Politics

The Mystery of the Free Lunch

By

President Reagan's inauguration was a landmark in the history of conspicuous consumption. It signaled the total rehabilitation of lavish extravagance after half a century when practices like sipping champagne in a limousine were in mild or severe disrepute. They had to pick the east coast clean to find enough limousines to satisfy the demand from people who had flown in from around the country, often in private planes, to attend more than 100 fancy parties, crowd into restaurants that charge $40 or more for a meal, and lay down their heads in triple-digit hotel rooms. The man from Ridgewell's, Washington's leading caterer, summarized the prevailing philosophy for a Washington Post party reporter: "Rather than shrimp salad, they want the whole shrimp."

When I read about people living this way, I often think it would be nice to do the same, and then I think it's unfair that some people can and others can't. Everything's relative, of course, and many might have the same thoughts if, for some reason, my lifestyle were chronicled in the newspapers. To me, these two reactions seem perfectly human and perfectly connected. But to conservatives they are very different. The first thoughtI would like to live like thatis called "incentive," and is considered crucial to the proper functioning of a capitalist economy. The second thoughtIt's unfair that some can and others can'tis called "envy," and is considered a dangerous symptom of that political infection known as "egalitarianism" or, in Irving Kristol's phrase, "infantile liberalism."

The social role of rich people and lavish living is a topic that is much on the minds of conservatives these days, and plays an important part in Reagan's economic policies. George Will wrote recently:

A society that wants to be extraordinarily productive and prosperous should resolve to ensure that those who produce extraordinarily also prosper extraordinarily. [That's "incentive."! Alas, an irrational and costly (especially to the non-rich) resentment of the rich [that's "envy"] has prevented implementation of sound policies, including substantial cuts in corporate taxes.

No longer. Reagan's tax plan involves massive cuts in corporate taxes and other changes frankly intended to make it easier to get rich and stay that way. These cuts are supposed to be so helpful to the non-rich that the least rich are being asked to accept "austerity" (the Reaganites' own word) to help pay for them.

Such thinking and such policies rest on many assumptions. Some are deep philosophical assumptions about things like the nature of human inequality. Some are technical economic assumptions about things like the incentive effects of tax rates. But one is a simple factual assumption: that in America today the greatest consumers of wealth are also the greatest producers of wealth. Both the moral case and the economic case for financial inequalityand the case against "envy" as a legitimate response to conspicuous luxuryrest on this, assumption. High living is a reward for socially useful activity, and an encouragement for more of the same.

But you can admire the productive power of capitalism, and still wonder how much of the lavish consumption you see and read about is really financed by productive activities that benefit the general populace in the textbook manner. If it's not, then the case against "envy," or "infantile liberalism," or other unattractive labels for skepticism about the social value of financial inequality, becomes somewhat weaker.

Let's look again at the extravagance surrounding the Reagan inauguration, for example. One striking conclusion is that much of it1 would say most, but I can't prove thatwas somebody's tax-deductible business expense. It is tempting to say that this means the average taxpayer was paying part of the freight (46 percent in the case of a corporation; up to 70 percent for a rich individual). But this sort of suggestion enrages conservatives. Irving Kristol complains in Two Cheers for Capitalism, in excited italics, that with such talk, "You are implicitly asserting that all income . . . belongs right to the government. . . ." So let's just stay calm and agree that there are two kinds of moneyBefore Tax (BT) and After Tax (AT)and that BT money buys a lot more goodies than AT money. Anyone who denies the reality of this distinction either hasn't experienced the joys of tax-free consumption (and I have spied Professor Kristo! at more than one BT social occasion around Washington) or is lying.

A few weeks ago I had lunch with the editor of a rival publication I sometimes write for. It was a nice restaurant, a treat for both of us. He suggested we split the check. Instead, I paid the whole thing and will deduct it as a business expense ("lunch with customer, $25"). This will reduce my taxes by about the cost of his lunch. If (unlikely, but let's suppose) he picks up the check next time ("lunch with supplier, $25"), we will have lunched twice for the same cost as if we'd lunched once and split the check. Who is paying for that second lunch? I wouldn't presume to say. It must have something to do with supply-side economics.

Reagan's inauguration can be seen as an elaborate round-robin version of the free lunch mystery, which has puzzled philosophers of accounting for centuries. For days the same people took turns entertaining one another while deducting the cost of the entertainment, the cost of getting there to provide it, the cost of staying to enjoy it, and so on. Many were corporate executives who passed on the pleasure of deducting the cost to their stockholders, and some were freeloaders with nothing to deduct. But what all shared was luxury paid for with BT moneymoney that had never passed through the tax system.

 

In the three days of January 19, 20, and 21 the Washington Post Style section had no fewer than 36 separate articles about different parties connected with the inauguration. By my conservative count, 14 of these were paid for entirely with BT money, two probably were BT, and another 11 were BT in large part. Only nine seem more likely to have been paid for with the kind of money you use for your night at the bowling alley. The "definitely BT" category includes affairs sponsored by corporations and trade associations such as a lavish brunch at the Four Seasons Hotel sponsored by NBc, a movie screening and champagne reception at the Motion Picture Association, and a modest cocktail party for 300 or 400 thrown by The New Republic. Fortune magazine ran a color photo essay featuring some of these functions under the title, "Business Goes to Washington," Ford chairman Phillip Caldwell (1980 losses: $1.5 billion) was quoted commenting with pleasure on the new mood Reagan had brought to Washington: "Hope feeds on itself, just as defeat feeds on itself," Caldwell, however, was feeding on poached steelhead salmon, or, in the other sense, was feeding on the Pepsi Cola Company. He did not feed on himself all week.

Another "definitely BT" affair was a "sumptuous" (said the Post) dinner given by Roy Cohn and his law partner at the Madison Hotel. Cohn, who is innocent of a variety of federal crimes, takes an "I dare you" attitude toward deductions. He told the New York Times recently that his firm pays him a salary of $75,000 to $100,000, but picks up (and deducts, I presume) $500,000 a year of his expenses, including houses in New York, Connecticut, and Acapulco,

In the "probably BT" category, there was a "Californians are Coming" party for 300 given by a California PR man named Peter Hannaford, A California PR man certainly would be entitled to deduct the opportunity to cultivate other prominent Californians, even though many of them were already his good friends.

The "partially BT" category includes events paid for by the inaugural committee itself, which was largely financed by tax-deductible contributions. For example, there was a "lavish buffet" at the State Department for VIPs to view the pre-inaugural fireworks. Tickets were sold for other inaugural events, such as the inaugural gala ($150 top) and dinner at the Kennedy C enter ($500). It is common for companies to buy and dispense such tickets. Good for business, you know. As the inaugural chairman. Bob Gray, said between bites, "Guilt? . . . No, Lord, . . . I had a sign made for my desk today: 'No government money, all private enterprise.'"

In such a world, what is not deductible? Well, Clement Stone, the insurance tycoon, gave a party for 250 at the Georgetown Club, and I wouldn't want to assume that he deducted it, although he probably could. Not one inaugural week self-indulgence reported in the Post was totally without possibilities for creative accounting.

The 36 parties do not include the coffee and donuts served Wednesday morning at National Airport to those waiting for their private planes to take off. These were BT donuts, of course, supplied by the airport management to pacify angry private plane passengers delayed by the crush. Commercial passengers, equally delayed though not equally responsible, were free to purchase coffee and donuts, AT.

 

Almost all of the 305 private planes departing from National on January 21 were registered to corporations, according to forms on file at the airport. Two patterns predominate in these records. Planes owned by large corporations like General Motors and General Electric swooped in with just a pilot and co-pilot, loaded up with passengers, and took off almost immediately. Some corporations ran shuttle services. US Steel, for example, took off four times during the day. Smaller companies generally had brought in a small plane on January 17, the day the partying began, and parked it at the airport until returning home January 21. Thanks to a multi-billion dollar annual federal subsidy to private aviation, it costs four dollars to land a small plane at National Airport, and $6.50 a day to park it. Parking a car at National costs about the same.

Now, perhaps six people from the Dome Petroleum Company of Denver and six from the Mossbacher Products Company of Houston and eight from Harrah's Hotel of Reno, Nevada, had important business reasons to be in Washington that week, and perhaps all are allergic to commercial boarding passes. Or perhaps all the passengers (such as Bob Hope, who rode back to Palm Springs with the Spanos Construction Company) either reimbursed the company for their flights or plan to declare the value as income next April. If not, these flights amount to tax-free consumption. Other planes departing that day were registered to familiar and unfamiliar names such as the Reader's Digest (two planeloads). Mustang Gas Products of Oklahoma City, Dow Chemical (three). Hooker Chemical, the King Ranch, Gulf States Toyota of Houston, Caesar's World Inc., William Moss Properties of Dallas, Hoffman-LaRoche, Pillsbury, West Texas Marketing Gorp. of Abilene, and so on.

The inauguration festivities were not unique. Read the papers for a few days with the BT/AT distinction in mind, and you will realize that most of the visible high living that goes on in this country is paid for with money that has never been taxed. Almost ail the gatherings of show-business celebrities that fill the "People" or "Personalities" section are somebody's tax-deductible business expensea movie company or a PR person or a theatrical producer. The same is true of many executive pastimes reported in business publications. A recent Wall Street Journal article on the demand for tickets to the Masters golf tournament reported, "On the weekend before the tournament, corporate executives start arriving in their private jets and, clients in tow, head for rented condominiums and a week of golf and business palaver." Another group with a rewarding BT lifestyle is journalists. They lunch with sources, travel on assignments, assemble regularly for mawkish BT celebrations of their trade, and are wined and dined at social occasions where their very presence is what makes the affair a tax-deductible business expense for their host.

A growing opportunity for tax-free high living is, of all things, charity and, in particular, corporate contributions to the arts. Two consulting firms in Washington alone specialize in lining up corporate sponsors for artistic groups or events, then staging elaborate parties to celebrate the connection. Corporate executives and their entourages fly in for the occasion and invite friends, politicians, journalists, and so on to wine and dine and hear speeches about private enterprise and culture. It's all BT. The cost of such a do is about $100 to $125 a person for "medium-level" food, wine, booze, waiters, flowers, guards, fees for the use of one of Washington's ceremonial buildings, and so on. A "nice" cocktail reception can be done for only $25 to $50 a person. Masterpiece Theater is made possible by a grant from Mobil Oil Corporation, but the frequent trips to England by Mobil's culture vultures to chat up BBC executives, view videotapes in screening rooms, and see what s new on the London stage are made possible by BT bucks.

Most industries in what might be called the luxury sector of the economy are deeply dependent on untaxed money. Of the consumer items associated with high living, only wearable clothes, furs, and jewelsare really rarely paid for with BT money. (Though even here, the Wall Street Journal has reported an arrangement whereby corporations lease business suits for their executives.) Relatively little luxury housing gets written off as a business expense. However, "business" apartments are quite common in resort communities and major cities here and abroad; and how to get deductions for second homes is a perennial topic in tax advice publications. Similarly, most luxury cars probably are paid for AT, but many self-employed professionals and small-business men manage to write off hefty chunks of their Cadillacs and Mercedeses, and top corporate executives often get company cars or limousines.

At the opposite extreme are luxury restaurants, almost all of which would fold if they had to rely on AT customers. In a city like Washington, 80 to 90 percent of the lunch crowd and perhaps half the dinner crowd at top restaurants is eating on "business." This is an unscientific estimate, but experienced Washington trencher persons don't challenge it.

The travel industryairlines, hotels, resortsis only somewhat less dependent than restaurants on tax-deductible customers. As with restaurants, the fancier the circumstances, the more likely the money is BT. According to the Air Transport Association, 55 percent of commercial air travel was for business purposes in 1979, up from 46 percent in 1973. Some of this represents traveling salesmen or computer engineers off to training sessions in Topeka, but much of it is doctors and lawyers heading for conventions in Hawaii and corporate executives attending conferences at the Greenbriar. The airlines won't say whether business is more heavily represented in first class or coach, but the question answers itself. The hotel industry has been developing its own equivalent of "first class" in recent yearsa special section of rooms with extra services like little chocolate bars on the pillow at night. The newly opened Marriott in downtown Washington charges $30 extra a night (about $125 for a double room) for its "Concierge Level." According to the Wall Street Journal, "Hotels say the bulk of luxury customers are on expense accounts." Surprise, surprise.

The Hyatt Hotel Corporation advertises as follows in the February issue of an airline magazine:

FOR YOUR NEXT BUSINESS MEETING

Lake Tahoe the way it was . . . and still is, 460 newly appointed rooms and suites on the North Shore, plus a Regency Club Level with Concierge and a special touch of Hyatt.

2 nearby Robert Trent Jones golf courses and 26 tennis courts close to the hotel. Our own beach for swimming, water skiing and water sports. A heated pool. 6 nearby ski areas, cross country skiing and snowmobiling. Indoor and Outdoor Theme Parties. . . .

Hyatt's notion of a "business meeting" is useful in interpreting another ad Hyatt placed in February, this one in the New York Times, celebrating President Reagan's economic program:

There's a new spirit in America. The nation is charged with a strong new determination; ready to go to work and spur the growth of a new prosperity.

It's back to business. . . .

Business? What do Indoor and Outdoor Theme Parties have to do with business? Where does the enormous amount of lavish living that goes on free of taxation, much of it existing only for that reason, fit into the prevailing mythology that we need to worry less about the have-nots and more about the haves in order to rebuild the economy? There is a conceptual trap awaiting inequality buffs here. If such luxury is considered compensation for services rendered, to specific businesses and to general prosperity, then the money that pays for it should be subject to tax like all other compensation. We can argue about the proper tax rate, as of course we are doing these days, but even the Laffer Curve recognizes that a tax rate of zero is not fiscally sound.

 

Fearful of this logic, connoisseurs of the BT high life tend to portray themselves as characters in a Bunuel movie, dragging from one lavish event to the next and deriving no pleasure at all from the constant travel, socializing, fancy dining, and so on they are forced to endure as part of their contribution to the economy. The Wall Street Journal tax column recently told of a Santa Monica surgeon who deducted $2,533 in expenses connected with playing golf twice a week at his country club. He claimed that golf was "a chore" that he endured in order to cultivate patients and other doctors. The tax court denied the deduction, but only because he had insufficient records.

"Business" high living, therefore, cannot be regarded as an appropriate reward and necessary incentive for productive activity. So what is its social value? Let us not be so unfashionable as to reintroduce here the fundamental question of fairnesswhy the people who can most easily afford luxury anyway get so much of it tax-free, while more modest lifestyles are paid for with post-tax money. Instead, let us consider the problem from a strictly supply-side point of view. From this perspective, favored tax treatment for"business"luxury has three defects.

 

First, it encourages consumption over productive investment, at a time when the nation requires the opposite priority. Should Pickaname Corporation spend $100,000 on modernizing its rusty plant, or on a lavish weekend at the Superbowl for Mr. Pickaname and some "clients"? Ordinarily the government doesn't try to second-guess businesses about how they spend their money, figuring that they know best how to maximize their profits, and therefore the government's tax take. But Mr. Pickaname is not likely to make a cool and rational business decision here if one option will let him stage a grand exercise in hospitality at about half of what it would otherwise cost him. If Mr. Pickaname has passed from the scene, and his firm is now run by professional executives, their preference for the Superbowl weekend is likely to be even more pronounced, since it won't cost them anything at all. Furthermore, even when "investing" in lavish entertainment is a sound decision for an individual business, it rarely brings any return for the economy as a whole. At best, competitive orgies of consumption merely redirect demand; they do not create new supply.

Second, tax-free "business" consumption is inflationary. A customer who is paying only about half the cost (if he deducts it), or none of it at all (if she's on expense-account) is not going to be as sensitive to prices as people who have to pay with their own after tax money. By any standard, the value-for-money ratio at establishments that cater primarily to business customers is lower than at places where most people pay their own way. The cost of a fancy meal or top hotel room has outpaced most consumer prices in recent years, whereas restaurant meals in general, for example, have lagged behind.

Third, business consumption deductions reduce tax revenuesabout three billion dollars a year for meals alone. This money could be used to cut marginal tax rates or to reduce the federal deficit, the two key conservative economic nostrums. Of course the money could also be used in other ways. The Congressional Black Caucus has proposed making restaurant meals only half-deductible, and using the money to restore Reagan's cuts in spending for child nutrition. But 1 suppose that suggestion smacks of envy.

Periodic crackdown attempts over two decades have added verses of sonorously forbidding language to the statute and regulation books. In practice, though, almost any sort of self-indulgence remains deductible. For example, the regulations state quite sternly that for a social occasion to be deductible, the "active conduct of business" must be the "principal aspect" of the occasion. The atmosphere must be "conducive to a business discussion." But read on. "Principal aspect," it develops, does not mean more than half of the time. And social occasions of any sort are deductible if they are "preceding or following a substantial business discussion." So are meals while traveling on business, and almost anything to do with a convention, and on and on.

And how about this passage from the IRS regulations for taking away with one hand and giving back with the other?

41. Question: Are there limitations on deductions for entertainment expenditures which are lavish or extravagant?

Answer: Yes. To the extent that the expenditure is lavish or extravagant it is not allowable as a deduction.

42. Question: Will entertainment expenses be subject to disallowance on grounds of being lavish or extravagant merely because they exceed a fixed dollar amount or are incurred at deluxe restaurants, hotels, night clubs and resort establishments?

Answer: No. An expense for entertainment will not be considered lavish or extravagant merely because it includes first class accommodations or services. An expense which, considering the facts and circumstances, is reasonable will not be considered lavish or extravagant.

The most complex rules surround the recondite question of deducting club dues. Business use of the club must be computed two different ways, one to determine whether the dues are deductible at all, and the other to determine how much. This can be a nuisance, but it Isn't much of a limitation. Unofficial tax guides contain pages of hints like this:

Make a point of having a quiet business lunch on the same day as you play golf. That makes it a directly related day. ANOTHER POINT: a few drinks . . . at the bar can also transform a casual golf date into a full-fledged business day.

The rules for writing off yachts and hunting lodges used to be the same as for club dues. But the only crackdown that survived from President Carter's "three martini lunch" campaign (besides a restriction on foreign conventions that was mainly for the benefit of the US tourist industry) was a new rule disallowing all deductions for fun-and-games "facilities." Even here, however, there is an exception for "out-of-pocket costs" of entertaining at such facilities. In the case of hunting lodges, this includes the guides, the dogs, the guns, the bullets, the food, the booze, the loose women, the private planes to get therein short, almost everything except the roof.

Even under present rules, with their loopholes and self-immolating limitations, the IRS estimates that 20 percent of all entertainment and travel deductions people take are illegitimate. The problem is not that the rules are too lax or that they're not enforced, but that such rules are conceptually unenforceable. How long must angels talk business before they can deduct the cost of going out dancing on the head of a pin? Faced with meaningless concepts like "principal aspect," impossible demands for precision in apportioning life's moments between business and pleasure, and restrictions on what counts as "business" that only a clairvoyant could supervise, taxpayers naturally treat themselves generously. The IRS, boxed in by the statute and by limited enforcement resources, is powerless to prevent billions of dollars a year of the most superfluous consumption from being subsidized by the taxpayers. (Sorry Mr. Kristol, that just popped out.)

 

Money spent on meals, parties, sports tickets, vacations, and lavish living in general should not escape taxation. Permitting so much of it to do so is both bad for the economy and, just by the way, terribly unfair, A few very simple and easily enforceable rules would solve the problem. Expenditures for food and entertainment should not be deductible unless they are also reported as taxable income to the recipients. Deductions for business travel should be limited to some modest but not spartan standard, such as coach air fare plus the daily allowance the government sets for its own employees. One or two conventions a year should be all that is considered necessary for fraternal comity within the professions.

There are three standard objections to proposals like these. One is that jobs in the luxury industries would be sacrificed. The answer is that subsidizing extravagant consumption by the already prosperous is a silly and costly way to create jobs for the deprived. A second objection is that some truly legitimate and necessary business spending would be caught unfairly in the tax maw. The answer is, not much, not nearly so much as the properly taxable consumption that now escapes, and not the kind that really contributes to national prosperity. A third objection is that defining consumption is an impossible task, and cracking down on only certain kinds is unfair. Should executives be taxed on offices beyond a certain size, or carpet above a certain thickness? Should doctors have to declare the value of their satisfaction at saving lives or their status in the community? The simplest answer to this is that the people who enjoy these inchoate forms of business income are the same ones who have been deducting the more material gratifications of their caste. Starting to tax just one category of income of this sort makes the tax code more fair, not less fair.

If people still wished to live high on the hog, they would be free to do so. Relieved of the need to pretend that they're not enjoying it, they could instead reflect that this was their just reward for their contribution to society, as accurately measured by a free market economic system. Whether this reflection would have any basis in fact is a question for another day.

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