Professor Joe Bankman is one of the nation’s leading tax law scholars. He’s also among the most effective—helping write a tough new tax shelter law that netted California $1.5 billion last year.

The saying, “Nothing is certain but death and taxes,” may have been true when Benjamin Franklin coined the phrase in 1789, but with today’s fancy tax shelters, it sometimes seems as if certainty has been confined to death alone.

Couple an increasingly arcane tax system that can be manipulated by sharp accountants and attorneys with a growing number of wealthy individuals and corporations looking to pay fewer taxes—and it’s no wonder that tax shelters have become big business—so widespread that state and federal governments are losing tens of billions of dollars each year in uncollected taxes.

Joseph Bankman is trying to change all that. Bankman, the Ralph M. Parsons Professor of Law and Business at Stanford Law School, is one of the nation’s leading tax law experts. His scholarly research and writings have had a major impact in academic circles, and his real-world proposals for more severe tax shelter penalties and simplified filing have inspired lawmakers to enact tougher laws and approve a pilot program that might benefit millions.

When California found itself in the middle of a huge fiscal crisis in 2003, Bankman joined forces with two state legislators to author a groundbreaking bill that imposed severe penalties on users and purveyers of tax shelters, along with an amnesty program for tax shelter users who paid up. The amnesty program has netted the state about $1.5 billion. The huge take, collected from about 1,000 individuals and corporations looking to avoid hefty penalties, was vastly more than the $90 million the California Franchise Tax Board predicted would be recovered.

The offer for tax evaders to come clean before the April 15, 2004, deadline was hailed by the Los Angeles Times as “one of the most wildly successful programs in memory—an incidence of Sacramento thinking smart.” The program made a noticeable dent in the $14 billion shortfall the state had anticipated for its 2004–05 budget, and is being offered again for the 2005 tax season. It earned Bankman and his coauthors—Assemblyman Dario Frommer (D-Glendale) and Senator Gil Cedillo (D-Los Angeles)—widespread kudos for foiling the state’s tax evaders, one of whom coughed up a check for $30 million to cover his abuses.

“The success of the program showed how good he [Bankman] was,” said Frommer. “He rolled up his sleeves, held lots of meetings with different stakeholders, and helped us do this right. We now have one of the toughest penalties in the country, not just for people using tax shelters, but for the promoters of tax shelters as well.” Bankman was as pleased as anyone at how lucrative the amnesty program turned out to be. But it didn’t exactly surprise him. “It just goes to show how many tax shelters are out there and what a huge market exists for them,” he said.

THE MAKING OF A TAX WATCHDOG

Bankman, 49, was born in Iowa, the son of a camera store owner who had a passion for business and a belief that everyone ought to pay his fair share of taxes. He went on to earn his BA from the University of California at Berkeley in 1977 and his JD from Yale three years later. The easy going academic, whose common-sense approach and chummy manner belie the rigor of his scholarship, started his career as a tax attorney in Los Angeles. He joined the law firm of Tuttle & Taylor as an associate in 1980, and soon discovered

an affinity for academia while coteaching a course on tax policy at the University of Southern California. He left practice in 1984 to teach fulltime at USC and in 1989 moved to Stanford Law School, where he has been ever since.

“He [Bankman] is one of a handful of top tax law academics in the country,” said David Weisbach, professor of law and director of the Law and Economics Program at the University of Chicago. “His work has been influential in a variety of fields.”

Reuven Avi-Yonah, professor of law at the University of Michigan, agreed: “He wrote two of the most famous articles in tax law in the past 50 years.” Both articles were coauthored with Thomas D. Griffith, professor of law at USC. The first, published in 1987, was “Social Welfare and the Rate Structure: A New Look at Progressive Taxation,” in California Law Review. The  second, published five years later in the Tax Law Review, was “Is the Debate Between an Income Tax and a Consumption Tax a Debate about Risk? Does It Matter?” Bankman’s reputation as one of the top experts in tax shelters was solidified with the publication of a third groundbreaking paper, “The New Market in Corporate Tax Shelters,” in Tax Notes in 1999.

Bankman has found ingenious ways to share his intellectual preoccupations with his two sons—Sam, 12, and Gabe, 9—both loyal San Francisco Giants fans. In 2002, he published a lighthearted op-ed in the San Jose Mercury News on a possible baseball strike, suggesting a high tax on teams and players that went on strike. The tax could be avoided—but only if for each game missed, teams offered nickel hot dogs to fans for a game, and players donated money to local charities. He wrote, “I’ve spent my lifetime writing obscure tax articles. This is my one chance to be a hero to my kids. Go Giants!”

WHAT IS A TAX SHELTER? 

Bankman’s work asks the seemingly simple question, “What is a tax shelter?” Some consider any tax-favored investment, such as an IRA or a home mortgage, a shelter. Others say that when a company moves offshore, it is finding a tax shelter. But according to Bankman these transactions don’t qualify as tax shelters. “By investing in an IRA and taking tax benefits, a taxpayer is simply following the incentives that Congress set up. The same is true when a company relocates offshore,” said Bankman. 

The types of dealings that Bankman has his eye on are paper transactions, unrelated to a taxpayer’s ordinary business or investments, that involve no real assets and no possibility of economic profit or loss. These deals produce huge tax losses in a manner that is inconsistent with legislative intent and existing case law, says Bankman. Most shelters involve what are called third-party accommodation agencies, such as foreign banks, whose role as an intermediary in the transaction is required for the elaborate schemes to work.

The shelters allow large companies to play shell games with profits, often channeled through offshore institutions in far-flung locales like Bermuda, the Cayman Islands, or Panama. The Cayman Islands, in fact, are now the fifth-largest banking center in the world, indicating just how pervasive offshore shelters have become, according to David Cay Johnston, the Pulitzer Prize–winning reporter for The New York Times, who probed the tax shelter business in his book Perfectly Legal: The Covert Campaign to Rig Our Tax System to Benefit the Super Rich—and Cheat Everybody Else.

The demand for tax shelters has exploded in the past two decades. The enormous wealth generated in the 1990s economic boom only fed the hunger. As more people earned more money, they sought new and improved ways—however dicey or inconsistent with the intent or common understanding of the law—to protect their gains, and abusive tax shelters proliferated.

“It’s a little like the ‘perfect storm,’” said Bankman. “The right elements came together at the right time.” As a result, the market for tax shelters has “gone retail,” as he puts it, with schemes so complex, they go over the heads of many of the clients who purchase them. An entire industry has evolved, comprised of accounting firms, banks, and law firms charging a king’s ransom to keep the wealthy one step ahead of the IRS. And the market is growing. Individuals with as little as $10 million in capital gains to shelter can benefit from these products, which are marketed openly and aggressively. Shelters have outstripped audits as the biggest income generator at some of the nation’s most respected accounting firms, according to reports in The Wall Street Journal. A February 7, 2003, Journal article on the tax shelter business revealed that, in 2000, BDO Seidman’s tax sales team, dubbed “the Wolf Pack,” managed to rake in more than $100 million in tax shelter sales, accounting for more than half of the firm’s tax revenue.

TAX SHELTERS ARE BIG BUSINESS

Bankman was the first academic to put a price tag on tax shelter activity. In a 1998 Forbes magazine cover story about corporate tax setups, he estimated the government’s lost revenue at $10 billion a year—the first time anyone had attempted to calculate the overall costs of tax shelter abuse.

Bankman says he wouldn’t have attempted to pinpoint a specific number at all if it hadn’t been for Larry D. Kramer, former law professor at New York University and now Richard E. Lang Professor of Law and Dean of Stanford Law School.

“It was Larry who convinced me to go public with the $10 billion figure,” said Bankman, who met Kramer in 1998 while Bankman was a visiting professor at NYU. “He said it would be important for policy purposes, that it would give the issue a kind of relative merit important to legislators, which otherwise would have been tough to get.”

Kramer said he knew politicians would normally “gloss over Joe’s claim as just another academic piece,” if no number were attached to it. Luckily, he says, Bankman possessed just the right mix of modesty and moxie to bridge the disparate worlds of academia and government and get the issue on the table. “Most people manage to get their feet planted firmly in one world or the other, and it’s hard to be taken seriously in both,” said Kramer. “But Joe is a respected academic who also does just as much important work in the policy world—a pretty unusual combination.”

As Kramer predicted, the $10 billion figure took on a life of its own, earning Bankman high-level supporters, as well as enemies. Lawrence H. Summers, former secretary of the treasury for the Clinton administration and current president of Harvard University, cited Bankman’s figure repeatedly in official speeches and Treasury Department reports, calling shelters the biggest threat to the tax system. But naysayers like prominent Washington, D.C., tax lobbyist Ken Kies also chimed in, attacking the accuracy of Bankman’s figure, saying it underestimated the recent progress government had made in reeling in the most egregious abuses.

For Bankman, who first began pursuing the topic while conducting academic research on the role of accountants in tax evasion, his snowballing notoriety gave him leverage in raising awareness of the issue among legislators. In 2003, he helped California write the first modern anti–tax shelter statute, which substantially increased penalties for transactions that fail to pass muster under existing law.

“In the past,” said Bankman, “corporate shelters were mostly plays on the so-called audit lottery. Taxpayers knew the shelters were unlikely to survive government challenge. They hoped the deals wouldn’t get noticed on audit and knew the worst case outcome was a 20 percent penalty, in addition to the tax they owed.”

The California statute, along with new methods for detecting shelters, make the audit lottery much less attractive. However, the system faces a new challenge. Some courts are throwing out anti–tax shelter doctrines that have been part of the law for more than 50 years. These courts find the doctrines overly vague and inconsistent with a literal reading of the statute on which the taxpayer relies.

“The problem with this approach,” said Bankman, “is that the income tax is riddled with potential loopholes. Without these doctrines, a shelter that is based on a loophole will work. By the time Congress has plugged one loophole, shelter promoters will have found another, which will work until it is plugged. Making the income tax loophole free is like retrofitting all of the buildings in California to make them earthquake proof. There aren’t enough resources in the world to do it. And all it takes is one shelter, if it is known ahead of time to work, to siphon off most of the corporate tax revenues.”

In the short run, Bankman favors keeping and enforcing existing doctrines as a way to safeguard the public treasury. In the long run, Bankman sees substantial tax reform as the only solution to the tax-shelter problem.

SIMPLIFYING TAX FILING

Whichever direction the shelter battle goes, Bankman isn’t stopping there. He is currently helping to devise a simplified tax-filing plan for California, called Ready Return, which he says will eliminate the headaches associated with tax form preparation for more than 3 million Californians. Many individuals, especially those for whom the mere mention of April 15 induces a cold sweat, are sure to like Ready Return. It’s a safe bet, however, that tax preparation firms won’t like it because it would cut into their fees.

“Filing a tax return now is difficult even for taxpayers with simple returns,” said Bankman. “The taxpayer has to save the W-2 and 1099s, find the right return to file, and so on. A large portion of the population cannot even understand the instruction booklet that accompanies the forms.”

Bankman’s solution is a tax filing system designed for wage income earners who do not itemize deductions. With the Ready Return, the state wouldn’t wait for those individuals to send in a tax return. Instead, it would send them a bill, which they could simply pay.

Since the state already keeps track of income from employers as well as past filing information, it already has a pretty good idea of what these individual taxpayers owe, even before they fill out all the tedious paperwork. With the Ready Return, the state would calculate the tax liability for each of these tax-payers, and send each one a return with the amount of tax owed, or refund due, already filled in. The taxpayer would then have a number of options. He or she could sign and return the form, use the form as a starting point from which to calculate his or her tax liability, or give the return to his or her preparer to check.

The proposed system, which would also be available online, would be voluntary. If a taxpayer preferred, he or she could simply throw away the Ready Return and file a traditional form instead. Bankman says the system would be cheap for the state to maintain, and would not pose any privacy concerns, because it relies only on information the state already has on file.

Bankman helped convince the state tax authority to allocate $200,000 on a pilot program to test the proposal. Ten thousand taxpayers will get a Ready Return during this filing season; another 10,000 similarly situated taxpayers will serve as a control group to measure the impact of the program. The pilot program was opposed by Intuit, maker of TurboTax and other tax preparation programs. Intuit argued that the program interferes with private enterprise, and is expected to oppose any full-scale enactment of the Ready Return.

But Bankman has been through this sort of thing before. His battle with accounting and law firms over tax shelters has provided him with a wealth of experience in the rough-and-tumble world of public policy. And he remains mostly upbeat in spite of it all. “I think the folks in the pilot pro- gram are going to love the Ready Return. And if our survey data shows this is true, we’ve got a pretty good chance of getting the state to move forward,” said Bankman. Once that happens, one can be sure that he will turn his sights on yet another part of the tax system that needs fixing.