Archer--now chairman of Ways and Means--plucked Kies to head the Joint Tax Committee. Two years ago, Kies left again, and, after a bidding war among several Washington firms, he chose PricewaterhouseCoopers, with an annual salary reported to approach $1 million.

With his every turn through the revolving door, the boundaries between Kies's role as a corporate representative and as a government official have grown less and less distinct. In 1996, while working on the Joint Tax Committee, Kies took 42 speaking trips, for which business shelled out $57,000 in travel costs--a sum that put him ahead of not only every other staffer but every member of Congress as well. Today, as a private lobbyist, he continues to hold immense sway with Archer. "I've never seen a guy who's got an influence over the tax chairman like he has," says a former federal tax official. It is because of this relationship that most reformers assume no reform bill will pass. Any tax-shelter bill must go through Archer's committee--Kies's home turf.

In one of his recent appearances before Roth's committee, Kies testified that "there is no demonstrated problem with `corporate tax shelters' that would require sweeping legislation." He is careful to always put the phrase "corporate tax shelters" in quotation marks, as if to suggest that the entire notion were a myth. In his K Street office, Kies dryly observes that "Chairman Archer, at least in his public comments, does not appear to be persuaded that there's a need [for a bill]."

Indeed, Archer seems persuaded--probably by Kies--of precisely the opposite. But, then, Kies only provides rationalizations for things that Archer and his GOP colleagues deeply want to believe. Recently Archer assured the Tax Executives Institute that tax shelters are not a problem and, in so doing, summed up his entire worldview. "Corporations are not bad," the chairman explained. "Corporations are very, very good."

Jonathan Chait is a senior editor at The New Republic.