Congress puts taxpayers on the "honor system"
"Charitable Giving Tax Perk May Prove Ineffective, Hard to Police" Bloomberg Tax, 4-2-20, Allyson Versprille and Sam McQuillan
"A new $300 tax break for people who make charitable donations adds to the IRS's workload while not necessarily boosting the nonprofit sector. The above-the-line deduction . . . was included in the third coronavirus response package (Public Law 116-136) and applies for tax years beginning in 2020. Since the existing charitable giving deduction is only available to those who itemize their taxes, the change makes the tax incentive more widely available. But some are skeptical about what it will do and say it will be nearly impossible for the IRS to prevent tax cheats from claiming the perk, given past experiences with similar measures."
"The US Federal Reserve's Debt Purchases Are a Warning"
David Ahn, Robert H. Dugger, Project Syndicate, March 9, 2020
"The US should . . . start a war on short-termism, by enforcing the tax laws already on the books. In 2019, tax evaders cost fellow citizens over $600 billion per year. Allowing such levels of tax theft is corrosive and encourages cheating across the board. How can we ask anyone to obey tax laws, or any laws for that matter, if tax cheaters can steal with impunity?
Without doubt, the activities of tax criminals contribute to the kind of generation-burdening "excessive debt" that Alexander Hamilton warned against in his first letter to Congress as Secretary of the Treasury. In fact, collecting what is owed would reduce the $900 billion deficit the US is now running by two-thirds. At the same time, it would confirm for the public that the US is serious about the rule of law and basic fairness, and set the tone for the shift in budget priorities that the US urgently needs." https://www.project-syndicate.org/commentary/america-debt-warning-for-future-generations-by-david-ahn-and-robert-dugger-1-2020-03
San Francisco Chronicle, Editorial: New report shows IRS is missing in action, Jan. 13, 2020 "The chances of getting away with cheating on your taxes have never been better. Thank anti-IRS Republicans who've steadily chopped the tax agency's budget for years. The mess erodes public faith in government, cuts money for needed programs and punishes honest taxpayers, while rewarding scofflaws."
The Director of the IRS whistleblower office, Lee Martin, issued its FY 2018 annual report and announced that the IRS collected $1.441 billion in taxes, penalties and interest from big-time tax cheats in FY 2018 thanks to information provided by whistleblowers. Director Martin announced $312 million in awards made to whistleblowers in FY 2018 – up from $33.9 million in awards made in FY 2017. Tax whistleblowers received from the IRS an average award of 21.7% based off of $1.441 billion in taxes, penalties and interest that were collected in FY 2018.
HOUSTON, Dec. 4, 2019 /PRNewswire/ The law firm of Zerbe, Miller, Fingeret, Frank & Jadav (ZMF) announced today that a group of whistleblowers received an award of more than $25 million dollars based on their information that led to the collection by the Internal Revenue Service (IRS) of more than $165 million dollars in corporate income taxes. The whistleblowers provided key information to the IRS about big-time tax cheating involving hundreds of millions of dollars in improper deductions made by a major U.S. corporation.
Symbol of '80s Greed Stands to Profit From Trump Tax Break for Poor Area
The New York Times
By Eric Lipton and Jesse Drucker, Oct. 26, 2019
"Michael Milken, who went to prison in the early 1990s for violating securities and tax laws, has worked to rebuild his reputation through the Milken Institute. In the 1980s, Milken embodied Wall Street greed . . . he was charged with playing a central role in a vast insider-trading scheme and was sent to prison for violating federal securities and tax laws."
"These days, the Milken Institute is a leading proponent of a new federal tax break that was intended to coax wealthy investors to plow money into distressed communities known as "opportunity zones." The institute's leaders have helped push senior officials in the Trump administration to make the tax incentive more generous, even though it is under fire for being slanted toward the wealthy."
"Mr. Milken, it turns out, is in a position to personally gain from some of the changes that his institute has urged the Trump administration to enact. In one case, the Treasury secretary, Steven Mnuchin, directly intervened in a way that benefited Mr. Milken, his longtime friend. The former "junk bond king" has investments in at least two major real estate projects inside federally designated opportunity zones in Nevada, near Mr. Milken's Lake Tahoe vacation home."
"The Treasury Department ignored its own guidelines on how to select opportunity zones and made the area eligible for the tax break. The unusual decision was made at the personal instruction of Mr. Mnuchin, according to internal Treasury Department emails."
For the first time in history, U.S. billionaires paid a lower tax rate than the working class last year
by Christopher Ingraham, The Washington Post, Oct. 8, 2019
"The top 400 families have more wealth than the bottom 60 percent of households, while the top 0.1 percent own as much as the bottom 80 percent. . . . [T]he tipping point came in 2017, with the passage of the Tax Cuts and Jobs Act. The legislation, championed by President Trump and then-House Speaker Paul D. Ryan (R-Wis.), was a windfall for the wealthy: It lowered the top income tax bracket and slashed the corporate tax rate."
"FBI accuses wealthy parents, including celebrities, in college-entrance bribery scheme"
Delvin Barrett and Matt Zapotosky, Washington Post, March 12, 2019
"The Justice Department on Tuesday charged 50 people — including two television stars — with participating in a multimillion-dollar bribery scheme that enabled privileged students with lackluster grades to attend prestigious colleges and universities. . . . The scheme's chief architect, William Singer, pleaded guilty in federal court Tuesday. Officials described Singer as a well-connected college admissions adviser and say he disguised the bribery scheme as a charity, enabling parents to deduct the bribes from their taxes."
"Paul Manafort Is Sentenced to Less Than 4 Years"
By Sharon LaFraniere, March 7, 2019, New York Times
"Alexandria, Va. — Paul Manafort, the political consultant and Trump presidential campaign chairman whose lucrative work in Ukraine and ties to well-connected Russians made him a target of the special counsel, Robert S. Mueller III, was sentenced on Thursday to nearly four years in prison in the financial fraud." "Mr. Manafort was indicted on 18 counts in the Northern Virginia case, but the jury convicted him on only eight: five counts of tax fraud, two counts of bank fraud and one count of failure to disclose a foreign bank account." "'It's atrociously low,'" said Barbara McQuade, a former United States attorney who teaches law at the University of Michigan and watched much of Mr. Manafort's trial over the summer. While 'many judges do sentence leniently in white-collar cases,' she said, 'dropping all the way from 19 years to four years is absurd.'"
The class-bound sentence was imposed by:
U.S. District Judge T.S. Ellis III
U. S. Dist. Court for the ED of Virginia
Albert V. Bryan U.S. Courthouse
401 Courthouse Square
Alexandria, VA 22314
The Manafort Trial
"One of Paul Manafort's accountants testified Friday that she went along with falsifying his tax records because she was afraid to confront a longtime client. Cindy Laporta said that in 2015, Manafort's right-hand man, Rick Gates, told her his boss couldn't afford to pay his taxes. To ease that burden, she said Gates instructed her to misrepresent $900,000 in income as a business loan. Laporta, who testified after she was granted immunity, said "I very much regret" the decision to go along with a plan that she estimated saved Manafort at least $400,000 in taxes."
Washington Post, August, 3, 2018
The Tax Prayer
On November 6, 2017, as the U.S. Congress prepared to complete work on a wide-ranging tax bill, the House Chaplain, Reverend Patrick J. Conroy, S.J., offered a prayer.
"As legislation on taxes continues to be debated this week and next, may all Members be mindful that the institutions and structures of our great Nation guarantee the opportunities that have allowed some to achieve great success, while others continue to struggle. May their efforts these days guarantee that there are not winners and losers under new tax laws, but benefits balanced and shared by all Americans."
The prayer angered some members of Congress who sought the chaplain's dismissal; they perceived the prayer as a political rather than a religious invocation.
Heather Nauert's Nanny Tax
If you pay cash wages of $2,100 or more (in 2019) to any one household employee or total cash wages of $1,000 or more in any calendar quarter of 2018 or 2019 to household employees, you must withhold and pay Social Security and Medicare taxes. Your employee's share is 7.65%. Your share is 7.65%. Let's say you pay your illegal alien $700 a week to care for your child. ($700 x 50 = $35,000) Your portion of the nanny tax is $2,677.50. Now let's say you are Heather Nauert, President Trump's pick to be the United Nations ambassador from the United States of America. Further suppose that a pesky background check reveals that you failed to pay your nanny taxes (when originally due)—on the nanny you hired who should have been stopped by Trump's border wall. Poor Heather will have the rest of her life to consider the career opportunity she elected to pass up for $2,677.50.
The Washington Post April 8, 2016
“For wealthy Americans trying to conceal their cash, stashing millions of dollars away in secret offshore shell companies is not as simple as it used to be.”
“Panama, the base of operations for the law firm at the center of the unfolding financial scandal, has never been a favorite place for Americans to hide their money. The nation’s reputation for bank fraud and drug smuggling has prompted U.S. citizens to send their money to more stable shores and nations, including the Isle of Man, the Cayman Islands and Switzerland, according to the offshore experts.”
“The United States is now becoming one of the world’s largest tax and secrecy havens.”
For the Wealthiest, a Private Tax System That Saves Them Billions
New York Times, December 29, 2015
“The very richest are able to quietly shape tax policy that will allow them to shield billions in income.”
“With inequality at its highest levels in nearly a century and public debate rising over whether the government should respond to it through higher taxes on the wealthy, the very richest Americans have financed a sophisticated and astonishingly effective apparatus for shielding their fortunes.” “Operating largely out of public view — in tax court, through arcane legislative provisions, and in private negotiations with the Internal Revenue Service — the wealthy have used their influence to steadily whittle away at the government’s ability to tax them. The effect has been to create a kind of private tax system, catering to only several thousand Americans.” “Many of these maneuvers are well established, and wealthy taxpayers say they are well within their rights to exploit them. Others exist in a legal gray area, its boundaries defined by the willingness of taxpayers to defend their strategies against the I.R.S. Almost all are outside the price range of the average taxpayer.” “The combination of cost and complexity has had a profound effect, tax experts said. Whatever tax rates Congress sets, the actual rates paid by the ultra-wealthy tend to fall over time as they exploit their numerous advantages.”
Tax cheats get early holiday present: Our view USA Today editorial, December 21, 2014
“The Republican backers of the drive to slash the IRS budget congratulate themselves on their fiscal responsibility, but the effect is exactly the opposite. Every dollar cut out of IRS enforcement costs the Treasury roughly $4 to $10. The IRS estimates that it's losing $6 billion a year that it would be able to collect from tax cheats and tax evaders. What better way to reduce the deficit than to raise money from people who aren't paying what they owe?”
“Not only do ordinary taxpayers suffer when service deteriorates, tax cheats have a lower chance of getting caught. There are 5,000 fewer enforcement agents than four years ago, and the agency has fewer resources to fight the epidemic of identity theft.”
“Congress has been slashing away at the agency's budget since 2010, cutting it by $1.3 billion, or about 10%. In inflation-adjusted terms, today's IRS budget is equal to what it had in 1998 — but now the agency has to process some 30 million more tax returns.”
“If Congress really wanted to help ordinary taxpayers, it would reform a tax code whose absurd complexity is why people have to call the IRS in the first place. But Congress would rather talk about tax reform than actually make it happen.”
Though not mentioned by USA Today, it should be obvious that collecting less taxes without reducing the cost of government means borrowing more money and paying more interest, continuing the downward spiral of congressional negligence. The predictable result was reported by the Wall Street Journal (11/3/15). "IRS Audits of Individuals Drop to 11-Year Low." "The IRS audited 0.84% of individual taxpayers in the 2015 fiscal year, the lowest level since 2004, the agency said. Revenue from audits declined by 41% to $7.3 billion." The IRS blames staffing cuts for fewer audits.
Judge Kocoras shows that giving to charity may be good insurance in case you get caught
The perception that wealthy individuals can get away with breaking the law more easily than others, was reinforced at the sentencing of billionaire Ty Warner for tax evasion on January 15, 2014. U.S. District Judge Charles Kocoras (Chicago) sentenced Warner to 500 hours of community service rather than prison time of up to five years. Warner also had to pay his back taxes of $5.5 million and a $55 million fine that was negotiated to avoid a trial. H. Ty Warner, the billionaire who created Beanie Babies, pleaded guilty in 2013 to one count of tax evasion for hiding $25 million in income in secret Swiss bank accounts and failing to report the interest earned, thereby understating his income for a decade. His lawyers argued last week that his charity donations and efforts to come clean mean he should be let off with probation or house arrest. Giving to charity turned out to be an important insurance policy for Warner, because Judge Kocoras gave that fact considerable weight in his sentencing. The pattern of wealthy individuals who have become rich through theft or embezzlement is well established. Ken Lay of Enron and Bernard Madoff, for example, were well known for their generosity. That money taken from others was given to charity seems to mollify some people, like Judge Kocoras, as a kind of moral money laundering. But the fact of how the money was spent has nothing to do with whether taking the money in the first place—whether through theft or insider trading or embezzlement or cooking the books or a Ponzi scheme—was legal or illegal, or right or wrong.
More news on tax cheating
Treasury Inspector General for Tax Administration (TIGTA) Notes a 39 Percent Increase in Fraudulent Tax Refund Attempts Made by Taxpayers
TIGTA found that as of April 28, 2012, the IRS had identified tax returns with $6.4 billion claimed in fraudulent tax refunds and prevented the issuance of $6.1 billion (95.3 percent) of the fraudulent tax refunds, representing a 39.1 percent increase in the number of fraudulent tax refund attempts identified as of the same period in 2011.
"Our report found that more unscrupulous individuals than ever are submitting fraudulent tax returns, but the good news is this: The IRS is doing a better job of stopping fraud in its tracks," said J. Russell George, Treasury Inspector General for Tax Administration.
The amount of fraudulent refunds stopped by the IRS continues to grow each year. TIGTA found that the IRS identified 2.1 million fraudulent-refund returns in 2011, up from 971,511 the previous year. And while it stopped $6.9 billion in fraudulent refunds from being issued in 2010, in 2011 it stopped $14.3 billion.
As of April 28, the IRS received more than 133.4 million individual tax returns and issued slightly more than 99.1 million tax refunds totaling approximately $269 billion.
As of April 28, 2012, the IRS had identified tax returns with $6.4 billion in fraudulent tax refunds and prevented the issuance of $6.1 billion of the fraudulent tax refunds. The IRS also identified 210,473 tax returns filed by prisoners for fraud screening, a 5.3 percent increase compared to last year.
TIGTA also found that the processing of some tax credits continued to present a challenge. While the IRS has improved its processing of Homebuyer Credit repayments, some taxpayer repayments continue to be inaccurately processed, resulting in almost $2.6 million in erroneous refunds and more than $290,000 in incorrect assessments to taxpayers’ accounts. Other problems involving credits in 2012 include:
• 125,684 taxpayers claimed more than $29.7 million in erroneous Nonbusiness Energy Property Credits;
• 109,618 taxpayers claimed more than $159 million for the American Opportunity Tax Credit for students who, based on age, are unlikely to be pursuing an undergraduate degree or vocational certification.
Taxation in Utopia “They think it completely unjust to bind people by a set of laws that are too many to be read or too obscure for anyone to understand.” Thomas More
A bad tax system as the cause of a bad government
“When we find society in an unhealthy state, wealth unequally and unjustly distributed, idle people rich, industrious people poor, gambling encouraged, industry and commerce discouraged, desperate and degrading poverty side by side with excessive and wasted wealth, it is not a mere delusion, as some would have us believe, which leads us to say that these are the results of bad government. But when we seek for the causes of bad government, why should we not do as we would in the case of the human body, and ask upon what food this government has lived? Bad taxation is as certain to produce bad government and bad social conditions, as bad food to produce indigestion and decay in the human body.” Thomas Gaskell Shearman (1834-1900)
20,752 taxpayers with adjusted gross income of $200,000 or more, paid no tax.
The latest Internal Revenue Service Statistics on Income (SOI) report for 2009, shows that 20,752 taxpayers with Adjusted Gross Incomes of $200,000 had no U.S. income tax liability.
According to the IRS, “For 2008, as revised to reflect refundable credits, of the 4,375,660 returns with AGI of $200,000 or more, 22,257 returns (0.509 percent) had no U.S. income tax liability, and 12,326 returns (0.282 percent) had no worldwide income tax liability . . .. For 2009, of the 3,975,288 tax returns with expanded income of $200,000 or more, 35,061 (0.882 percent) had no U.S. income tax liability; and 19,551 (0.492 percent) had no worldwide income tax liability. For 2008, of the 4,416,986 returns with expanded income of $200,000 or more, there were 31,539 (0.714 percent) with no U.S. income tax liability and 17,127 (0.388 percent) with no worldwide income tax liability.”
Justin Bryan, spring 2012 edition of the IRS’s quarterly Statistics of Income Bulletin.
While paying no taxes under our current system may be done legally or illegally, the question to Congress is whether we are operating with the fairest and most effective system available? If not, why not? During the past 100 years, Congress has tinkered with a simple tax system in an effort to make it more fair to increasingly narrow constituencies; the result is a complex and metastasizing tax code which applies an Alternative Minimum Tax and a Kiddie Tax to children earning interest income and absolves 20,752 adults of any tax. While the characteristics of a fair system may be difficult to agree upon, the first requirement is certainly that the system should discourage and not encourage tax cheating. Our current system is an open invitation to cheating.
The Tax Revolt Movement “The tax revolt movement of our age will be clearly visible to historians in the future. They can’t help but note the weakness of the movement . . . It has no center, no strong national leadership; it is at best, a hodgepodge of disorganized groups that are divided and easily conquered.
On the positive side, the revolt is grass roots and is pervasive among the populace as a whole—it is a mood. It is among the rich, and many of them leave the country to take up residency and citizenship elsewhere. No studies have been made that indicate how many people leave the United States to avoid the tax system, but considering the millions who live abroad and who, according to the General Accounting Office, don’t file tax returns, the tax motive could be a major factor in their emigration.
With the poorer classes, the cash economy offers defiance as well as relief. With those in the middle, it is axiomatic that most citizens, however law-abiding in other respects, will yield to the temptation and evade taxes when it is easy to do so. In short, the tax revolt stems from public opinion that we are getting a raw deal from the tax system and government expenditures. This is the underlying message in the writings of the tax reformers and resisters, the one common denominator of an otherwise badly divided movement.” Charles Adams, For Good or Evil: The Impact of Taxes on the Course of Civilization
“Angry taxpayers can be a lethal threat to a government that institutes oppressive taxation. Taxpayers instinctively rebel: the first warning phase of rebellion is rampant tax evasion and flight to avoid tax; the second phase produces riots; and the third phase is violence.” Charles Adams, For Good or Evil: The Impact of Taxes on the Course of Civilization
What form of tax is the most fair? This may be like asking who was the greatest quarterback of all time; there is little hope of consensus. When this question is raised, we frequently look to economists for the answer. But economists cannot determine what is most fair, because that is a question of ethics and social philosophy; it is not a question that can be answered by empirical investigation. Suppose we begin instead with the proposition any tax is unfair; someone will be benefitted or harmed more than someone else. But if we believe that any tax is unfair, does this mean that the form of taxation adopted does not matter? I propose that in seeking an answer to the question of tax fairness we need to look at formal characteristics of tax administration—how the tax is assessed and who does the assessing—and at how it is enforced. No matter what characteristics a tax possesses, if it is easily cheated—like the current Internal Revenue Code—it is unfair.
While people will never agree on the substance of an ideal tax—what is taxed and by how much—or even that any tax can be ideal, we may move closer to an answer by looking at whether and how the tax can be cheated. For example, rather than trying to design an ideal tax from an economic point of view—one that accomplishes this or that social ideal or provides the least impact on markets—we need to look at the practical outlook for collecting the tax. Rather than ignoring the impact of tax cheating, as is currently the case—we should begin by weighing each proposed system’s imperviousness to cheating in evaluating its fairness. Regardless of other characteristics of a tax, the more easily the tax can be cheated, by definition, the less fair it will be, especially if the system gives some taxpayers an edge in overcoming the rules.
A primary purpose of this book is to show how easily the current income tax can be cheated and to show who is in the best position to do this cheating. It is a call to reform the tax system by looking at alternatives in terms of which system is most difficult to cheat and—in at least that one dimension—is thereby more fair. When this is done, I believe we will also find that the cost of administering a tax system (its compliance cost) is directly related to that system’s resistance to being cheated: the easier it is to cheat, the greater the costs of compliance. Because of this, we need only look at the tremendous compliance costs associated with the current tax code—estimated at 25 percent of taxes collected—to realize that these costs are caused by the ease with which the current rules can be cheated.
Educating ourselves about tax cheating A recent report from the Treasury Inspector General for Tax Administration dramatically illustrates the problem of tax cheating. It has been known for some time that prison inmates commit a significant amount of tax fraud. In 2009, for example, prisoners claimed fraudulent refund claims with the IRS for $295 million of which $39 million were paid. Among the frauds were 4,608 prisoners claiming the $8,000 first-time homebuyer credit. In response to this problem, in 2008, President Bush signed the Inmate Tax Fraud Prevention Act of 2008. If there was any question that the current tax system is in disrepair, the need for this law is a metaphor for the depth and breadth of the problem of tax cheating. If the tax law cannot prevent tax cheating among inmates locked up in prison, what chance does it have in its battle with ordinary citizens?
Compliance with the federal income tax system is controlled by a number of factors including 1) the inherent enforceability of the law 2) deterrents employed in seeking compliance and their relative effectiveness 3) the ability of the IRS to measure compliance 4) the definition of compliance used when measuring compliance. Thus, the design of an ideal tax--whether a national sales tax, a value added tax, a flat tax or a lumpy tax--is of secondary importance if the the tax is easily cheated. Regardless of one's political leanings, the starting point for designing a fair tax system is ensuring that cheating the system is equally difficult for all, and the consequences of cheating, equally painful. The current income tax and most proposed replacements to this tax, suffer from a reliance on self-assessment which naturally leads to cheating. Any such system, regardless of its theoretical virtues, is flawed in that it punishes honest taxpayers and rewards dishonest ones.
“While a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of this choice, whether contemplated or not.” Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U. S. 134
What about tax reform? While the need for tax reform is widely acknowledged, there is no agreement on whether the current tax code can be reformed or whether we must start over with a new system.
The calls for change in the tax system are resisted by those currently benefitting from special-interest tax breaks, for fear that a new system will mean more taxes for them.
On the use of a self-assessment system, one 19th century critic wrote, “That which all the tremendous power of Rome, in its grandest days, failed to accomplish, that which the infernal tortures of Spain could not accomplish, when it beheaded hundreds, burned thousands, and massacred tens of thousands . . . in a vain struggle to tax . . . [Americans] are still apparently convinced that they can accomplish, by distributing blank forms, administering . . . oaths, and threatening penalties.” Thomas Gaskell Shearman (1834-1900) Natural Taxation (New York: Doubleday & McClure Co., 1898).
The call for tax simplification is not new. “Taxes should be simple. The payers should be able to understand the whole process by which they are to be taxed, and be able to calculate beforehand about what the government will demand from them as their contribution to the public burdens. Every thing in taxation should be open and clear. To conceal, to complicate, to play fast and loose, is bad enough anywhere, and too bad in taxation.” Arthur Latham Perry, An Introduction to Political Economy, 1877.
While complexity is widely believed to be the problem with the tax code, the nature of the complexity is often misunderstood. The code's complexity is the accretive result of 100 years of special provisions and exceptions inserted into the law in an attempt to make some aspect of the law more fair to a particular constituency.
But this accretion has not been orchestrated to accomplish any overall policy goal because the tax code is not founded on any underlying moral insight that would provide guidance and unity to even a complex system.
A survey by the IRS Oversight Board reveals that four percent of taxpayers believe it is acceptable to cheat as much as possible on their income taxes. Tax cheating in the U.S. is most easily identified in those who opt out of filing and paying income taxes, often citing the voluntary nature of the income tax as their justification. The IRS and the courts call them tax protestors. The Justice Department established a special Tax Defier program to deal with those who not only refuse to pay taxes but also seek convince others that the income tax is optional. Some tax protestors object to the existence or substance of the law. Others believe the law’s jurisdiction does not extend to them or their income. Some protestors have claimed that their wages and salaries are exempt from taxation. Their argument is based on the dollar’s removal from the gold standard in 1933, or on an exchange theory of labor in which a person’s efforts are exchanged in the marketplace for pay of an equal amount, resulting in no gain. However, as the court in Connor stated, “Every court which has ever considered the issue has unequivocally rejected the argument that wages are not income.” U.S. v. Connor, 898 F.2d 942, 943-44 (3d Cir. 1990)
Nina Olson, the IRS National Taxpayer Advocate testified before the Senate that “when honest taxpayers feel like chumps, some of them start fudging too. And when that happens, voluntary payments drop even more, necessitating more examination and collection actions. This sense that the system is unfair can result in a vicious cycle of increased noncompliance and increased enforcement.”
Tax Code Complexity and Cheating
The term “tax expenditure” is used by economists and politicians who deal in tax policy to differentiate what avoids taxation (or reduces what is taxed)—and is thereby subsidized—from what is taxed. Income earned but used to pay deductible mortgage interest is an example. Tax expenditure is an unfortunate term, for it further obfuscates the ordinary taxpayer’s understanding of the tax régime. In everyday English a tax expenditure sounds like spending money generated from taxes; that is not its meaning on Capitol Hill. One economist tells us, “The term ‘tax expenditure’ refers to departures from the normal tax structure designed to favor a particular industry, activity, or class of persons.”
The U.S. Government Accountability Office (GAO) lists as examples of tax expenditures “tax exemptions, exclusions, deductions, credits, and deferrals” and has criticized their widespread use in the Code. Effectively tax expenditures represent the cost—in lost tax revenue—from items afforded special tax status and benefitting special groups of taxpayers. As a consequence of placing so much income beyond the scope of the income tax, much higher tax rates must be employed than would otherwise be necessary to raise a given amount of tax revenue.
The Government Accountability Office reports, "In 2005, we recommended that the federal government take several steps to ensure greater transparency of and accountability for tax expenditures by reporting better information on tax expenditure performance and more fully incorporating tax expenditures into federal performance management and budget review processes. . . . As of May 2011, this recommendation has not been implemented."
The Tax Gap is the annual amount of tax the IRS projects should have been assessed and collected but was not. The last estimate of the size of the tax gap was released in 2012 by the IRS and was for 2006. The gap for that year was estimated to be $450 billion. This exceeds the previous esimate made for 2001 of $345 billion annually by twenty-five percent. In The Great American Tax Dodge, the authors report that if tax cheating were a business, it would be the nation’s largest corporation. Others have pointed out that the amount of unpaid taxes equals the amount the federal government pays each year for Medicare or the amount of the 2005 budget deficit. Former IRS Commissioner Lawrence Gibbs noted, “There will always be a gap—some would say an ever-widening gap—between the compliance level that the law requires of taxpayers and the level of compliance that the IRS can obtain through its compliance and taxpayer assistance programs.”
Is there a sound reason to believe that the tax gap problem is not a dynamic and evolving situation that will produce more tax cheating as knowledge of its magnitude and mismanagement resonates with previously compliant taxpayers, eroding confidence in the government’s ability to effect a solution? In a book on tax reform, economists Slemrod and Bakija write, “Human nature being what it is, it won’t work to just announce how to calculate the tax base and what tax rates to apply, and rely on taxpayers’ sense of duty. . . . Some dutiful people will undoubtedly pay what they owe, but many others would not. Over time the ranks of the dutiful will shrink, as they see how they are being taken advantage of by the others.”
The IRS reports that even federal employees are part of the problem, owing $3 billion in back taxes for 2008. These delinquencies include U.S. Postal workers who owe $298 million, U.S. Senate employees who owe $2.5 million, and employees of the U.S. House of Representatives who owe $5.8 million to the treasury.
Another cause of the tax gap is the misclassification of workers. Congress and the IRS know that millions of workers are treated as independent contractors who should be classified as employees. The last study of this problem was undertaken by the IRS in 1984. At that time it was estimated that 15% of workers are misclassified. The result is an unknown amount of Social Security and federal income tax withholding that goes missing each year.
The estimated tax gap is based on nonfiling, underreporting, and underpaying, however, and does not include unpaid taxes on illegal income (embezzling, illegal drugs, prostitution, illegal gambling, loan sharking, and so on) or whatever additional tax might be due from the cash or underground economies, making a final estimate of unpaid taxes surely larger but hard to measure.
Dwarfing the tax gap and apparently also escaping measurement, according to a former IRS Commissioner, is money transferred offshore. Asked whether or not he knew the offshore economy could be as large as $10 trillion, and growing by $800 billion a year, Commissioner Mark Everson admitted that he had “seen large numbers like that.” He explained: “The international disguising of flows of funds offshore, particularly by individuals, is very hard to track, especially if it goes through tax havens or countries that have secrecy laws.” In Tax Havens: How Globalization Really Works, the authors cite three estimates of the total U.S. financial assets held offshore in the range of $9 to $10 trillion. The missing tax revenue from these offshore investments is estimated at $62.5 billion, none of which is included in the official tax-gap figure.
The portion of the tax-gap pie composed of unintentional tax cheating—referred to by one commentator as “unknowing noncompliance”—is undetermined. As explained in chapter 3, the IRS admits, “The data do not reveal how much of the gap is attributable to willful non-compliance or carelessness and how much is the result of a lack of understanding [of the taxpayer’s] . . . full tax obligation.” But Justice Holmes reminds us, regarding the importance of intention in law, “It is no doubt true that there are many cases in which the criminal could not have known that he was breaking the law, but to admit the excuse at all would be to encourage ignorance where the law-maker has determined to make men know and obey, and justice to the individual is rightly outweighed by the larger interests on the other side of the scales.”
I have no doubt that much tax cheating is intentional. One field study found that 17 percent of taxpayers intend to cheat on their tax returns. Strong indirect evidence is provided by the fact that individual taxpayers will engage in more risky tax behavior if they owe money than if they are due a refund. In my accounting practice I encountered this phenomenon on an anecdotal basis. Taxpayers who were accustomed to receiving refunds would commonly dig deeper for more deductions once they were told they were going to have to pay the IRS. While digging for more deductions is not itself cheating, risk-prone behavior may induce taxpayers to invoke questionable deductions when trying to get out of a tax-due position.
Psychological research supports this finding. Cognitive psychologists Tversky and Kahneman found that individuals are “generally risk averse when it comes to gains and risk seeking when it comes to losses.” Known as prospect theory, this account of human action has been tested in a number of settings, including predicting the behavior of gamblers and taxpayers.
In a public poll, 62 percent of taxpayers reported believing that if others cheat it increases their taxes.
“Inasmuch as all persons and property within the jurisdiction of a sovereignty are subject to taxation, and since the property cannot speak and the persons have no direct voice in wording the tax laws, it is a fundamental duty of the law-givers to make the scope of a tax law definite and its meaning clear; and therefore all doubts respecting scope and meaning are to be resolved in favor of the taxpayer.” First Trust & Saving Bank v. Smietanka 268 F. 230 (1920).
Recent psychological research on why people obey the law indicates that the fairness of a legal system is not judged by its final outcome so much as by the formula employed to reach that outcome. “Within the general framework of fairness,” these researchers report, “procedural concerns consistently take precedence over distributive concerns.” In the case of an income tax this implies that the absolute amount of tax owed is not as significant in judging the fairness of the tax régime as the system used to compute the amount owed, and that the same system is uniformly applied to all taxpayers. “Whether our taxes are fair or not,” one commentator reminds us, “is an ethical, not an economic question.”
Personalized tax laws Though special-interest tax legislation is nothing new, the crypt where the bodies are hidden was opened for a brief period in the late 1990s. The Taxpayer Relief Act of 1997 contained 79 items that applied to 100 or fewer taxpayers. The reason we know this is the result of a short-lived law aimed at bringing some transparency to the tax-legislation process. The Line Item Veto Act, subsequently ruled unconstitutional by the Supreme Court in Clinton v. City of New York, required the Congressional Joint Committee on Taxation to prepare a statement identifying each “limited tax benefit”—earmark directed at 100 or fewer taxpayers—“contained in a bill or resolution.” One of these measures, and a target of the President’s veto, affected only one taxpayer. Its cost was estimated at “$84 million over five years, allowing for deferral of taxes on the sale of a sugar beet processing facility owned by Dallas businessman Harold Simmons to a farmer-owned cooperative.” For those who believe federal legislation should have some bearing on the nation and its general welfare, this was a stretch.
The inclusion of this narrow rule and others like it—what one observer calls “‘special interest’ provisions buried within the arcane language of the income tax code”—is symptomatic of the lack of authentic generality. A law designed to apply to anyone in a particular class—but where that class has been so narrowly defined as to circumscribe a very few taxpayers—abuses the spirit of the moral principle of universality. The potency of the principle that like cases be treated alike depends on the moral relevancy of the criteria used to determine likeness. Congress has frequently violated this requirement; without it, however, the moral grounding of the Code is eroded. If the sugar beet plant sale mentioned earlier were an isolated incident, it might be forgiven. But the fact that we had a law requiring disclosure of tax items affecting 100 or fewer taxpayers—even briefly—indicates a general problem with the Tax Code and its moral standing.
The workings of special-interest legislation can be instructive for its brazenness. Buried in the massive Tax Reform Act of 1986 was a provision benefiting one newspaper, the Houston Chronicle. Rather than naming the paper, however, Congress elected to describe it in general terms, thereby thumbing its nose at the public in a veiled gesture. Specifically the law change exempted from an effective tax increase (caused by the removal of a tax credit), “any daily newspaper . . . which was first published on December 17, 1855, and which began publication under its current name in 1954, and which is published in a constitutional home rule city . . . which has a population of less than 2,500,000.” In spite of its use of the word “any,” Congress intended to benefit only one taxpayer and—like Cinderella’s glass slipper—this description fit only one daily newspaper.
With a wondering eye out for the nation’s general welfare Congress has also come to the aid of a small group of high-profile taxpayers—professional golfers. The American Jobs Creation Act of 2004 which, according to the Wall Street Journal, was “larded by Congress with all sorts of goodies for all sorts of industries,” contained a provision designed to limit the benefits of deferred compensation plans for certain wealthy taxpayers. However, the law provided an exception to help out golfers like Tiger Woods and Vijay Singh. Rather than directly naming the golfers or their professional organization in the law, Congress conferred its benefits only on deferred compensation plans “established or maintained by an organization incorporated on July 2, 1974,” the very day the PGA Tour, Inc. was incorporated.
Describing the organization in this way also saved Congress the potential embarrassment of having to explain how the PGA, as well as other sports organizations like the National Football League (NFL) and National Hockey League (NHL), qualify as non-profit organizations with tax-exempt status. There may be nothing wrong with providing tax breaks for members of already tax-exempt organizations except that it clearly exposes the lack of direction or the political agnosticism of the overall tax strategy. Rather than seeking a settled body of law by aiming the Tax Code in the direction of its constitutional mandate to “provide for the common defense and general welfare,” congressional tax policy often appears to be driven by no more than several hundred fingers testing the current direction of the wind.
Georg Simmel (1859-1918) from The Philosophy of Money
“The fact that the relationship of the State to its citizens is determined basically by a monetary relationship has its origin primarily in taxation. This refers to a correlation which is important in the present context and may be presented in the following manner. If social strata are primarily differentiated by their money income, then a policy based on the various strata is very restricted because the most divergent objective interests are bound up with the same money income, and therefore any measure taken in the interests of one stratum unavoidably harms many interests within that particular stratum. It is, for instance, impossible to have a uniform middle-class policy if one understands by middle-class levels of income . . . [within a stated range]. For those who are included in this group—businessmen, manual workers, peasants, artisans, white-collar workers, people of independent means and civil servants—have almost no parallel interests in other points of legislation.”
Herbert Spencer on increasing taxes
“From the outset the growth of revenue [taxes] has, like that growth of the political headship which it accompanies, been directly or indirectly a result of war. . . [which] continues to be the usual reason for imposing new taxes or increasing old ones."
"Tax evasion is not always an evil; it has often been a safety valve against violence and rebellion.” - Charles Adams, For Good and Evil: The Impact of Taxes on the Course of Civilization
The shoemaker's son "IRS reports show that about 3 percent of IRS employees are noncompliant each year." June 21, 2011 Press Release -- "IRS Needs to Improve Oversight Of Its Employees’ Compliance With Tax Laws, TIGTA Finds"
"The Internal Revenue Service (IRS). . . is unable to detect whether all IRS employees are complying with the law, according to a new audit report released publicly today by the Treasury Inspector General for Tax Administration (TIGTA). While the IRS electronically matches its employee payroll records with tax account records maintained for all taxpayers, it does not detect all potential noncompliance, TIGTA auditors found."
"TIGTA identified 133 potentially noncompliant employees who were not detected by the IRS’s computer application over a two-year period. As a result, no action was taken by the IRS to analyze and address this potential employee misconduct for noncompliance with tax laws."
“To maintain public confidence in the agency entrusted to administer the Nation’s tax law system, the IRS must ensure that potential misconduct concerning noncompliance with the tax laws is identified and addressed,” said J. Russell George, the Treasury Inspector General for Tax Administration.
Many Investment Theft Loss Deductions Appear to be Erroneous
Treasury Inspector General for Tax Administration(TIGTA)
November 23, 2011 Press Release
TIGTA - 2011-83
WASHINGTON – Taxpayers may have erroneously claimed deductions of more than $697 million a year in investment theft losses that did not appear to qualify as such, resulting in revenue losses to the U.S. Government totaling more than $41 million, according to a report publicly released today by the Treasury Inspector General for Tax Administration (TIGTA).
Federal law, along with associated regulations, procedures, and rulings, provides taxpayers with tax relief for investment theft losses. The Internal Revenue Service (IRS) estimates that more than 19,200 taxpayers filed Tax Year 2008 tax returns claiming a combined total of more than $8 billion in property income casualty and theft loss deductions.
TIGTA conducted its review to assess the IRS’s efforts to ensure the validity of investment theft loss deductions. The number of investment theft loss victims as a result of Ponzi schemes increased significantly in Tax Years 2008 and 2009. With the potentially large number of victims filing tax returns claiming these losses, IRS officials issued guidance to minimize both its administrative burden and the burden on the victims of these schemes, which are investment frauds that involve the payment of fictitious investment returns to existing investors from funds contributed by new investors.
Based on TIGTA’s review of a statistically valid sample of 140 electronically filed Tax Year 2008 tax returns on which taxpayers reported an investment-theft loss deduction, TIGTA estimated that 1,788 (82 percent) of 2,177 taxpayers may have erroneously claimed deductions totaling more than $697 million, resulting in revenue losses totaling approximately $41 million. The potential revenue loss estimate was conservative in that it only represented electronically filed tax returns for one year.
Government Waste and Tax Cheating
One reason claimed for increasing amounts of tax cheating is the perceived wastefulness of the federal government. According to a Gallup poll, in 1979 Americans believed the federal government wasted 40 cents of each dollar spent. In 2011, according to Gallup, the public believed federal wastefulness had increased to 51 cents of each tax (or borrowed) dollar. Among college graduates the estimate was 50 cents, while for high school graduates the estimate was 52 cents per dollar. The perception of wastefulness has been correlated by the Gallup organization to differences in political ideology between the party in power and the opposition party. Under a Republican president Democrats perceive greater government wastefulness and under a Democratic president Republicans perceive greater government wastefulness. If perceived government waste is a cause of tax cheating, and this perception is related to political ideology, a question for future research is whether Republicans cheat more when the president is a Democrat and whether Democrats cheat more when a Republican is president.
(Gallup© poll is based on telephone interviews conducted Sept. 8-11, 2011, with a random sample of 1,017 adults, aged 18 and older, living in all 50 U.S. states and the District of Columbia.)