[Senate Hearing 109-973]
[From the U.S. Government Publishing Office]
S. Hrg. 109-973
DECONSTRUCTING THE TAX CODE: UNCOLLECTED TAXES AND ISSUES OF
TRANSPARENCY
=======================================================================
HEARING
before the
FEDERAL FINANCIAL MANAGEMENT, GOVERNMENT
INFORMATION, AND INTERNATIONAL
SECURITY SUBCOMMITTEE
of the
COMMITTEE ON
HOMELAND SECURITY AND
GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
SEPTEMBER 26, 2006
__________
Available via http://www.access.gpo.gov/congress/senate
Printed for the use of the Committee on Homeland Security
and Governmental Affairs
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30-601 PDF WASHINGTON DC: 2006
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COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
SUSAN M. COLLINS, Maine, Chairman
TED STEVENS, Alaska JOSEPH I. LIEBERMAN, Connecticut
GEORGE V. VOINOVICH, Ohio CARL LEVIN, Michigan
NORM COLEMAN, Minnesota DANIEL K. AKAKA, Hawaii
TOM COBURN, Oklahoma THOMAS R. CARPER, Delaware
LINCOLN D. CHAFEE, Rhode Island MARK DAYTON, Minnesota
ROBERT F. BENNETT, Utah FRANK LAUTENBERG, New Jersey
PETE V. DOMENICI, New Mexico MARK PRYOR, Arkansas
JOHN W. WARNER, Virginia
Michael L. Alexander, Minority Staff Director
Trina Driessnack Tyrer, Chief Clerk
FEDERAL FINANCIAL MANAGEMENT, GOVERNMENT INFORMATION, AND INTERNATIONAL
SECURITY SUBCOMMITTEE
TOM COBURN, Oklahoma, Chairman
TED STEVENS, Alaska THOMAS CARPER, Delaware
GEORGE V. VOINOVICH, Ohio CARL LEVIN, Michigan
LINCOLN D. CHAFEE, Rhode Island DANIEL K. AKAKA, Hawaii
ROBERT F. BENNETT, Utah MARK DAYTON, Minnesota
PETE V. DOMENICI, New Mexico FRANK LAUTENBERG, New Jersey
JOHN W. WARNER, Virginia MARK PRYOR, Arkansas
Katy French, Staff Director
Sheila Murphy, Minority Staff Director
John Kilvington, Minority Deputy Staff Director
Liz Scranton, Chief Clerk
C O N T E N T S
------
Opening statements:
Page
Senator Coburn............................................... 1
Senator Akaka................................................ 3
Senator Carper............................................... 4
Prepared statement:
Senator Levin................................................ 41
WITNESSES
Tuesday, September 26, 2006
Hon. Mark Everson,, Commissioner, Internal Revenue Service....... 8
Hon. J. Russell George, Treasury Inspector General for Tax
Administration (TIGTA), Department of the Treasury............. 17
Nina E. Olson, National Taxpayer Advocate........................ 19
Jay A. Soled, Professor of Taxation, Rutgers University.......... 21
Stephen J. Entin, President and Executive Director, Institute for
Research on the Economics of Taxation.......................... 28
Jason Furman, Non-Resident Senior Fellow, Center on Budget and
Policy Priorities, and Visiting Scholar, New York University
Wagner Graduate School of Public Service....................... 31
Neal Boortz, Co-Author, ``The FairTax Box''...................... 33
Alphabetical List of Witnesses
Boortz, Neal
Testimony.................................................... 33
Prepared statement........................................... 162
Entin, Stephen J.:
Testimony.................................................... 28
Prepared statement with an attachment........................ 131
Everson, Hon. Mark:
Testimony.................................................... 8
Prepared statement........................................... 45
Furman, Jason:
Testimony.................................................... 31
Prepared statement........................................... 156
George, Hon. J. Russell:
Testimony.................................................... 17
Prepared statement........................................... 62
Olson, Nina E.:
Testimony.................................................... 19
Prepared statement........................................... 90
Soled, Jay A.:
Testimony.................................................... 21
Prepared statement........................................... 126
APPENDIX
Chart submitted by Senator Coburn................................ 44
DECONSTRUCTING THE TAX CODE:
UNCOLLECTED TAXES AND ISSUES
OF TRANSPARENCY
----------
TUESDAY, SEPTEMBER 26, 2006
U.S. Senate,
Subcommittee on Federal Financial Management,
Government Information, and International Security,
of the Committee on Homeland Security
and Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 2:36 p.m., in
room SD-342, Dirksen Senate Office Building, Hon. Tom Coburn,
Chairman of the Subcommittee, presiding.
Present: Senators Coburn, Carper, and Akaka.
OPENING STATEMENT OF SENATOR COBURN
Senator Coburn. The Federal Financial Management
Subcommittee of the Committee on Homeland Security and
Governmental Affairs will come to order.
I want to first take a moment--we delayed, waiting for
Senator Carper to be here. I understand he will be here
shortly. I want to thank each of our panel participants today
for participating in this, and I have a complete statement that
I will put into the record.
We had our first hearing some months back on the tax gap,
and it is to Senator Carper's credit that we continue to follow
this. It is not just about controlling spending, but it is also
about collecting the revenue that is due. And we are going to
have a wide view of positions put forth today, both on tax
expenditures--which I do not know how we ever coined that word
because the assumption behind a tax expenditure is the
government should have all the money and what they do not take
is a tax expenditure. We are going to talk about that. We are
going to talk about the IRS' plans on the tax gap, as well as
Senator Bayh's bill on terms of reporting capital gains, which
I support and have co-signed as a cosponsor on, which I think
as a minimum needs to be done.
I am pleased with what we have heard in the testimony. I
have read all the testimonies and seen the summaries. I think
there are a lot of ideas.
There is no question that in our country one of our biggest
problems in creating the tax gap is not intentional non-
compliance but the complexity of our Tax Code. And at some
point in the future, the American people are going to demand
that we make it simpler, fairer, and more easily transparent so
that you can fulfill your obligation as a citizen of this
country and participate in funding the real obligations of our
country.
President Bush called our tax program a ``complicated
mess.'' I think if you look at anybody out there who has any
other than one source of income and that can do a simple,
straight-line form, everybody would agree with that, whether
you are on the side of preparing it--and I will never forget
the study that was done when I was in the House where we took
10 different accounting firms to 10 different locations with 10
different IRS locations, and everybody came up with a different
answer on exactly the same facts, which proves the point.
So I will not belabor my point. I am extremely thankful for
Senator Carper and his insistence, and also Senator Lautenberg,
as we look at tax expenditures because there are loopholes or
intended expenditures that are not necessarily in sunshine, in
sunlight, that the American people ought to know about. And
they ought to know where we are not taxing and what the
intended benefit with that should be.
[The prepared statement of Senator Coburn follows:]
PREPARED STATEMENT OF SENATOR COBURN
As anyone knows who has ever barely made it to the post office in
time on April 15, the tax code can be a nightmare. President Bush has
called it ``a complicated mess.'' Riddled with exceptions, credits and
deductions, the United States has the most complex tax system in the
world. In many ways, the tax code is designed to strengthen our economy
by its incentives such as encouraging small businesses to thrive by
raising expensing limitations, and helping those who have decided to
return to school through education tax credits.
In other ways, however, because of its inherent complexity, the tax
code is difficult for Americans to understand. We have a whole industry
of professionals for hire to help you file your returns. Some people
have used this complexity to their advantage and cheated the system.
Others--which I believe make up the majority of taxpayers--are trying
to do the right thing but may fail to accurately file a return and what
deductions or credits they are eligible or ineligible to claim.
Today we are here to talk about several important issues relating
to the transparency of our tax system. Increased transparency means
better data, recordkeeping and reporting about uncollected taxes. You
cannot treat a disease until you diagnose it.
The gap between revenues that should have been collected and those
that actually were is known as the ``tax gap.'' According to the
Internal Revenue Service's most recent estimate, the tax gap was $345
billion for tax year 2001. Everyone wants the tax gap closed--we can't
afford it with a $550 billion deficit--we are mortgaging our children's
future. If we closed it today, we would eliminate the deficit in less
than two years. We don't know the size of, scope of, and reasons for
the problem. Either the IRS must find a way to develop a more precise
picture of where money is being lost; or Congress better get moving on
fundamentally revamping the tax code.
I believe the biggest rate limiting step here is uncovering motive.
IRS can't distinguish who is intentionally evading paying taxes versus
those who unintentionally underreport or misreport their taxes. The
``fix'' we invest in is entirely dependent upon knowing how much of our
problem is intentional--that is an enforcement problem--, and how much
is unintentional, where the solution is education and simplification.
One proposed solution is to require securities brokerage firms or
mutual finds to track and report the adjusted basis a taxpayer has in
his or her stock, bond, and mutual find investments to both the IRS and
the taxpayer. Some have suggested this could save as much as $25
billion a year; IRS estimates it could save around $8 billion annually.
Some argue it's too burdensome on industry, but others say many firms
already have this information, and reporting it to the IRS wouldn't be
too hard. I'm eager to discuss the idea more with our witnesses.
Last October, IRS reported before this Subcommittee that it had
estimated the tax gap to be somewhere within the range of $311 and $353
billion for the 2001 tax year. Unfortunately, last October, 4-year old
data was the most recent data we had. Today, revised four-year old data
is the most recent we have. In 2006, IRS came out with its revised
estimate, which put a price tag on the 2001 tax year to be $345
billion. Until this morning, the IRS had no plan to regularly measure
compliance.
The IRS hopes to eventually recover $55 billion in late payments
and taxes, bringing the net tax gap down to $290 billion for tax year
2001, but the Treasury Inspector General for Tax Administration (TIGTA)
questioned this figure. The IG says that because IRS currently does not
correlate either type of payment to the applicable tax year, IRS will
be unable to determine whether the $55 billion is ever collected. How
can we insure that $55 billion will be collected against the 2001 tax
gap if we don't assign money as it comes in to its applicable tax year?
The IRS balances its approach to tax gap reduction by focusing on
both prevention--that is, improving taxpayer services--and enforcement
after the fact. I am not convinced that this is as thorough a plan as a
$345 billion tax gap deserves. At our last hearing we learned that
there are no official long-term compliance goals driving IRS' efforts,
other than to continue to serve taxpayers and enforce the tax ode
through audits and examinations. There has been ample pressure by
Congress on the IRS to make a plan to close the tax gap, yet there is
still no clear plan. While tax reform may be on the horizon, we still
must be good stewards of our existing resources under our existing tax
regime, as oppressive as it might be.
I am encouraged that the IRS has taken Congress' oversight
seriously and is planning a strategic approach to reducing the tax gap,
including plans to regularly measure compliance. I am even more pleased
that the Treasury Department is studying the report of the President's
Advisory Panel on Tax Reform and is considering options for
simplification of the tax system.
Another issue we are here to discuss today is the transparency of
tax preferences. As we go forward to make more information public on
the categories and amounts of tax deductions benefiting certain types
of filers, we need to obey important privacy laws.
We have a lot to cover today, so I think you all ahead of time for
your patience. I want to thank our witnesses for their time and
preparation, and thank Senator Carper and Senator Lautenberg for their
help in pushing for this hearing.
Senator Coburn. So, with that, I will turn to Senator Akaka
for hisopening statement, and we will proceed.
OPENING STATEMENT OF SENATOR AKAKA
Senator Akaka. Thank you, Mr. Chairman, for calling today's
hearing. It is a very important hearing. We are joined today by
several panels of distinguished witnesses, which includes
Internal Revenue Service Commissioner Everson and the National
Taxpayer Advocate, Nina Olson, who has been a tireless advocate
for taxpayers' rights.
The tax gap is even more important than ever because of the
need to shrink our deficit. I have long been concerned about
the reduction in taxpayer services provided by the IRS. Helping
taxpayers who want assistance in filing their taxes correctly
will help reduce this tax gap.
In fiscal year 2003, according to data from the Wage and
Investment Operating Division, the IRS prepared 665,868
returns. However, the IRS has reduced the number of prepared
returns each year. Plans for fiscal year 2006 indicate that
only 305,000 returns will be prepared by the IRS. This is a
reduction of more than 50 percent in 3 years.
In my home State of Hawaii, I have seen the effects of the
reduction. For years, the IRS and Hawaii State Department of
Taxation had made it an annual practice to help prepare returns
on the island of Molokai. They typically help more than 100
taxpayers within 2 days. This service has been extremely
helpful because there has been only one individual that
provides paid tax preparation on the entire island. Then a few
years ago, the IRS ended its participation in the partnership.
AARP stepped in to help out for a year, and thankfully, the IRS
again took part in the program this past filing season.
However, it is uncertain whether the IRS will help out Molokai
taxpayers for the upcoming filing season. In addition, the
Hawaii Taxpayer Advocate's Office has seen a significant
increase in the number of people seeking help with their tax
questions because they have been unable to get the answers or
assistance that they need from the IRS.
Due to the complex nature of the Tax Code and the
importance of voluntary compliance in helping reduce the tax
gap, we must make sure that the IRS has the resources to
provide assistance to those that seek out help. Reducing these
services may result in a larger tax gap.
Mr. Chairman, I am also disappointed by the often poor
quality of paid tax preparation services. Errors made by paid
tax preparers contribute to this tax gap, too. Senator Bingaman
and I have been advocates of legislate to regulate tax
preparers for many years. I appreciated the contributions to
this issue from Senators Grassley and Baucus, and I remember
hopeful that one day we will be able to pass the Taxpayer
Protection and Assistance Provisions found in the Finance
Committee-approved Telephone Excise Tax Repeal and the Taxpayer
Protection and Assistance Act of 2006. This bill would also
expand access to free tax preparation services for low-income
taxpayers.
In addition, the legislation includes the Free Internet
Filing Act, which will empower individual taxpayers to file
their taxes electronically through the IRS website without the
use of an intermediary or with the use of an intermediary with
which the IRS contracts to provide free universal access. If
taxpayers take the time necessary to prepare their own returns,
they must be provided with the option of electronically filing
directly with the IRS.
As the National Taxpayer Advocate has stated, nearly 45
million returns prepared using software are mailed in rather
than electronically filed. With universal access to free e-
file, this number could be substantially reduced. Electronic
returns help taxpayers receive their refunds faster. This would
also save the IRS resources and reduce possible errors that can
occur when mailed-in returns are transcribed.
Mr. Chairman, I look forward to a thorough discussion of
these issues as part of today's hearing on the tax gap, and I
thank the witnesses for appearing this afternoon.
Thank you very much, Mr. Chairman.
Senator Coburn. Thank you, Senator Akaka, and publicly to
acknowledge your victory this past week, we congratulate you.
Senator Akaka. Thank you.
Senator Coburn. Senator Carper.
OPENING STATEMENT OF SENATOR CARPER
Senator Carper. I want to join in that congratulations. I
am happy for you, happy for the folks of Hawaii, at least thus
far, and really happy for us. Congratulations. I realize there
is another election to come, and we wish you well there as
well.
I want to thank you, Mr. Chairman. I have been looking
forward to this day. I understand some of our friends on
another committee have written to us to remind us of their
jurisdiction on legislative issues on tax matters, and we
appreciate that.
Senator Coburn. Let me just interrupt. Federal financial
management is unlimited when it comes to either receiving
dollars or spending dollars, and we are not going to limit our
inquiry into waste, fraud, abuse, or inefficiency.
Senator Carper. Good. I could not have said it better
myself.
As we all know, each year the amount of money that is paid
into the Treasury is a good deal less than what is owed. I have
a statement I am going to enter for the record, but I think in
February this year, the IRS estimated there was about $345
billion that was due from last year, and after money came in,
we ended up with still about $290 billion less than what we
should have had. That is, I think, actually more than the
projected deficit for the current fiscal year.
Our goal ought to be to collect as much of these owed tax
revenues as possible without unduly burdening those taxpayers
who are doing their dead level best to comply with the law,
which I believe is really the vast majority of taxpayers of our
country.
I was with a group of people yesterday and said, ``How many
are paying your taxes?'' Most people raised their hand. And I
said, ``I do not know about you, but it frustrates me that for
those of us who actually pay what we are supposed to pay to
know that a lot of people are not.'' And that is up to about
$300 billion, and that is really the size of the deficit. I
think people were ``enraged'' is probably not too mild a word
to use or too strong a word to use.
However, for any number of reasons--the complexity of the
Tax Code, which is a problem, haphazard record keeping, math
errors--some taxpayers unintentionally make mistakes when
completing their tax returns. We have probably all done that at
one time or the other.
But, on the other hand, some taxpayers knowingly cut
corners, and I hope to be able to ask our Commissioner in a
couple of minutes to what extent the IRS can separate these
folks, the tax evaders, from those who make honest mistakes.
That information would allow for even better targeting of what
had been limited enforcement resources, at least until lately.
The Chairman and I agree that what we need to do is a
better job of collecting the tax dollars that are owed to the
Federal Government, the same way that we agree on the
importance of reducing the number and amount of improper
payments.
I think we have had two hearings, Mr. Chairman, in this
Subcommittee to examine the fact that Federal agencies are
making about $45 billion each year in improper payments. I
think that is a net number. We learned from these hearings that
about $45 billion likely is just the tip of the iceberg. I
think what we have heard is that the Department of Defense's
financial systems are in such disarray that we do not even know
what the improper payments are. And my guess is there are some
overpayments included among them.
But like improper payments, then we are probably pretty far
from knowing everything we ought to know about the extent of
the tax gap in this country. In all likelihood, that gap may
actually be larger than $345 billion.
While we may not know the exact size of the tax gap, we do
know the impact of not better managing our country's finances.
We know that every dollar wasted on erroneous or fraudulent
payments means there is one more dollar we will not have that
we will have to borrow from China or South Korea or Japan or
Great Britain or someplace else. And the same holds true with
uncollected taxes. Every dollar owed to the Treasury that goes
uncollected is being replaced by a dollar from somewhere else,
whether it is a borrowed dollar or a new tax dollar that is
levied on a family or small business in my State or your State
or in Hawaii or some other place.
I am pleased that Commissioner Everson is here with us
today, and I commend him for the attention I know he has
provided to this tax gap issue. Your acknowledgment of the
importance of this issue and your commitment to doing something
about it is both necessary and important, and we applaud you
for that.
But to achieve our goal of collecting every dollar that
reasonably can be collected, we are going to need a
comprehensive plan for success, a plan that serves as a tax gap
road map to this and future Administrations and Congress.
Having a plan like that helped us in Delaware when I was
privileged to be the governor of our State, and my team and I
set out to turn around a State Division of Revenue that just
was not getting the job done in some areas. I need to offer
that the work was begun before our Administration, and I think
we took it to the next level.
But after years of hard work that included the
Administration of my predecessor, Mike Castle, and the DuPont
administration before that, we succeeded in bringing
collections of delinquent taxes up to record highs.
I love to tell this story, Mr. Chairman, and I will be very
brief. We have a quality award every year in Delaware, and we
honor a business that--it is like a miniature version of the
national quality awards. It is named in honor of a guy named
Bill Gore who started WL Gore company, Gore-Tex, and a lot of
other projects. And given their commitment to quality, we named
it after him. One year it could be this company, another
company next, or maybe a non-profit, an occasional non-profit.
I think it was my last year as governor or the year after I
left, the winner of the quality award that year was the
Delaware Division of Revenue, and their job performance and
their customer satisfaction numbers were in the 80s. The idea
that the tax collector would win the quality award and have
that kind of customer approval was really pretty amazing. And
what we would like to someday be able to--for Commissioner
Everson, and the folks that he leads, for you guys to win the
national quality award and take on at the national scale what
we were able to do on a small scale in our little State.
But while Delaware's budget is only a fraction of the
Federal budget, I am concerned that some of what we did there
and much of what is being done in other States to identify
problems, to fix them, to improve collections and customer
satisfaction at this same time could be replicated, at least in
part, at the Federal level. We want to help you to do that.
Thank you very much for coming today, Mr. Chairman. We look
forward to hearing from you and all of our other witnesses.
Thanks a lot.
[The prepared statement of Senator Carper follows:]
PREPARED STATEMENT OF SENATOR CARPER
Thank you, Mr. Chairman, for holding this hearing. Welcome to our
witnesses.
Each year, the amount of tax that is paid voluntarily and on a
timely basis does not match the amount of tax owed by taxpayers for
that year. The difference between these two amounts is referred to as
the ``tax gap.''
In February of this year, the IRS estimated that the tax gap was a
gross $345 billion and a net $290 billion in Tax Year 2001, an amount
larger than the projected deficit for the current fiscal year.
Our goal should be to collect as much of these owed tax revenues as
possible without unduly burdening those taxpayers who are doing their
level-best to comply with the law, which, I believe is the vast
majority of taxpayers in this country.
However, for any numbers of reasons--the complexity of the tax
code, haphazard recordkeeping, math errors--some taxpayers
unintentionally make mistakes when completing their tax returns.
On the other hand, some taxpayers are knowingly cutting corners. I
hope to ask the commissioner in a few minutes to what extent the IRS
can separate those folks--the tax evaders--from those who make honest
mistakes. That information would allow for even better targeting of
what have been limited enforcement resources.
The Chairman and I agree that we need to do a better job of
collecting the tax dollars that are owed the Federal Government, the
same way that we agree on the importance of reducing the number and
amount of improper payments.
We've had two hearings in this Subcommittee to examine the fact
that Federal agencies are making about $45 billion each year in
improper payments each year. We learned in those hearings that the $45
billion figure is likely just the tip of the iceberg.
Like with improper payments, then, we're probably pretty far from
truly knowing everything we should know about the extent of the tax gap
in this country. In all likelihood, the tax gap is larger than $345
billion.
While we may not know the exact size of the tax gap, we do know the
impact of not better managing our country's finances. We know that
every dollar wasted on erroneous or fraudulent payments means there's
one more dollar we will have to borrow from China or Japan or Great
Britain.
The same holds true with uncollected taxes. Every dollar owed to
the Treasury that goes uncollected is being replaced by a dollar from
somewhere else whether it's a borrowed dollar or a new tax dollar
that's levied on a family or a small business in Delaware or Oklahoma.
I'm pleased that Commissioner Everson is here with us today and I
commend him for the attention he has paid to the tax gap issue. Your
acknowledgement of the importance of this issue and your commitment to
doing something about it are necessary and important steps toward the
greater goal.
But, to achieve our goal of collecting every dollar that reasonably
can be collected, we're going to need a comprehensive plan for success,
a plan that serves as a tax gap roadmap to this and future
administrations and Congress.
Having a plan helped us in Delaware. When I was Governor of
Delaware, my team and I set out to turn around a State Division of
Revenue that just wasn't getting the job done in some areas. After
years of hard work, we succeeded in bringing the collection of
delinquent taxes up to record highs.
While Delaware's budget is only a fraction of the Federal budget.
I'm certain that some of what we did there and much of what's being
done in other States to identify problems, fix them, and improve
collections and customer satisfaction at the same time could be
replicated at least in part at the Federal level.
Thank you again, Mr. Chairman, for focusing our attention on this
issue.
Sentor Coburn. Thanks you, Senator Carper.
Our first panel is Commissioner Mark Everson. He is the
Commissioner of the Internal Revenue Service. Prior to his time
at the IRS, he was Deputy Director for Management at the Office
of Management and Budget, where he provided governmentwide
leadership to Executive Branch agencies to strengthen Federal
financial management and improve program enforcement.
Commissioner Everson, first of all, let me thank you for
your service to our country. You could do something else at a
higher salary, and we appreciate it. Too often it is not
recognized. The floor is yours.
TESTIMONY OF HON. MARK EVERSON,\1\ COMMISSIONER, INTERNAL
REVENUE SERVICE
Mr. Everson. Thank you. Good afternoon, Mr. Chairman,
Senator Carper, Senator Akaka. I am pleased to be before your
Subcommittee once again to discuss our efforts to increase
taxpayer compliance and reduce the tax gap. I very much
appreciate the continuing interest of the Committee on Homeland
Security and Governmental Affairs in our work. Mr. Chairman, I
applaud the efforts of this Subcommittee to bring greater
transparency and accountability to government. As you know, as
you indicated, that was central to what we tried to do in my
OMB days, and I know that Clay Johnson, my successor, is doing
that and working with you now.
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\1\ The prepared statement of Mr. Everson appears in the Appendix
on page 45.
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I am also deeply appreciative of the work of the Permanent
Subcommittee on Investigations, also a part of this Committee,
led by Senators Coleman and Levin, which has been instrumental
in our efforts to strengthen enforcement of the tax laws.
Before making several points on today's subject, please indulge
me as I make my regular plea for adequate resources for the
IRS. As you may know, the House has cut the President's funding
request for the IRS for fiscal year 2007, which begins next
week, by over $100 million. Action to date in the Senate has
been more favorable, a little bit above the President's
request, although the bill has not yet gone to the floor. I ask
once again for your strong support for this vital funding. We
will put the money to good use.
Concerning today's subject, I would like to make two points
before taking your questions: First, a comment or two on our
operations for the fiscal year ending this week; and, second,
brief remarks on the summary administration plan to reduce the
tax gap, which was forwarded earlier today to the Finance
Committee by the Treasury Department. We have delivered an
excellent operational year for 2006, both on the services side
and in our enforcement activities. We have also made
significant strides in modernizing the IRS.
We had an excellent filing season, maintaining levels of
telephone service and, again, improving the accuracy of our
responses in both accounts and tax law. The number of
individual returns filed electronically has again increased, as
has the number of returns processed by volunteers in
partnership with the IRS. That is the program Senator Akaka was
talking about, which has replaced a lot of the reduction in our
preparation of returns. It has gone over the last few years
from 1.1 million returns prepared by VITA volunteers up to over
2.2 million.
In terms of enforcement, although I, of course, do not yet
have the final numbers, we project that enforcement revenue--
and that is the money that comes in from our collections
activities, our document matching, and our examinations--will
exceed $49 billion as against $47.3 billion last year. You can
see this growth over the last several years is quite
significant. This, as I was indicating to the Chairman before
we started, is only the direct result of our activities. It
does not capture the indirect effect of the fact that when we
audit, Dr. Coburn, Senator Carper and Senator Akaka play it
maybe a little straighter, if you will indulge my example.
In terms of modernization, we have had several successes.
Our new system for updating the individual master file has
processed almost 8 million returns and generated over $3
billion in refunds. But perhaps our most significant
achievement this year is the successful launch of our
initiative mandating electronic filing of returns by large
corporations and not-for-profit institutions. Electronic filing
of large corporate returns will significantly speed the audit
process and allow us to use improved analytics to better target
our enforcement activities. Compliant taxpayers will benefit
from prompter resolution of uncertainties, and the government
will benefit by identifying and addressing compliance problems
at an earlier date.
This morning, the Treasury Department delivered to the
Finance Committee an outline of the Administration's strategy
for addressing the tax gap. The strategy builds on efforts that
the Treasury Department and the IRS have taken over the last
several years to improve compliance. It focuses on seven areas:
Legislative proposals for reducing evasion opportunities follow
on existing proposals made in the 2007 budget; a commitment to
research; further improvement in information technology;
strengthened enforcement programs; enhanced services to
taxpayers; reform and simplification of the tax law--the point
you made, Mr. Chairman--and partnership with practitioners and
other stakeholder groups. The document is intended to provide a
broad base on which to build. More detailed steps are being
developed as part of the 2008 budget to be delivered to
Congress next February.
I know that the need to reduce the tax gap is well
understood and supported both by my boss, Secretary Paulson,
and OMB Director Robert Portman. I think that the strategy
delivered today is an important step forward. Thank you.
Senator Coburn. Thank you. Let me ask you, would you
outline for us this new strategy for the tax gap? I am a big
believer in transparency and results and accountability, and
what you cannot measure you cannot manage. And it is my
understanding that some of this new program is to put into
place key metrics so you can know what the problem is.
Mr. Everson. Yes, sir. I agree, first of all, entirely with
your assessment that you need to measure your progress and see
how you are doing. This particularly comes into play in the
research area. It is something we talked about last October
when we were talking about the tax gap research at the time
before it was finalized.
What we are going to be doing here is definitely giving a
sharper focus on research. We want to update as an example the
2001 study to which Senator Carper referred. We are currently
working on 1120S returns, but we want to circle back and do
more work on individuals and look at not just the enforcement
issues, but also what was referenced in terms of the impact on
service delivery channels.
So part of that effort over the coming months is to return
the targets that would be associated with each of these seven
areas, and they cover a broad range of topics. Some of these
are difficult to quantify--the impact of new systems, as you
can imagine, what are you going to get for those, just updating
the infrastructure. But we are going to do our level best
wherever we can to have hard and set goals.
What I would ask you, to the Senate and to the House,
though, is that clearly we are helped in defining reasonable
goals if there is stability in the system. All the constant
changes to the system make it very hard to neutralize the
effects of the moving parts and to understand what is really
happening. So the degree to which we can calm down the Tax
Code, that would help.
Senator Coburn. One of the questions as you go forward and
looking at this and re-looking at--and having the measurement
of the tax gap is this idea that you cannot attribute what you
collected to past years in terms of the tax gap. Why can't we?
If the tax gap is $348 billion and you are going to collect $52
billion, but you do not know if that was for 2001 or for 2000
or 1999 or 1998, why can't we have a metric that applies that
so that you can actually eventually measure what you are doing?
In other words, the application of collected monies against
the tax gap, why can't you apply those in the year in which
they were a gap rather than against the year that you see the
gap?
Mr. Everson. If I understand your question, I think we do
that. What we said with the study was that there was a gross
gap of $345 billion for tax year 2001, and that over time we
expected, based on that study and other things that we knew, to
get back $55 billion.
Now, if you would put that chart back up \1\--there are two
ways we are going to get after this problem, sir. We are going
to bring down that gross number through better compliance up
front, and then we are also going to be bringing up the
reduction number.
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\1\ The chart referred to appears in the Appendix on page 48.
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We have already done that to a certain degree because
through better collections and more examinations, that $55
billion number, if you took that on a steady state year after
year, would already have increased because of this piece.
Because there are two components in the $55 billion: There is
our enforcement efforts, and then there is the money that just
comes in over time because you strike an arrangement with us
for payment over time or you just paid late.
Senator Coburn. OK. My key point is that of that $49
billion enforcement revenue, how much of it was due this year,
in 2005's returns, versus how much was due in 2000 versus----
Mr. Everson. Yes, you have to spread that out. We would
have to analyze that for you.
Senator Coburn. But my point is if you are ever going to
measure performance against the tax gap, here is the gross tax
gap, here is what we are doing against it, if you do not do it
against the year in which it was supposedly owed, you are not
going to have an adequate metric.
Mr. Everson. I agree with that.
Senator Coburn. All right. What percentage of individual
returns now are filed electronically?
Mr. Everson. This year, it is in excess of 50--about 54-
point-something percent.
Senator Coburn. Fifty-four percent.
Mr. Everson. Yes.
Senator Coburn. And do you foresee that is going to grow?
Mr. Everson. That I believe will continue to grow, yes,
sir. Now, there was a mandate to bring that up to 80 percent.
It was, I think most observers would suggest, rather arbitrary
when it was set. I think it had a very beneficial impact,
though, on the whole system because the organization and others
have pushed towards that.
We are a champion of electronic filing. I think that
obviously it is better for the system, better for the
government, and certainly better for individuals as well.
Senator Coburn. So one other point that you made was that
if we keep changing the Tax Code, that makes enforcement even
more difficult, both in terms of your ability to measure and
institute the changes on the enforcement side, but also for
those that inadvertently file wrong because the law has been
changed.
Mr. Everson. I think that is absolutely true. It goes hand
in hand with complexity. When I talked with the tax reform
panel, which was referenced earlier, back in March of last
year, they asked me what were the areas you could work on if
you just took an incremental approach. Look at all the credits
you get for education and things like that. There is just so
many different overlapping kinds of programs. It is very hard
to know what to do if you are an individual. As was indicated,
the practitioners see things slightly differently, depending on
the fact circumstances. Simplification would help both the
taxpayer and the government, sir.
Senator Coburn. OK. We are going to have in one of our
panels, we are going to be talking about tax expenditures
today, both at my request and the request of Senator
Lautenberg. How big of a problem do you see that one? How much
does it complicate your job? The largest tax expenditure, by
the way, is for health care in this country, and several others
that most people would agree are socially good investments to
create certain behaviors. How much of a difficulty is that? And
how much of this is large versus how much of it is small? How
much of it is very small in terms of both the numbers and the
impact that have been written into the Tax Code as tax
expenditures? And what kind of problems does that cause you?
Mr. Everson. I think what you are getting into tax policy
questions, really, as to how the Code is constructed and what
our Nation chooses to subsidize.
There can be enforcement ramifications on this. An example
is we testified and wrote quite clearly that the manufacturing
provisions in the Jobs Act were going to cause us great
enforcement issues. So it gets down largely to this question of
complexity, and that word over there, your first word,
``transparency.'' If things are not transparent, then any
expenditure or any policy choice is just an awful lot harder
for us to deal with.
Senator Coburn. All right. Thank you. Senator Carper.
Senator Carper. Thanks, Mr. Chairman.
One of the things we worked on in Delaware--and I am sure
other States did, too--at the State level was to figure out
what we could do to make sure that folks who had an obligation
to the State of Delaware, a tax obligation, whether it was
personal, corporate, or otherwise, that they met their
obligation. And we would do that through our own employees
within the Division of Revenue, and occasionally we would
contract with a private form to do that work for us.
We tried to be sensitive to the needs for protection of
confidential information and to make sure that we did not
simply ignore the needs of having State employees do the work
within the Division of Revenue and to train them and give them
the resources, technical and otherwise, that they needed.
My recollection is that about 10 years ago there was an
effort at the Federal level to use private sector resources for
debt collection by the IRS. My recollection is it did not go
well, and I know that the IRS is trying it again, trying to do
it this time, but differently, to operate on the lessons that
we learned from the misadventures of a decade ago.
I would like for you to talk a bit about that, what we
learned and what we are doing differently. I understand that
the firms that you hired to do this work, get to keep anywhere
from 21 to 24 cents out of a dollar. I understand that about 25
cents out of a dollar that they collect comes back to the IRS
that you can use to hire more people to do the work, to have
better technology to enable your folks, to empower your
employees to do the work. And I want to make sure that 25 cents
actually does come back through to the IRS and that you are
able to increase your resources and improve your ability to
collect taxes.
Just talk a little bit about that whole thing, if you
would.
Mr. Everson. Sure. Certainly, sir. We have commenced with
that program. Earlier this month, we sent forward about 11,500
cases to the contractors. Already we have received in, I am
told, over half a million dollars in cash thus far from 250-
some-odd taxpayers. These are cases that we would not be
working. For 4 years, we have not received the funding that we
have asked for from the Congress. The budget scoring rules, you
would be throwing money at us if projecting an increase in our
appropriated resources would also show an increase on the
revenue side from the enforcement revenue and the indirect
effect we get.
So I have freely acknowledged, sir, that it is more costly,
because of this percentage that the contractors would keep,
than it would be were we to do this work ourselves. I would say
to you, though, that even if you gave me more money to allocate
within the IRS, I would not necessarily use it all on
collections. We have to run a balanced program. That includes
our work on charity and a host of things.
Turning to the substance of what happened in 1996 versus
now, you are entirely correct; I do not think that program was
well run. We were not, as I would say, deliberate in our case
selection to make sure that we were giving the contractors
cases with a reasonable prospect of collection. We have been
pretty careful there this time. We are working very--we have
had, as you can imagine, some start-up issues, but we are very
closely monitoring what they are doing, making sure that they
are following the law and that they protect taxpayer privacy
and rights. And thus far I think it is off to a good start.
So we are going to monitor it. I know you will hear from
Mr. George afterwards. He is the Inspector General. He is all
over this, and we are very accountable, I would say to you, on
this program. But I am cautiously optimistic that it is going
to supplement and bring in more money and help us. But if there
are any warts or problems with it, we are going to be very
transparent about it and make whatever adjustments we have to
do.
Senator Carper. Good. It is important to me--I cannot speak
for the Subcommittee, but it is certainly important to me that
the 25 cents out of that dollar that we are talking about that
comes back to the IRS is--that we know how you are spending it.
Mr. Everson. Yes, I neglected to mention that, but this
will be good for us in terms of building our infrastructure and
making sure that we are addressing the collection issues.
I want to mention one thing. We actually did get an award,
Senator. We got Points of Light Foundation Award.
Senator Carper. Was it the Delaware quality award?
Mr. Everson. No, it was not, but we got the Points of Light
Foundation Award, the first time a government agency got that
award, a year or two ago for this volunteer program, the
partnership we have. Our partnership organization works with
others to get support for our activities. So we are not totally
in the doghouse on this.
Senator Carper. We want to make sure you earn some more
awards as well. Well, let's stay in touch on this, and we will
see how it goes.
I want to talk a little bit about the capital gains tax
gap, and we are going to have a witness or two later on to
explore that with. The Chairman and I have been working a
little on it with Senator Evan Bayh.
Mr. Everson. Yes.
Senator Carper. He has championed legislation, along with
some others, to try to make sure that the tax gap that exists
with respect to capital gains is somehow narrowed.
Any idea what that capital gains tax gap might be these
days?
Mr. Everson. The number that I recall is something more
than $10 billion for 2001, which 2001 might have been a
difficult--you have got to go back and say what year are you
measuring, and if you recall, the markets reached a peak in
2000, so maybe that is hard to know at any one time whether
that is a good number or a bad number.
As a general rule, if you will indulge me for a second,
where we have visibility as to data or facts, compliance is
very high. Wage reporting, the non-compliance on wages is about
1 percent. You are not going to cheat on how much money you
make as a Senator. We know that.
Senator Carper. You do?
Mr. Everson. Yes. If you are going to--despite the rumor,
there is some cooperation between the Executive and Legislative
Branches, and you send over that material to us. But if you
look at wage reporting, there is no problem on that. We know
what wage earners make.
If, on the other hand, where there is little or no
information reporting, non-compliance is much more dramatic.
This gets back into that component of the tax gap map we talked
about last year, where underreported business income for small
businesses is 50 percent.
Senator Carper. Fifty percent.
Mr. Everson. Now, we have made some proposals in the 2007
budget, one of which is a modest but, I think, important
proposal, to get credit card reporting on gross receipts. That
is a starting point. We have one of our five legislative
proposals enacted earlier this year. It actually reflects the
work of the Permanent Subcommittee on Investigations and the
hearings we have had on contractors, Federal contractors.
We will look at the proposal you are referencing. It is
just the kind of thing we are looking at now as one of the
issues that I mentioned in terms of the legislative proposals
to address non-compliance. So that is in the hopper.
What I really would counsel you is if the Congress could
make a downpayment by getting that credit card reporting
proposal done, it would really show that there is a stomach to
do some of these tough things. Because anytime you do one of
these, you very much find that out of the woodwork come a lot
of people who say we do not want to do something like that.
Senator Carper. OK, good. My time has expired. Are we going
to have another round here?
Senator Coburn. Yes.
Senator Carper. Great. Thanks.
Senator Coburn. A couple of things. First of all, in terms
of capital gain reporting, every brokerage firm I know right
now has to report a Form 1099 on dividends, has to report a
Form 1099 on interest. Correct?
Mr. Everson. Yes.
Senator Coburn. And they have the data on capital gains.
And if they do not have the data, they can put zero, and so the
gain is the total thing, and it is up to the taxpayer to prove
what their basis is.
Mr. Everson. Let me respond to that. People change
brokerage accounts, and the basis needs to shift over. I think
that, clearly, going forward you could establish this on a
going-forward basis.
I am somewhat sympathetic to the complexity going back with
splits and everything else and changes of accounts. It would
just take a while to get it fully----
Senator Coburn. Yes. I am not sympathetic at all. I have to
do it every year for my taxes, and if it was split I have to
figure it out. And the fact is that the onus is on the taxpayer
to report their basis.
Mr. Everson. Yes.
Senator Coburn. The onus is not on the IRS to prove their
basis. And so I think what Senator Bayh is on is great. It will
not require significant equipment. It is one other slip for
each account based on capital gains, and I think it is
something we should do, and I think that we are going to have
testimony that is, at a minimum, $25 billion, not $10 billion.
I want to go back to the tax gap for a minute because we
are going to have testimony from your own IG that suggests that
this tax gap is larger than what we are reporting. Why do you
think they think that?
Mr. Everson. Well, there is growth in the economy. I think
we did a good job of updating and estimating the gap for the
individuals. We did not look at the underreporting gap as to
corporations. That is the principal area.
Now, I say that knowing that is a very hard thing to get
because of the nature of the population, and the blunt reality
is I would not allocate more resources into that corporate--the
box there with the $30 billion. I have said maybe it was
understated by a factor of half--I would not be allocating more
resources into that than what I was already doing within the
range of resources that I was getting.
Again, we have given very high priority to high-income
individuals where we have doubled the number of audits over the
last several years, and we have brought back the corporate
work, very much so. I think we are seeing some positive effects
on that.
So, to me, the real importance of the study is to get the
update and make the allocation decisions, to use it to make the
sensible decisions on what lines you are looking at on the
return.
Senator Coburn. Where do you get the greatest return for
your investment in assets?
Mr. Everson. Well, right now it is right over in
individual, and if we go to the chart, the detail on the
visibility, that shows some $68 billion based on that study,
that is the underreporting of income by individuals and it is
unincorporated businesses. So, clearly, I think we have made
some headway on high-income individuals, and we have made some
headway on--this just shows that out of that--remember the
chart that showed the $110 billion where you had low
visibility? This just analyzes that and says you have $68
billion on Schedule C income. That is an individual who has a
business that they are running and they are not incorporated.
That means we are understating that income.
So, clearly, there is a lot of money to go after there. We
would be strengthening our oversight in that area, I would say
is one of the first things we would be doing.
Senator Coburn. Senator Carper.
Senator Carper. If I may, I want to go back to the
legislation that Senator Bayh has introduced and we have
cosponsored. I think it is called the SMART Act. If you would,
give us some of your thoughts on the proposal to the extent
that you are familiar with it. I just would like to hear more
about how you feel about it.
Mr. Everson. Again, I think that we were accused of being
rather too modest in the five proposals we put forth in the
2007 budget. But I can only tell you the storm of criticism we
got, particularly from the small business community, as to the
additional burden we seemed to be creating. I believe that what
we have done is we have tried to be very targeted so that we do
not increase burden.
As an example, I am not proposing additional withholding.
The Administration is not going there. Some have suggested
that. So what we do want to do is craft proposals that can be
dealt with, with the least amount of burden. I agree with the
Chairman that the big companies who are handling these
brokerage outfits are much better able to make that kind of an
adjustment.
So we are actively looking at that proposal. We are working
with OMB, the Treasury, and the IRS. We have a group that is
refining our proposals now. That is why the plan, the outline
of the plan that we sent up to the Finance Committee today does
not have all the details yet, because they are part of the
budget process, both as to the funding of our IT and
enforcement activities and, very importantly, the legislative
proposals. What you have there, what you are championing is
under active consideration, and I will carry back your support
for it.
Senator Carper. Good, thanks. One more question. I
understand you said before that the IRS could close the tax gap
by an additional $100 billion without unduly burdening
taxpayers. And you talked a little bit about this today, but,
generally speaking, what kind of things need to be done to
bring in that $100 billion? And what kind of burdensome
measures do you think would be needed to go beyond that $100
billion figure? Feel free to repeat some things, reinforce some
things you have already said, but add anything else to that
that you wish.
Mr. Everson. Sure. The remark that I made earlier this year
was that I believe from the starting point of 2001, that $345
billion versus $290 billion, that you could close $50 to $100
billion through a combination of measures--and I think those
measures are largely reflected in the document we sent forward
today. They include more enforcement. They include legislative
solutions with more reporting, a more efficient IRS through a
better infrastructure--a whole series of things that would not
fundamentally alter the relationship between the government and
the taxpayer. I think they would address this issue of
confusion. Simplification would be in there, all the things
that we point to in that seven-point proposal.
What I do get concerned about is sometimes people will
throw around the idea that, well, you can just close this tax
gap and then the deficit is gone and we can all be happy
campers. I do believe there gets to be a point--I am not sure
where that is.
Senator Coburn. Diminishing returns.
Mr. Everson. Diminishing returns, where you are really
adding a lot of burden. That is one reason right at this stage
I am not proposing more withholding. Withholding works. We have
wage withholding. But I hesitate to ask for that.
I would like to see us get that $50 to $100 billion first
and assess as we go, do as the Chairman suggested, get more
research to get a better fix on an ongoing basis of the
progress we are making. I have my Director of Research here. If
you would nod and say, ``Amen,'' it would be useful for me. I
am pressing him to get regular updates, not just these big
projects every 4 or 5 years.
I would like to answer that question in probably more
detail a few years down the road once we have already captured
the $50 or $100 billion.
Senator Carper. OK. I would just observe, before closing
here, Mr. Chairman, if we could collect even half of the $300
billion, the tax gap, and if we could just reduce the improper
payments or overpayments by about half, that would be another
$25 billion, put them together and that is $175 billion. And
that is certainly a bit more than the operating deficit we are
going to face this year.
As we look forward to the coming decade as the boomers, our
generation--I think it is our generation--start to----
Senator Coburn. You are a lot older than I am, Senator.
[Laughter.]
Senator Carper. When they start to retire and we know what
impact, potential impact that is going to have on the Treasury
with Social Security, Medicaid, and Medicare, we are going to
need all the help that we can get if we are going to avoid
piling on that debt on our kids and grandchildren. So this is
important stuff.
I just want to say to you, Mr. Commissioner, and to your
team that you lead, all the way to the rank-and-file folks that
you lead, the work that you are doing is real important. We
appreciate the efforts that are going on, on the part of
everybody, including the people that work in our States and
your offices in our States as well.
Mr. Everson. Thank you.
Senator Coburn. I would echo Senator Carper's comments, and
I would also note that this Subcommittee has found in excess of
$100 billion in fraud--$100 billion in fraud--and that is
looking at less than 40 percent of the Federal Government. So
if you took half the tax gap, half the improper payments, and
half of the fraud, we could have the Chinese borrowing from us
rather than us borrowing from them.
Thank you, Commissioner.
Senator Coburn. Our next panel, first is Russell George. He
is the Treasury Inspector General for Tax Administration where
he has served for 2 years. Prior to this time, Mr. George
served as Inspector General of the Corporation for National and
Community Service.
With him also is Nina Olson, the National Taxpayer
Advocate, where she serves as an advocate for taxpayers to the
IRS and Congress.
And Jay Soled is Professor of Taxation at Rutgers
University and practices law at the firm of Pfizer and Soled.
Welcome to you all. Inspector General George, you are
recognized.
TESTIMONY OF HON. J. RUSSELL GEORGE,\1\ TREASURY INSPECTOR
GENERAL FOR TAX ADMINISTRATION (TIGTA), DEPARTMENT OF THE
TREASURY
Mr. George. Thank you, Mr. Chairman.
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\1\ The prepared statement of Mr. George appears in the Appendix on
page 62.
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Chairman Coburn, Ranking Member Carper, I appreciate the
opportunity to appear before you today to discuss the tax gap
and opportunities for closing it.
In 2006, the IRS updated its estimate of the tax gap based
on data from the 2001 tax year. The updated information on
individuals is a significant improvement because individuals
comprise the largest segment of the tax gap. However, there is
no new information about employment, corporate, and other
taxpayer segments. With no firm plans to update the study of
these segments, we will be left with an incomplete picture of
both the tax gap and the current voluntary compliance rate.
Senator Coburn. Could you suspend for just a minute? Is
anybody still here from the IRS? OK. I just would like for one
of them to hear what the Inspector General has to say.
Mr. George. Thank you.
Senator Coburn. Go ahead.
Mr. George. Although we cannot be certain about the size of
the tax gap, we do know that the three primary sources of it
are underreporting, non-payment, and non-filing.
Underreporting--which is estimated at $285 billion--is by
far the largest portion and greatest challenge in closing the
tax gap. Yet TIGTA concluded that even this estimate may not be
complete because substantial amounts are not included in the
tax gap projections. For example, the IRS tax gap projections
describe the non-filing estimate as reasonable, despite the
missing segments of corporate income, employment, and excise
taxes. The IRS does not have definite plans to update the
estate tax segment or to estimate the corporate, employment,
and excise tax non-filed segments, suggesting that the non-
filer estimate is incomplete, and likely inaccurate.
One recommendation that could significantly address the
underreporting and non-filing segments of the tax gap involves
third-party reporting. The IRS has estimated that compliance
rates are as high as 96 percent when third-party reporting is
involved. In contrast, self-employed individuals are estimated
to report only about 68 percent of their income. Even more
alarming, self-employed individuals operating on a cash basis
report just 19 percent of their income.
Three years ago, TIGTA recommended that the IRS initiate a
proposal for a legislative change to mandate withholding on
non-employee compensation payments. Implementing such a
provision could reduce the tax gap by billions of dollars. In
addition, other actions should be taken to improve compliance
among independent contractors.
For example, improvement is needed to address inaccurate
reporting of taxpayer identification numbers for independent
contractors. For tax years 1995 through 1998, the IRS received
about 9.6 million statements for recipients of miscellaneous
income--reporting approximately $204 billion in non-employee
compensation that either did not contain a taxpayer
identification number or it had a number that did not match the
IRS' records.
Withholding could be mandated for independent contractors
who fail to furnish a taxpayer identification number.
Implementing mandated withholding for this segment of
independent contractors could result in an estimated $2.2
billion in increased revenue each year.
IRS compliance efforts are also limited by the lack of
available information on the basis of investments, which could
be used to verify investment gains or losses, as we discussed
earlier. Such information reporting would allow the IRS to
better focus its enforcement resources on non-compliant
taxpayers.
Although individual wage earners receive a wage and tax
statement--the W-2 Form--have their wages verified through a
matching program, a similar comprehensive matching program for
business documents received by the IRS does not exist. TIGTA
has recommended that the IRS evaluate all types of business
documents it receives to determine whether this information can
be used to improve business compliance. An IRS study, based on
TIGTA commission, found that in fiscal year 2000, business
information documents report $697 billion in potential taxable
income.
Last, investments made abroad by U.S. residents have nearly
tripled in recent years, growing from $2.6 trillion in 1999 to
$7.2 trillion in 2003. To address the tax compliance challenges
presented by these investments, TIGTA has recommended that the
IRS make better use of foreign-source income information
received from tax treaty countries.
In summary, it is unlikely that a massive change
involuntary compliance can be achieved without significant
changes to the tax system. Strategies have been identified to
decrease the tax gap and improvements can be realized. However,
the IRS faces formidable challenges in accurately estimating
the tax gap and finding effective ways to increase compliance.
Mr. Chairman, Mr. Carper, I appreciate the opportunity to
share my views on the tax gap and the work TIGTA has done in
this area. I would be happy to answer questions at the
appropriate time.
Senator Coburn. Thank you, General George. Ms. Olson.
TESTIMONY OF NINA E. OLSON,\1\ NATIONAL TAXPAYER ADVOCATE
Ms. Olson. Mr. Chairman and Senator Carper, thank you for
inviting me to testify today regarding the causes of possible
legislative and administrative solutions. At the outset let me
suggest that the ultimate question we should be focused on is
not how can we reduce the tax gap but, rather, how can we
increase voluntary compliance. This is so because voluntary
compliance, as opposed to enforced compliance, creates
taxpayers who are willing to work with the tax system rather
than taxpayers who hide from the tax system. Moreover, in the
long run, voluntary compliance is the most cost-effective way
to achieve lasting compliance.
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\1\ The prepared statement of Ms. Olson appears in the Appendix on
page 90.
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To determine how to allocate its resources most effectively
to increase voluntary compliance, the IRS needs to do a better
job of understanding the reasons why the tax gap exists. At the
risk of oversimplifying matters, let me suggest that we
consider three types of taxpayers: First, taxpayers who will go
to great lengths to comply with whatever requirements exist;
second, taxpayers who view taxes as one of many burdens they
face in everyday life and who will comply only if doing so is
straightforward and not time-consuming; and, third, taxpayers
who will willfully seek to evade their tax obligations.
What percentage of taxpayers fall into each of these
categories? It is impossible to know with precision, but
available data suggests that the majority of taxpayer errors
are attributable to inadvertent error rather than intentional
non-compliance.
When IRS auditors conducted approximately 46,000 of
individual taxpayers for purposes of the National Research
Program, the auditors were asked for each issue they identified
to characterize the reason for non-compliance. The results were
striking. Among issues IRS auditors examined that resulted in a
change in tax liability, the auditors listed 67 percent as
inadvertent mistakes, 27 percent as computational errors, or
errors that flowed automatically, and only 3 percent of errors
as intentional.
A recent GAO study on capital gains misreporting also
suggests that deliberate cheating is responsible for
significantly less than half of all reporting inaccuracies. We
need to keep these data in mind as we craft our compliance
strategies. Equally important, these data suggest the need for
more refined research because classifying errors as either
intentional or inadvertent does not get us very far.
Consider, for example, a taxpayer who cannot determine the
cost basis of a stock or mutual fund holding he sold during the
year and who intentionally reports a number that he believes
represents a good-faith estimate but is likely to be wrong.
That sort of intentional error is very different and calls for
a very different compliance response as compared with the
taxpayer who deliberately underreports his income.
In the next phase of the National Research Program, the IRS
should seek to refine its determinations of the sources of non-
compliance to enable it to develop a more refined and cost-
effective compliance strategy.
I remain concerned that the IRS is proceeding on a course
that emphasizes stepped-up enforcement over stepped-up taxpayer
service. It should not be a question of service or enforcement.
The IRS should integrate taxpayer service within its
enforcement activities. Particularly in light of its limited
resources, the IRS should focus its enforcement activities not
merely on collecting unpaid past due taxes, but on trying to
bring taxpayers into compliance prospectively.
The IRS could also do a better job of going where the money
is, and that means the cash economy. The NRP data indicate that
where taxable payments are reported to the IRS by third
parties, reporting compliance comes to roughly 96 percent of
the tax due. But where taxable payments are not reported to the
IRS by third parties, reporting compliance drops below 50
percent. In my annual reports to Congress and in previous
congressional testimony, I have offered numerous proposals to
help the IRS to do a better job at combating the cash economy
portion of the tax gap. Some of those proposals are summarized
in the appendices at the end of my written statement, and I am
not afraid to propose withholding, as some others are.
Even though the IRS can do more to improve voluntary
compliance, I do believe the compliance rate will not raise
dramatically unless Congress passes legislation to make it
easier for the IRS to detect non-compliance, primarily through
expanded third-party information reporting or withholding. And
I do want to call your attention to a recommendation in my
annual report to Congress about expanding reporting for--
requiring brokers to track the cost basis of stock and to make
it easier for taxpayers who are self-employed to make estimated
tax payments, improving the offer in compromise program, and
strengthening standards in the tax return preparation industry.
In addition, tax simplification would help enormously. Thank
you.
Senator Coburn. Thank you, Ms. Olson. Mr. Soled.
TESTIMONY OF JAY A. SOLED,\1\ PROFESSOR OF TAXATION, RUTGERS
UNIVERSITY
Mr. Soled. Mr. Chairman and Ranking Chairman, my name is
Jay Soled. I am a tax professor at Rutgers University. I have
written several papers on the issue of the capital gains tax
gap. Thank you for inviting me to testify in favor of closing
the capital gains tax gap and passage of the Simplification
Through Additional Reporting Tax Act, aka the START Act.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Soled appears in the Appendix on
page 126.
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Before detailing the problem of the capital gains tax gap,
I would like to take this opportunity to highlight several
salient points that were and were not made by the GAO in a
report it issued earlier this year entitled ``Capital Gains Tax
Gap.''
First, what the GAO report stated is that for tax year
2001, an estimated 38 percent of individual taxpayers who had
securities transactions failed to accurately report their
capital gains or losses from these transactions. What the GAO
report did not say is that if security ownership continues to
expand is left unchecked, almost four out of every ten American
taxpayers will submit income tax returns that are incorrect.
Second, the GAO report stated that these mistakes cost the
government over $11 billion annually. What the GAO report did
not emphasize, however, is that this $11 billion figure relates
to individual income tax returns. As such, it probably grossly
understates the magnitude of the problem. If the GAO were to
have expanded the scope of its investigation to include
corporate and other taxpayers such as trusts and estates, the
estimated revenue loss to the government could easily exceed
$25 billion annually.
Third, the GAO report stated that the IRS is virtually
powerless to close the capital gains tax gap. Without trying to
paint too bleak of a picture, what the GAO report was really
trying to say is that even if the IRS could audit the tax
return of every single American--pity that thought--the problem
of the capital gains tax gap would remain largely intact. This
is because most Americans lack accurate records and the ability
to track the tax basis they have in their investments.
Why is the problem of the capital gains tax gap so
prevalent? Let me offer three of the most compelling reasons.
Reason number one: Taxpayers are notoriously lax record
keepers. When it comes to record keeping, few taxpayers would
deserve Oscars for their efforts.
Reason number two: Computation of an investment's tax basis
can be extraordinarily complex. Consider, for example, the
plight of 18 tea shareholders who, after a series of split-
offs, mergers, and reverse stock splits, each now own stock in
11 different companies, each with its own independent tax
basis.
Reason number three: When it comes to third-party
information returns, there is no tax basis reporting to the
IRS. Prior studies indicate, however, that in the absence of
information returns, taxpayers compliance plummets.
The START Act offers hope to taxpayers and the government
that tax basis misidentifications will be a problem of the past
and that the capital gains tax gap will narrow. If enacted, the
START Act would require that mutual fund companies and
brokerage firms track the tax basis of their clients'
investments, and upon the triggering of a reporting event, such
as a sale or other disposition, the mutual fund company or
brokerage firm would, in addition to reporting the amount
realized, also report the investment's tax basis.
Passage of the START Act would be a boon to taxpayers, the
government, and even mutual fund companies and brokerage firms.
Taxpayers would have easy access to critical tax basis
information. Put slightly differently, every April 15 there
would likely be far fewer shoe boxes that taxpayers would have
to dust off to bring to their accountants.
The most identifiable government benefit is that it could,
over a 10-year scoring period, collect up to an additional
quarter of a trillion dollars of revenue. That number bears
repetition. That is a quarter of a trillion dollars' worth of
tax revenue without increasing taxes.
Insofar as mutual fund companies and brokerage firms are
concerned, around tax season no longer would their employees
who staff telephone and offices be besieged by clients who call
or stop by to make tax basis inquiries.
My biggest complaint with the START Act is that it does not
go far enough. More comprehensive reforms such as tax basis
simplification measures are probably required to narrow the
capital gains tax gap even further. So, from my perspective,
the START Act is just that: A starting point that should
immediately be put into place.
In closing, Senators, before you ask me any questions,
please allow me to take this opportunity to ask a question of
each of you. Do you know the tax basis you have in each of your
investments? Assuming you do not, then you should recognize the
importance of the START Act and the need for its immediate
passage. Thank you.
Senator Coburn. Mr. Soled, to answer your question, the
answer is yes, I do.
Mr. Soled. Very impressive.
Senator Coburn. I happened to be an accountant before I was
a doctor. [Laughter.]
So it made a big difference.
I want to ask all of you to respond to this and just give
me a--does everybody agree that one of the ways to increase
compliances is simplification?
Mr. George. Most definitely.
Ms. Olson. Yes.
Senator Coburn. And do you, Mr. Soled?
Mr. Soled. Absolutely.
Senator Coburn. And would you agree that there is almost a
linear relationship between the more we simplify, the more
compliance we get?
Mr. George. Yes, Mr. Chairman.
Ms. Olson. Ah, yes.
Senator Coburn. That was a quasi yes. Mr. Soled.
Mr. Soled. No hesitation in my voice. Yes.
Senator Coburn. The simpler we make it. Are there things in
your mind----
Ms. Olson. Sir, could I clarify? I mean, you could simplify
things by telling everyone they have to pay a flat 50-percent
tax, and you might end up with increased non-compliance because
you have made it simple.
Senator Coburn. I agree. But for the Code that we have----
Ms. Olson. Right, yes.
Senator Coburn. Each of you have testified on things that
you think need to change. What I would like to just say, based
on we have what is highly probable, a $450 billion tax gap
rather than a $350 billion tax gap. In order of priority, what
are the first three things that should change?
Mr. George. Well, third-party reporting, there is no
question about it. I cited the figures of individuals, 90-plus-
percentage, versus those operating on a cash basis who do not
have third-party reporting, I mean under 20 percent. The lack
of tax compliance data, the NRP was a good first step on the
part of the IRS, but it was only a first step. There is so much
more information, as I noted in both my oral and written
testimony, that is needed in terms of the corporate and other
aspects of it. And then, lastly, unreported income, I mean
literally if we were able to institute the withholding,
especially for the independent contractors, that would make
such a difference.
Senator Coburn. OK. And you do have communication with the
researchers at IRS? They do read your reports?
Mr. George. We hope so.
Senator Coburn. Well, but I am asking, do you have one-on-
one communication with the gentleman that Mr. Everson referred
to in terms of working with them----
Mr. George. Yes.
Senator Coburn [continuing]. And trying to massage what can
we do here in terms of measuring so we can manage?
Mr. George. Yes, we do, Mr. Chairman.
Senator Coburn. OK. Ms. Olson.
Ms. Olson. I would have to say that if I would go to the
cash economy first and look at expanded information reporting.
The proposals that I have made about estimated taxes, making
them easier, like a monthly payment coming automatically out of
accounts so people who want to comply but cannot quite save to
pay in those estimated taxes quarterly. And then instituting
some kind of a back-up withholding requirement on independent
contractors who have been----
Senator Coburn. Proven to be non-compliant?
Ms. Olson. Proven non-compliance, exactly, so that you have
2 or 3 years where they have not been able to pay. And the
whole idea of that would be you get their attention and then
you say to them, OK, now go into this estimated tax payment on
a monthly basis, map it out a year in advance so we know you
are going to make payments and, go and sin no more, and now we
will work on your back liability. So sort of changing behavior.
On simplification, I believe Congress has to act on AMT,
which is not just a current problem right now, but as you go to
2010 and 2012 and you see 33 million taxpayers being pulled
into the system, that is going to increase non-compliance among
a group of taxpayers who are currently compliant.
Senator Coburn. It is also going to be the very wedge
pressure that we have to get simplification.
Ms. Olson. Tax reform, exactly. And the third point would
be additional research. We have to understand what causes
taxpayer behavior.
I am sponsoring a research thing right now, a study right
now, to look into taxpayer behavior, and one of the things we
are looking at is why taxpayers--for example, looking at not
just taxpayers, but why people stopped smoking, the non-smoking
campaign. Why were we able to change behavior of the public
over a period of time? And how can we change behavior about
compliance with taxes over time?
Senator Coburn. Mr. Soled.
Mr. Soled. Three ideas, and these are akin to what you just
heard. First, we might look to expand information returns.
Here is an idea that you might also consider. Second, the
promotion of credit cards and debit cards so that we could have
people, in lieu of using cash to pay their plumbers and pay
their painters, they would turn to using credit cards and debit
cards, and we could almost think of perhaps a government
program that would offer a rewards program akin to frequent
flyer miles for people who use their credit cards and the like.
I know that might strike some as being radical and strange, but
countries like Mexico, I understand, are instituting such a
program.
And third, another thing that we might consider that I
understand other countries have done that would be interesting
is perhaps every 5 years to change over our currency so that
people like Mr. George was referring to who have investments
overseas, all of a sudden they have to be forthcoming, or less
they might risk losing their currency. So, some different
angles that other countries--we might want to look at what some
other countries have done to close their tax gaps, and maybe in
some instances where they have been very successful, use that
as a model.
Senator Coburn. OK. Mr. George, have you looked yet at the
utilization by the IRS of the private collections, and have you
started looking at that and watching that? What are your
comments on that?
Mr. George. Well, we are in the process of reviewing that,
Mr. Chairman. Just as background, over 10 years ago I was the
Staff Director for Congressman Steven Horn of the Subcommittee
on Government Management, Information, and Technology, who took
a very strong interest in this subject matter, pushed the Ways
and Means Committee to develop that pilot that, as he stated
publicly, was set up to fail. It did fail, and it cost more
than the amount it generated in revenue, in collections.
So when I first started this position, I indicated to my
staff, as well as to the Secretary and others, this would be a
top priority for me. So we have been very engaged in terms of
working with the Internal Revenue Service and their preparation
to establish this program, and it is too early for us to give a
complete assessment as to its benefits.
Senator Coburn. OK. Senator Carper.
Senator Carper. I am just sitting here thinking what a good
hearing this is, Mr. Chairman, and we welcome each of you.
Thank you for coming, for testifying, and really it is kind of
like keying off of one another and reinforcing what others are
saying.
One of the witnesses--I do not recall who, but one of the
witnesses--maybe it was Professor Soled who said--I think you
talked about what other countries have done and show how they
are narrowing their own tax gap. Who said that? Who mentioned
that?
Mr. Soled. I just did.
Senator Carper. Yes, OK. Take just a minute and let's just
focus on that, what are some other countries that could be held
out as best models in terms of reducing their own tax gap? And
the second half of my question is the States, the 50
laboratories of democracy? Some of them do a pretty good job on
their own tax gap. But what are some States, if you are aware
of any States, that have done a particularly good job? And what
can we learn from them?
Ms. Olson. Sir, in the United Kingdom, I went over and did
some consulting with the United Kingdom last spring and their
tax system, and one of the proposals--one of the programs that
they have that they instituted with the construction industry,
which is notorious for cash economy, is that they have had
something for the last 30 years called a ``Compliance
Certificate,'' and they have told that individuals who are
self-employed in the construction industry, the employers or
the contractors will have to withhold a particular percentage
on their independent contractors unless they get a Compliance
Certificate from the tax authority that says to the contractor
this person is compliant with their taxes, whether it is an
installment agreement or whatever, and you do not have to
withhold.
And I really like that proposal because it puts the
incentives in the right place. It makes the contractor want
to--it is easier for them to hire compliant taxpayers as subs
rather than people who are hiding out from the IRS. And it
helps--it gets them working with the tax authority to get these
people in compliance.
Senator Carper. That is good.
Ms. Olson. So I have recommended that procedure. What I
have recommended to the IRS about working with the States is
that the States have an enormous amount of information, if you
just keep working on the cash economy through State business
licenses, where people who are contractors or hairdressers or
lawn care people, they have to get a business license. And
States and localities really enforce that because it really is
their revenue stream. The people have to give their Social
Security numbers and their employer identification numbers in
order to get that, and if we could work out arrangements with
the States to just do data matching, does this person who has a
construction license show up in our tax system, or are they
truly in the cash economy? Then maybe we should go pay that
person a visit or at least send them a letter, and do it
jointly with the States.
Senator Carper. Good. Other thoughts? Those were excellent.
Mr. George. Senator Carper, I would just note that, first
of all, I have to be careful because of the restriction on
addressing tax policy, too, as the Secretary has delegated that
authority within the Department to the Tax Policy Division.
That stated, there is no question that a good example would
be what California and a few other States recently did with tax
shelters and extending the amount of time that tax revenue
entities had to review those, which some perceive to be
abusive. They have a longer time frame than does the Federal
Government in terms of the ability to go back and to examine
it. And when you consider the complicated nature of many of
these schemes, to put it diplomatically, a lot of time is
needed, and in many instances, the Federal Government just does
not have the resources with which to do it on a timely basis.
Senator Carper. Good.
Professor Soled, what are some countries or maybe some
States that we might hold out as models? We have heard a couple
good ideas here.
Mr. Soled. I cannot point to any particular States, but I
just want to emphasize, if I could, the importance of your
Subcommittee and what it is doing, because when people focus on
the issue of the tax gap, what I think they fail to understand
is that so many States piggyback off the Federal Government and
what shows up on a Form 1040 and a Form 1120, they seem to
forget that whatever you guys do and the importance of your
work, that effect carries over onto State income tax returns.
So whatever the tax gap is and the magnitude--and we are all
fearful of what it might be--it is that there are billions of
dollars that go uncollected because the Federal Government is
not doing its job in terms of its collection.
So I think you can add, by a factor of about 20 percent to
the Federal tax gap what the State tax gaps are, just because
the work that--like I said, this piggyback effect. So I cannot
point to any particular States, but I will say this: That, in
general, States do some--are fairly effective in what they do
in terms of getting people out there and doing perhaps more
face-to-face audits. That has just been my experience, at least
in New Jersey.
Senator Carper. The Chairman asked a question a bit
earlier. I think he asked you to give him your top three sort
of like suggestions, and let me just ask you the reverse of
that question or the inverse of that question, maybe two or
three things that we ought not to do, not just we as two
Senators, but as a Congress. What would be wise to avoid doing?
Mr. George. Well, there is no question that if certain
policies were adopted that requires complete disclosure of
every financial interaction--or transaction, rather, that one
engaged in, you could in theory ensure the IRS the ability to
collect or at least know what it needs to collect from
taxpayers. But given the burden that would place on the
taxpayers, I do not think anyone would advocate making that
type of drastic policy.
Ms. Olson. I think that we should not plow forward on the
assumption that enforcement of a one-size-fits-all type
approach--I talked in my testimony about unintentional versus
deliberate errors, and I believe that those two buckets are
much too clunky, that we need to even refine that even more.
You have people who make errors because the procedures are
just too burdensome. You have people who make errors because
they do not understand what we are asking them to do. Those are
two different things. We have people who make errors because
their preparers have suggested that it is OK to do this or are
acting as facilitators. And then you have the truly asocial
taxpayers who are making not errors but are actively evading.
And each one of those types of non-compliance require a
different approach. And if you take the wrong approach, if you
just use the same audit or the same collection action for each
one of those people, you are going to run the risk of
converting people who are really trying to comply into angry
taxpayers who are going to say, ``The IRS treated me badly, and
I am now going to do everything I can to not comply.'' And you
will have really done something terrible there.
I really want the IRS to be more nuanced and not just sort
of plow ahead.
Mr. Soled. I would be careful about giving taxpayers too
many options, and let me just give you the example with respect
to reporting of tax basis. Right now taxpayers can use several
different methods to report their tax basis. They can use the
specific identification method. They can use first-in, first-
out. They can use averaging. I mean, you give too many
taxpayers too many options, and it becomes very complex both to
taxpayers and, as complex as it is to taxpayers, it becomes
that much complexity to the IRS to monitor compliance.
So I would just be careful about trying to be too nice to
taxpayers. I do not mean this in a harsh way to taxpayers, but
in trying to be too kind to taxpayers, you may overdo a good
thing.
Senator Carper. Mr. Chairman, I would just observe that a
couple of our friends, John Breaux and Connie Mack, were asked
by the President to lead a review of our Tax Code and give us
their thoughts, along with, I guess, the Commission that they
led, as to what we might want to do differently. And they
floated their ideas, and I do not think much has happened with
respect to those ideas.
Obviously nothing is going to happen this year. We are
going to have in the next couple of years a lot of focus on
folks running for President, people wanting to lead the
country, and they are going to be talking about what they would
do differently, better or worse. And I think we will have an
opportunity probably during the course of a Presidential
campaign to consider changes we might want to make in our Tax
Code. And I think what we are hearing today, keep it simple
would be a good principle to underlie that. But somebody is
going to be elected President--I don't know if we are going to
do major tax reform in the next 2 years, but somebody is going
to be elected President in 2008, and then they will have an
opportunity to lead us in a new direction.
I do not know that we will have an opportunity in the next
year or two to do as much as we might want to do on this front.
But to the extent that we can tie the debate on tax reform,
which I think will flow from a Presidential campaign, into the
kind of efforts that we are discussing here, we will do our
country, I think, a big favor, a big service.
Thank you.
Senator Coburn. Thank you.
One of the reasons you have not heard much, I think, on
that Tax Commission is they filtered it with politics instead
of policy, and they said not what was possible, but they said
what might be politically possible, rather than how do you fix
the problem and then go sell it to the American public. And
when you do that, the American public gets shortchanged.
I want to thank each of you for your service. Professor,
thank you for coming. And this panel is dismissed.
Thank you very much.
Panel three consists of Stephen J. Entin. He is President
and Executive Director at the Institute for Research on the
Economics of Taxation, an economic public policy research
organization based in Washington, DC. He served as the Deputy
Assistant Secretary for Economic Policy at the Department of
the Treasury during the Reagan Administration. Prior to his
time at the Treasury, he served as staff economist with the
Joint Economic Committee.
Also with us is Jason Furman, Visiting Scholar, New York
University. He is also a Non-Resident Senior Fellow at the
Center on Budget and Policy Priorities. He previously served as
Special Assistant to the President for Economic Policy in the
Clinton Administration.
And, finally, Neal Boortz, co-author of ``The FairTax
Book'' and nationally syndicated talk-show host.
Welcome to each of you. Mr. Entin.
TESTIMONY OF STEPHEN J. ENTIN,\1\ PRESIDENT AND EXECUTIVE
DIRECTOR, INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION
Mr. Entin. Chairman Coburn and Ranking Member Carper, thank
you for inviting me to testify on the issues of the tax
expenditure database and its relationship to the issue of tax
transparency.
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\1\ The prepared statement of Mr. Entin with an attachment appears
in the Appendix on page 131.
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What is tax transparency? Tax transparency is an attribute
of the tax system. It does not mean publishing everyone's tax
returns. People should not be afraid of that.
Transparency means adopting a tax system based on sensible
principles that are widely agreed upon. It would measure income
correctly and have simple, clear calculations of tax
liabilities and would treat all income and all taxpayers alike.
Clarity and simplicity would put to rest suspicions that some
people were not paying what they should due to deficiencies in
the Tax Code as opposed to enforcement problems.
Each taxpayer would have to apply that set of tax rules to
his or her income and pay the resulting tax liability. The tax
returns and tax payments, however, would not be made public.
The tax law and tax rules would be transparent to everyone, not
the incomes, business arrangements, and tax payments of the
taxpayers.
Section 6103 of the U.S. Code requires that the IRS protect
taxpayer privacy, and the IRS has very strict policies to
enforce that legal mandate. The raw information in the master
tax file is available only to employees of the IRS and the
Treasury's Office of Tax Policy and to employees of the Joint
Tax Committee.
Tax file data that is shared with other Federal agencies or
the public is shared only in a form that has been organized in
large enough subgroups to protect the identities of the
taxpayers.
Would a tax expenditure database, akin to the earmark
database, improve tax transparency? I do not think so. A list
of tax expenditures, numbers of users, and dollar amounts are
already published by the Treasury, the Joint Tax Committee, and
the Ways and Means Committee in print and on the Web. The
Treasury tables are also presented in the Federal budget.
The estimates are obtained from the master tax file by
means of a sample of about 200,000 returns out of about 130
million individual returns and 20 million business returns.
Creating a tax expenditure database by examining all 150
million returns would be difficult and expensive. A more
detailed presentation would run into serious privacy concerns,
could thereby damage voluntary compliance by taxpayers, and
would involve greatly expanded reporting requirements for
individuals and businesses.
The aim of a database would be to highlight tax provisions
that are clearly unwarranted favoritism toward a small group of
taxpayers. Under informal Senate Finance Committee and House
Ways and Means Committee rules, such ``rifle shot'' tax breaks
are currently supposed to be identified and disallowed by the
Committee Chairmen before the bills are voted upon. Once
enacted, it is difficult for the IRS to determine which
taxpayers are using the provisions. It really is the
responsibility of Congress to avoid creating such provisions in
the first place.
A more basic question is: What is a tax expenditure? It is
defined in the law as ``revenue losses attributable to
provisions of the Federal tax laws which allow a special
exclusion, exemption, or deduction from gross income or which
provide a special credit, a preferential rate of tax, or a
deferral of liability.'' That is easy to say, sort of, but hard
in practice to deal with.
What is or is not a tax expenditure depends critically on
what is regarded as regular treatment under the tax system. The
Analytical Perspectives section in the Federal budget reports
tax expenditures under two income tax baselines. And since the
fiscal year 2004 budget, it has also provided a list of tax
expenditures measured against a neutral or consumed-income tax
concept.
In the pure Haig-Simons income tax, there would be no
double taxation of corporate income. Anything now listed as a
corporate-related tax expenditure would disappear, and the
corporate tax itself would be a ``negative'' tax expenditure.
Capital gains and the imputed income from owner-occupied
housing would be taxed as accrued. Deferral of the tax on
capital gains would be considered a tax expenditure. However,
failure to adjust for inflation, as in the current system,
would result in ``negative'' tax expenditures on the inflation
component of capital gains, interest income, and depreciation,
and a tax subsidy on interest deductions.
The current income tax does not follow the Haig-Simons
definition of ``income.'' They report tax expenditures under
the ``normal tax baseline'' and the ``reference tax law
baseline.'' Each accepts the corporate income tax and the
deferral on unrealized gains as normal, and not as a negative
or a positive tax expenditure. The reduced tax rates on
dividends and capital gains that currently offset some of the
double taxation of corporate income are not considered tax
expenditures by the Treasury and have not been since 2005.
The normal baseline counts the lower than maximum corporate
tax rates and accelerated depreciation and the tax exemption of
cash welfare payments and the deferral of foreign-source income
as a tax expenditure while the reference baseline does not.
The personal exemption and the standard deduction are
considered normal. The exclusion of income from owner-occupied
housing is not considered a tax expenditure. The exclusion of
health care premiums on employer-provided health insurance is
considered a tax expenditure. The arbitrary nature of these
rules is obvious.
The differences are greater versus a neutral or
consumption-based tax. Pension arrangements and IRAs are
considered tax expenditures under the income tax, but would be
normal tax treatment under a neutral tax system. The extra tax
on ordinary saving under the income tax today would be regarded
as a negative tax expenditure, or punitive tax. Investment
would be expensed. Even accelerated depreciation would be a
negative tax expenditure.
Treasury reports other differences under these concepts. It
also reports in this section in the budget that there are many
measurement issues, timing issues, behavior issues involved,
and the numbers cannot simply be added because we are feeling
one set of provisions would affect the revenue estimates on
others. They give a lot of warnings in that chapter. It is a
good one to read.
In conclusion, let me say that tax expenditures are
generally fairly broadly available and accessible at the
initiative of the taxpayer, much like entitlements on the
spending side of the budget. They are not typically the ``rifle
shot'' special interest benefits that would be comparable to
earmarks on the spending side of the budget that have been
inserted by Members of Congress. I do not support rifle-shot
provisions, but generally tax expenditures are not rifle-shot
provisions.
Tax expenditures are often deliberate and well-crafted
offsets to the relatively heavy tax burden imposed by the
income tax on income from capital. They are partial steps
toward a consumption base. There is nothing wrong with moving
in that direction. In fact, the income base is so detrimental
to capital formation, productivity, and wages that many
economists regard the neutral tax base alternatives as clearly
superior.
Some tax expenditures are bad tax policy. Some are intended
as social policy. Listing all tax expenditures by beneficiary,
even if it were possible to do so, would offer no guidance as
to which ones ought to be repealed.
Tax expenditure provisions are part of the Tax Code. Using
them is not tax evasion. The provisions are not part of the tax
gap from non-compliance.
A tax expenditure database akin to the earmark and grant
database is not a sound concept, nor a workable idea.
Thank you.
Senator Coburn. Thank you. Mr. Furman.
TESTIMONY OF JASON FURMAN,\1\ NON-RESIDENT SENIOR FELLOW,
CENTER ON BUDGET AND POLICY PRIORITIES, AND VISITING SCHOLAR,
NEW YORK UNIVERSITY WAGNER GRADUATE SCHOOL OF PUBLIC SERVICE
Mr. Furman. Thank you, Mr. Chairman, for the invitation to
address you today, and thank you very much for your legislation
adding transparency to Federal spending. I would like to see
the Subcommittee consider taking the next step and moving that
transparency to tax expenditures.
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\1\ The prepared statement of Mr. Furman appears in the Appendix on
page 156.
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As the GAO recently warned, although tax expenditures are
substantial in size, little progress has been made in the
Executive Branch to increase the transparency and
accountability for tax expenditures. In particular, I would
suggest that the Subcommittee consider three recommendations:
First, requiring government agencies to provide more detail
about tax expenditures, including their magnitude and
distribution across States, incomes, industries, and budgetary
functions.
Second, subjecting tax expenditures to the same performance
and evaluation processes as spending proposals, including
procedural reviews that apply to outlay programs.
And, third, extending the searchable Internet database
established by the Federal Funding Accountability and
Transparency Act of 2006 to cover more tax expenditures, going
beyond the Treasury and the Joint Committee on Taxation's
current practice of listing major entities that directly
benefit from targeted tax expenditures.
I will provide more motivation and detail for these
recommendations, and then my written statement provides even
more.
As you well know, the government allocates hundreds of
billions of dollars annually through tax expenditures. If the
government wants to allocate resources towards, for example,
the production of $1 billion worth of tanks, it could
appropriate the money and pay a weapons supplier $1 billion in
exchange for the tanks, or it could enact a $1 billion weapons
supplier tax credit. Although our government accounting system
treats the spending provisions differently from a targeted tax
cut, they are essentially the same.
The same could be said if we converted the child tax credit
into an entitlement program that gave $1,000 per child or,
conversely, converted Social Security into a refundable tax
credit, the government accounting system would record
substantial changes. In terms of the reality of our society and
our fiscal system, there would be no difference at all.
In recognition of this parallelism, the United States has
adopted a statutory definition of ``tax expenditures'' which is
widely accepted among economists and other policy analysts. In
the last budget, the Treasury listed a total of $911 billion,
nearly as much as what we spend on discretionary spending or
mandatory entitlements.
If the government approves a $1 billion spending project,
it must either raise taxes or cut other spending to pay for the
project. The financing choices for--or borrow money, which
postpones but does not alter those choices. The financing
choices for a tax expenditure are exactly the same: The
government will have to raise taxes on everyone who is not
specially favored by the tax expenditure or cut other spending.
It is identical in terms of its fiscal impact.
Tax expenditures also raise additional concerns for fiscal
policy. They create the perception or reality of unfairness,
add complexity to the Code, encourage inefficient policies,
reduce fiscal flexibility, and, importantly, they disguise the
true size of government.
The proper measure of the size of government is the degree
to which it allocates and redistributes resources. Tax
expenditures allocate and redistribute substantial amounts of
resources, yet they are accounted for as reductions in
government revenues rather than increases in government
outlays. As a result, although tax expenditures increase the
government's intervention in the market economy, in some cases
warranted and in some cases unwarranted, the most common
measure of the size of government records them as a reduction
in the size of government.
For these reasons, tax expenditures should receive the same
scrutiny as government outlays. Under current law, they receive
substantially less scrutiny than spending. Tax expenditures are
not incorporated into the main budgetary tables prepared by OMB
and CBO. They are not subject to annual reviews, periodic
reauthorizations, or other tools of budgetary evaluations.
But as you are thinking about increasing transparency and
accountability for tax expenditures, you should be mindful of
concerns about privacy and other issues not faced in
constructing a database for government outlays.
Americans are compelled to file tax forms. They are not
compelled to apply for government grants. Thus, there is an
asymmetry between disclosing information about tax expenditures
and information about grants. But this asymmetry should not be
exaggerated. Spending also faces important privacy concerns
that were successfully addressed in the Federal Funding
Accountability and Transportation Act of 2006 by exempting
individual recipients of Federal assistance and government
employees. A similar approach could be applied to taxes. For
example, entity-level reporting could be limited to business
tax expenditures. This reporting could be further limited to
provisions that target benefits to narrowly defined classes of
entities or only entities that exceed a specific dollar amount
from the tax expenditure, like $100,000, or, say, the top 25
entities benefiting from a specific provision. It should be
stressed, though, that disclosing individual tax expenditures
like medical deductions or mortgage interest deductions would
be a gross violation of privacy and contrary to the public
interest.
In conclusion, as you move forward in your work to think
about taxes, I think the most important principle to be guided
by is parallelism to the greatest degree possible. When you
tighten up the rules on spending, it creates the incentive to
shift things over from the spending side of the ledger to the
tax side of the ledger. That could undo a little bit of the
good work that you have done, and so plugging that second set
of holes I think will form an important complement to the steps
Congress has already taken.
Thank you.
Senator Coburn. Thank you. I assure you we are going to
tighten both. Mr. Boortz.
TESTIMONY OF NEAL BOORTZ,\1\ CO-AUTHOR, ``THE FAIRTAX BOOK``
Mr. Boortz. Mr. Chairman and Mr. Ranking Vice Chairman, I
am not adept at the language of Washington. I am a reformed
lawyer and a radio talk-show host. But sitting here listening
to much of this testimony, I can tell you that you can work
until the cows come home, and you are never going to make the
American people understand even the concept of a tax
expenditure. If your goal here is to make our Tax Code more
transparent and to simplify it, there are, I think, some
certain ways that you can go. The Tax Code today is anything
but transparent. I will give you a few ideas.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Boortz appears in the Appendix on
page 162.
---------------------------------------------------------------------------
On Tax Day, if you were to ask almost any co-worker or
almost any friend, ``How much did you have to pay in taxes this
year?'' the response you are going to get is: ``I did not have
to pay anything. I am getting some back.''
Likewise, if you ask a co-worker, ``How much do you make?''
the most common response you are going to get is, ``None of
your business.'' But those who do choose to answer are going to
say, ``Well, I take home . . . '' and they will plug in a
figure. People do not know what they pay in taxes. They do not
even know what they earn, thanks to the magic of withholding.
Now, if you are an obnoxious radio talk-show host, such as
myself, you can just say, ``Look, pal, I did not ask you how
much you took home. I asked you how much you made.''
But the message is clear here. Due to the intricacies of
our current Tax Code and the withholding system, most wage
earners do not have any idea where they stand in this arena.
If the path to true tax transparency is the real goal here,
then the solution already exists in the form of S. 25, H.R. 25.
It is called the FairTax Act. Saxby Chambliss introduced it
into the Senate, John Linder into the House of Representatives.
It has been in the Congress for 6 years now.
Under the FairTax, personal and corporate income taxes
would be eliminated. Capital gains taxes, estate taxes, Social
Security taxes, Medicare taxes, taxes on dividends, they are
gone. And in the place of all of these taxes, we have one
embedded national sales tax at the rate of 23 percent, which is
revenue neutral for businesses, for the taxpayers, and for the
government. We do not have to talk about credit card net
receipts reporting. We do not have to talk about withholding on
independent contractors. Those concepts become just completely
unnecessary.
Now, let's be clear here that this does not mean that the
cost of goods and services in the marketplace go up by 23
percent. We already have--and extensive research has shown
this--an embedded tax on virtually everything that we buy in
the marketplace in the form of goods and services of about 22
percent, some items higher, some items lower. The embedded
taxes through the competitive aspects of the marketplace, they
disappear. They are replaced by the national retail sales tax.
Now, if it is tax transparency we want, consider this:
Under this FairTax proposal, you go buy a $100 toaster, the
receipt you receive at the store says ``Toaster, $77. FairTax,
$23.'' Now, that is tax transparency. The person walks out of
the store knowing exactly what they have paid. No longer would
American workers lack that understanding of the effect on the
Tax Code on them.
Now, when we talk about the FairTax, people say, oh, my
goodness, this would be just onerous on the poor. To mention
that the FairTax bill, however, has a system of rebates where
no household in this country ever has to pay this national
retail sales tax on the basic necessities of life, as measured
right up to the Tax Code.
Now, there is a lot more in my prepared statement, but I
want to mention this: The FairTax drives voters to the polls.
In three counties in Georgia during the recent primary, the
FairTax was on the ballot versus the flat tax. Which way would
you like to reform our tax system? The national retail sales
tax took 85 percent of the vote in every one of those
instances.
I received letters and comments from people that said, ``I
would not even have voted in that primary if it had not been
for the fact the FairTax was on the ballot.''
One man wrote me to tell me that his wife had just had four
wisdom teeth removed that morning. She was not feeling very
good. She was on the painkillers. But she heard me on the radio
say, ``The FairTax is on the ballot in your county.'' She told
her husband, ``We are not going home. We are going by the
precinct. We are going to vote on this issue before I go
home.''
I think there are a lot of people in Congress, Senate and
House both, that would love to see an issue that would drive
people to the polls like that, and the FairTax will do it.
So one more thing, very quickly, because I am 6 seconds
over my time. Since I co-wrote ``The FairTax Book'' with John
Linder, which debuted No. 1 on the New York Times best-seller
list--and I think that is worth noting. A book on taxes
debuting No. 1 on the New York Times best-seller list? I have
noticed that there is a lot of burgeoning opposition to the
FairTax idea, and in my customary fairness, I will say that
people have a very difficult time raising objections to it
unless they first rewrite it, as the President's Tax Reform
Commission did, or they just flat out lie about it. So I would
just ask in your deliberations that the Members of this
Subcommittee give a quick look to S. 35 and perhaps some close
attention to the letters I am sure you are getting from your
constituents on this issue.
Thank you very much.
Senator Coburn. Thank you, Mr. Boortz.
I want to spend just a minute talking about this idea of
tax expenditure. How did we ever get to where we used that
nomenclature? The assumption to use the idea of a tax
expenditure assumes that all wealth should belong to the
government and that if we incentivize certain behaviors through
tax credits or rifle shots, as Mr. Entin said, we are giving
something back. What is the history of that nomenclature, Mr.
Entin?
Mr. Entin. I think it began with Stanley Surrey, who was a
professor of law at Harvard. He became Assistant Secretary of
the Treasury-Tax Policy during the Kennedy Administration, and
he wanted to create a method that would reveal the sort of
spending nature of some tax provisions. Treasury worked on that
issue through the Johnson Administration, and by the end of
that, they reported out their findings. And I believe that is
when the term ``tax expenditures'' came to be.
Treasury Secretary Joseph Barr presented the results at a
hearing of the Joint Economic Committee a few days before
President Nixon's inauguration. That is the hearing which is
best remembered for Mr. Barr's disclosure that 21 people earned
more than $1 million in 1967 without paying any Federal income
tax due to tax preferences. This is what ultimately resulted, I
think, in the alternative minimum tax, which is a whole
different issue. But I think that is the origin of the term.
Senator Coburn. I take it from the testimony we have heard
from all of you, even you, Mr. Furman, that we really need to
be clear about our language, and simplification--and I am
really going toward simplification. Your whole goal for having
transparency on ``tax expenditures'' is so we can have the
transparency required to get the changes we need to eliminate
those that are egregious.
Mr. Furman. That is right.
Mr. Furman. Certainly one should not get too hung up on the
semantics. I prefer the term ``tax expenditure'' as it is the
statutory term. Also, among economists, tax lawyers, and among
a number of others, there are important conceptual parallels
between them. But you do not have to accept that term or that
concept to accept the idea that we should be more transparent
about this. Ones that work well we should do more of or the
same, and ones that do not work well we should get rid of or
modify.
Senator Coburn. OK. Do we have a lot--and, again, the focus
of our hearing really is not this, but do we have a lot of
rifle-shot tax expenditures?
Mr. Furman. We have a number of them. In my testimony, I
listed, for example, the Jobs Act of 2005 included a provision
that ``extended placed in service date for bonus depreciation
for certain aircraft . . . '' If that was not enough, it
limited it to ``excluding aircraft used in the transportation
industry,'' and only for things ``properly placed in service
after September 10, 2001.''
Senator Coburn. So that obviously was for one company's
benefit that made one airplane?
Mr. Furman. Correct. That is reportedly the case. You could
not look in the tax law and know what company it was that
received it, and that was an estimated $247 million. You could
not look in the tax law and see that, and you could not look at
any Federal database and find out the identity of that company.
Senator Coburn. So if we had the Fair Act, we would not
have any of that.
Mr. Furman. That raises a number of other tax policy
issues. It does not require changing the tax base. An income
tax base, a consumption tax base, a retail tax base--all of
those can be simple or complicated. Those are two different
dimensions, the choices of base versus the degree of
complication.
Senator Coburn. But the whole idea is to simplify it and
make it transparent. That is like our previous panel. They all
wanted to simplify it, make it more transparent.
Mr. Furman. I agree with that, and I would even go one step
further and say, in general, the government should be less
involved in the economy at the level of tax expenditures in
terms of picking and choosing winners and losers and desirable
activities and undesirable activities. I think that is a
measure of the growth of government, and it grows in a way that
is invisible to people who focus just on the total amount of
spending.
Senator Coburn. That is a very good point.
Any other comments? Mr. Entin.
Mr. Entin. Many of the rifle-shot provisions, such as that
one, expired. In looking at the area in which it occurred, it
had something to do with expensing. Under a consumed income or
sales tax, you would have expensing of capital assets rather
than depreciation. You need to decide on what your appropriate
tax base is before you can decide whether you want to get rid
of the rifle shot giving the expensing to one airplane company
or expand it to all investment for all companies and all small
businesses. As an economist, I prefer having the expensing and
go to the sales or--excuse me, not the sales, the saving
consumption neutral base rather than the income base. The
broader question of what do you do all across the spectrum with
something like that is one that needs to be addressed in the
fundamental issue of tax reform. Until then, I would agree, we
should stop the rifle-shot approach, and supposedly the
Committee Chairmen are not doing that anymore since 1986. But,
clearly, occasionally one of these things still slips through.
Senator Coburn. It is interesting that we penalize savings
but incentivize borrowing by our Tax Code, because we charge
income tax on interest earned, but we give you a deduction for
interest paid.
Mr. Entin. I have no quarrel with giving a deduction for
interest paid when the recipient has to pay tax on it. More
fundamentally, the income tax says to you, if you save your
money, we do not count the cost of foregone consumption as a
cost to you. We sort of say we are going to tax the money
before you save it, and we are going to tax the returns. But if
you spend it, we have taxed it before you spent it, but we then
do not tax again what you spent it on.
Now, when I eat the sandwich or watch the television, that
is what I bought with my money. When I put my money into the
bond, I bought the interest. I bought the future income stream.
I bought the dividends. I am taxed on those again, but I am not
taxed again on the sandwich or the television, except where you
have a few selective excise taxes. That is the problem with the
income tax. It hits income used for saving more heavily than
income used for consumption--on top of which you put on the
corporate tax, which we then overstate by not having expensing
instead of these depreciation allowances that do not reflect
the full value of the outlay. And then, of course, there is the
death tax on top of that.
That whole structure needs to be reformed in one of the
neutral manners. The FairTax is one. The flat tax is another.
The consumed income tax, the old Nunn-Domenici tax, the VAT--
all of these are neutral taxes. Until you know which tax base
you want, many of these provisions cannot be identified as a
tax expenditure or not a tax expenditure.
Senator Coburn. OK. Thank you. Mr. Boortz.
Mr. Boortz. I was just thinking, Mr. Chairman, I appreciate
your comment, very closely to the adage you get more of the
behavior you punish, you get less of the behavior you reward.
And our current tax system punishes the very behavior we seek
more of out of the American people, rewards the behavior of
free spending that perhaps we do not want in some instances.
And I would just say--and I hope that this is taken in the
spirit, Mr. Entin, in which I say it, but if I could play for
my listeners that excerpt we just heard about sandwiches and
televisions and let them hear how taxing their labor is
discussed in Washington, I would certainly win a lot more
converts to my side of this argument.
Senator Coburn. Mr. Furman.
Mr. Furman. If I could just add one thing, and it is
repeating what I said before, which is that people who think
about tax reform think about two separate issues. You could
have a consumption tax, exactly the type that Mr. Entin might
like, and then Congress could monkey around with it and add
rifle shots and it could then add really large tax expenditures
along the form of tax entitlements.
Similarly, you could have an income tax and keep it really
pristine and really pure. So these are really two very
different issues, what you want in terms of your tax base and
your tax system--it is a very important issue--what you want in
terms of simplicity and complexity. And for the most part you
can move sort of in either direction within either set of
bases.
Senator Coburn. All right. Thank you. Senator Carper.
Senator Carper. The last time I recall the Congress and the
President attacking with some success tax simplification may
have been legislation that was adopted in 1986 when Ronald
Reagan was our President and I believe Dan Rostenkowski chaired
the House Ways and Means Committee. I am not sure who chaired
the Senate Finance Committee. It might have been Bob Dole. It
may have been Daniel Patrick Moynihan. In any event, it was a
divided government. But they were able to come to agreement on
what I think will be a pretty tough issue to find consensus on.
Thinking back, some of you might actually be old enough to
remember that, and just recall with us, if you will, the
elements that enabled us to make what I think most of us would
say was a little progress toward tax simplification. Think back
to the elements that were in place to enable us to make a
little progress. If you do not agree we have made any, then
that is another issue. But how might we go about replicating
that progress in the next couple of years?
Mr. Boortz. Senator, if I might say, that 1986
simplification of our Tax Code has been modified to date nearly
10,000 times by the Congress of the United States. That hardly
fits my definition of ``tax simplification.'' You talk about
rifle shots. We even have a specific tax exemption in there for
one manufacturer of ceiling fans.
Senator Carper. No, excuse me. I want you to answer my
question, if you will. My question was--somehow in 1986, in a
divided government, I think we took at least some measured
steps toward tax simplification. It has been, I think arguably,
undone to a great extent----
Mr. Boortz. Absolutely.
Senator Carper [continuing]. Over the last 20 years. But
what existed then in 1986, and how might we replicate that,
even if we do not go to the extent of some of the reforms that
you all are talking about?
Mr. Furman. All right. Thank you. First of all, I would not
exaggerate the degree to which it has been undone. The top
marginal rate was 50 percent prior to the Tax Reform Act of
1986. The top marginal rate is well below that right now, and
we are raising the same or more revenues as a share of GDP, in
addition to the fact that we have added the child tax credit
and a number of provisions that are very broadly supported. So
I think our tax system is in greater shape today than it was in
1985, thanks to the effort of this body.
That being said, it is not in great shape, and this body
really needs to return to it, and I think on a bipartisan basis
is the only way, both as a practical matter and as a
substantive matter that you can get it done. Basically, any tax
reform creates winners and it creates losers if it is revenue
neutral, and the losers in our political system tend to be
angrier than the winners.
Senator Carper. I noticed. [Laughter.]
Mr. Furman. There are two ways to deal with that. One is to
pretend there are no losers, and some have taken that approach.
They have taken a free-lunch approach, and they pretend they
have a magical elixir that will cut everyone's taxes, make
everyone richer, and have no trade-offs whatsoever. Every
serious analyst who has ever looked at one of those free-lunch
proposals has said that is not the case. It will substantially
raise taxes on some people and cut them on others.
That is not an argument against it. That is not an argument
for it. That is a fact we need to face in reality in evaluating
proposals and a political fact. That is why the two parties
working together is the best recipe, because then you may not
demonize the other party for some of the losers they create and
they will not demonize your party for some of the losers you
create, and you all hold hands and jump together, and that is
what I would like to see happen.
Senator Carper. Mr. Entin.
Mr. Entin. I was at Treasury during that period.
Senator Carper. What were you doing there?
Mr. Entin. I was Deputy Assistant Secretary for Economic
Policy.
Senator Carper. OK.
Mr. Entin. My Assistant Secretary was discussing with the
Secretary how the Treasury proposals ought to go, but, of
course, the tax people did not want the economic people butting
in. So let me say that the 1986 proposals that came over from
the Treasury were not conducive to capital formation. They came
from a career staff that was raised on the income tax and
Stanley Surrey's definition of ``tax expenditures.'' The hybrid
tax system, which is partway between income and consumption
bases now, and was to some extent then, had been pulled a
little further toward the consumption base by the 1981 tax
changes, which were gradually eroded in 1982 and 1984, and the
career people were bound and determined that they be further
eroded in 1986.
We raised taxes on capital substantially to lower the
individual tax rates. The stock market crashed the next year,
and it paved the way for the 1990 recession after two payroll
tax hikes followed.
We curtailed access to IRAs. We lengthened asset lives, and
had initially asked that they be indexed for inflation, the
depreciation write-offs. But the Senate Finance Committee
decided not to do that because it wanted a few dollars to have
some rifle-shot things for some friends. So it raised the cost
of buying plant and equipment instead of lowering it and turned
the bill into an anti-growth bill instead of a pro-growth bill.
I would not call it reform. I would call it an anti-reform.
On the international side, it took something that was
miserably complicated and made it hideously complicated. The
tax attorneys were delighted.
Now, why did it happen? There was a deficit. People were
nervous about it, even though interest rates were coming down,
even though it turned out to be disinflationary rather than
inflationary. There was a prevailing view of how the economy
worked and the tax system worked that was out of line with
reality. There was a frenzy. The President proposed an
improvement. The old guard took over to undo reforms that had
recently been made, and that was true on the Hill as well as at
the Treasury.
I think we need a much broader understanding of what is and
is not good tax policy before we have any more of that sort of
thing going on. I think we have had a broader understanding. In
the years since 1986, we have had one very good Presidential
panel, which was constrained in what it could offer by a number
of items in its directive from the White House and could have,
as Dr. Coburn has explained, gone further had they not been
constrained. But they did resurrect the notion of the consumed
income tax or the neutral tax systems that were the non-income
base rather than the income base. They resurrected the
blueprints for basic tax reform that the Treasury wrote in 1976
under David Bradford. They made it intellectually acceptable
again, and they opened up the entire debate. They have warned
us: You have to know where you are going before you start down
the reform road. And I think that was a very important
contribution of that panel, although, again, I do wish they had
gone further.
We have a deficit today, but it is coming down. We have
learned now for the second time that major deficits can occur
in a situation of low interest rates and low inflation. We are
not as panicked as we were back then, but we do have more
reason now to proceed with a tax reform. We can look around the
world at successful tax reform experiences. You have the flat
income taxes that were adopted in parts of Europe. You have the
dramatic lowering of corporate tax rates in the EU because they
realized that it was detrimental to growth, and the
substitution of a neutral tax, they chose the VAT. That is not
my favorite. But they have been moving their tax codes in a
direction that is less harmful to capital formation, partly
because they are competing among themselves for locating
capital in their countries. Ireland put the cat among the
pigeons, God bless them.
We need to learn from that, and we also can learn that if
you do that sort of thing, it is doable and it can improve the
welfare of the general public. We will need to trim some
spending to make it work well, as has been pointed out. I do
not want to call it a free lunch, but there are a lot of
distortions and anti-growth elements in the current system that
would yield some revenue reflow. You do not have to cut
spending by a dollar for each dollar you cut taxes if you cut
taxes correctly. Treasury is now exploring that trade-off as a
matter of fact. They should have done it years ago. The Joint
Tax Committee is doing it, but in a manner I do not think is
going to work well.
So this whole area of research needs to be supported and
pushed.
Senator Carper. All right. Any closing words, gentlemen?
Mr. Furman. I do not want to refight something that I was
not present for, but the broad agreement among economists is
that 1986 is a real model of broadening the base and lowering
the rates. Just to appreciate the magnitude, the top rate was
50 percent. It brought it down to 28 percent.
I think Mr. Entin has his views, and I am sure all of us,
if we went back, would have things that we would want to
change, but that type of model, to work together, broaden the
tax base and bring rates down, is on that I think is the most
promising way to move forward for tax reform.
Senator Carper. All right. Mr. Boortz, please? And I have
about 1 minute to finish, so I would ask you to wrap up.
Mr. Boortz. One thing very quick. Yes, the 50-percent tax
rate down to--what was it?--28 percent, I believe, also at the
same time eliminating many of the deductions that would make
that 50-percent tax rate much lower in actual basis.
Mr. Furman. We are talking about marginal rates, what
economists believe affect the economy.
Senator Carper. Yes. Good enough. Mr. Chairman, it has been
a good hearing.
Senator Coburn. Thank you all.
Senator Carper. Thank you.
Senator Coburn. Thank you each for your testimony and your
time. We appreciate it.
Mr. Furman and Mr. Entin, I look forward to working with
you again in the future. Thank you. Mr. Boortz, thank you.
Mr. Boortz. Thank you, sir.
Senator Coburn. The hearing is adjourned.
[Whereupon, at 4:37 p.m., the Subcommittee was adjourned.]
A P P E N D I X
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PREPARED STATEMENT OF SENATOR LEVIN
The most recent IRS estimate of the Nation's ``tax gap''--the
difference between the amount of taxes owed by taxpayers and the amount
collected--is a staggering $346 billion. I commend Chairman Coburn and
Ranking Member Carper for their ongoing effort to get to the bottom of
the many reasons for this massive tax gap. It is a subject that merits
urgent attention from Congress, not only because it shortchanges the
U.S. Treasury, but because it forces honest American taxpayers to pick
up the tab.
Those who abuse the tax system shortchange the men and women who
serve in our military, the children who attend our schools, and the
millions who rely on Social Security. Tax cheats make it harder to
maintain our highways, protect our borders, advance medial research,
and inspect our food. They also deepen the deficit ditch that threatens
the economic well-being of our children and grandchildren.
Even in Washington, $350 billion is a huge amount of money. It is
larger than the budgets last year of the Departments of Agriculture,
Commerce, Education, Interior, Justice, Labor, State, Veterans Affairs,
and the Environmental Protection Agency combined. The tax gap is so
huge that it would force each individual U.S. taxpayer to pay more than
$2,500 in extra taxes annually to make up for those who are dodging
Uncle Sam.
Over the past 4 years, Senator Coleman and I, as Chairman and
Ranking Member of the Permanent Subcommittee on Investigations, have
conducted extensive investigations that provide insight into two major
ways that some Americans are exploiting the system to dodge taxes--
offshore tax haven schemes and abusive tax shelters.
Last month, we released a bipartisan report that blows the lid off
of offshore tax haven abuses using shell corporations, phony trust, and
fake economic transactions to help some people dodge millions of
dollars in U.S. taxes. Before that, we released a bipartisan report
with case histories showing how accountants, lawyers, bankers, and
other tax professionals develop dubious tax shelters and hawk them to
Americans across the country. Briefly, here's what we have found.
Offshore Tax Haven Abuses
Experts Joe Guttentag and Reuven Avi-Yonah estimate that offshore
tax haven abuses by individuals cost the U.S. Treasury between $40
billion and $70 billion every year in taxes that are owed but not
collected. On top of that, the IRS has estimated that corporate
offshore tax evasion in 2001 totaled about $30 billion. Put together,
that means up to $100 billion per year in being lost to offshore tax
abuses.
Offshore tax haven countries have, in effect, declared economic war
on honest U.S. taxpayers by giving tax dodgers a way to avoid their tax
bills and leave them for others to pay. Offshore tax havens attract
these tax dodgers not only by charging them low or no taxes, but also
by shrouding their financial transactions in a ``black box'' of secrecy
that is extremely difficult to penetrate. They sell secrecy to attract
customers.
This legal black box allows tax dodgers to hide assets, mask who
controls them, and obscure how their assets are used. An army of
``offshore service providers''--lawyers, bankers, brokers, and others--
then joins forces to exploit the black box secrecy and help clients
skirt U.S. tax, securities, and anti-money laundering laws. Many of the
firms concocting or facilitating these schemes are respected names here
in the United States.
These schemes require the secrecy of tax havens because they can't
stand the light of day. Our investigation laid out six case studies
that illustrated the scope and seriousness of the problem. In one case,
two U.S. citizens moved about $190 million in untaxed stock option
compensation offshore to a complex array of 58 offshore trusts and
corporations, and utilized a wide range of offshore mechanisms to
exercise direction over these assets and hundreds of millions of
dollars in investment gains. These untaxed earnings were then used to
provide loans, finance business ventures, acquire real estate, and buy
art, furnishings and jewelry for the personal use of the family
members.
Much of this elaborate scheme involved an offshore bank and
administrative services firm for offshore entities, both housed in this
building in the Cayman Islands, the Ugland House. Believe it or not,
this pretty waterfront building is the official address of 12,748
companies. Just having a post office box here enables these shell
companies to shift profits that otherwise should be reported as taxable
income in the country where it's actually earned.
In another case study, two offshore shell corporations engaged in
fake stock transactions, seeming to trade stock back and forth as if it
were fantasy baseball to create the illusion of economic activity. The
shell corporations pretended to run up hundreds of millions of dollars
in fake stock losses and then used these phantom losses to offset about
$20 billion in real capital gains, the result was $200 million in lost
tax revenue to the Treasury. This offshore scheme, shown in this chart,
would be comical because of its complexity but for sobering fact that
these tax haven abuses are eating away at the fabric of the U.S. tax
system, and undermining U.S. laws intended to safeguard our capital
markets and financial systems from financial crime.
Congress could act to shut down these offshore abuses. One step we
could take would be to change how the government views transactions in
secrecy tax havens. We should shift the burden of proof so that those
who move assets offshore or engage in offshore transactions have to
prove that income claimed there is not taxable; i.e. that there are
real economic transactions, involving real gain or loss, or at least
economic activity.
Another simple step would be to require third-party reporting by
U.S. financial institutions on a Form 1099 for accounts opened by
foreign trusts or corporations where the money is beneficially owned by
a U.S. taxpayer.
Congress also needs to dig further into transfer pricing
activities. Transfer pricing is an accounting method supposedly
requiring that related multinational entities engage in transactions at
arm's length to ensure the proper reporting of taxable income.
``Supposedly'' is the operative word. IRS Commissioner Everson has said
that transfer pricing manipulations are one of the most significant
challenges that the Service faces, and I don't doubt that one bit.
Earlier this month the IRS settled a transfer pricing dispute with drug
giant Glaxo Smith Kline for $3.4 billion. The size of this settlement
with just one company indicates that it's worth looking to see if there
are ways to improve the relevant portions of the tax code. Treasury has
proposed regulations in this area, and I urge the Administration to
finalize those rules in as strong a form as possible. I also hope that
these and other international tax dodging issues are some of the first
we take up in the next Congress.
Abusive Tax Shelters
In addition to offshore shenanigans, there are plenty of homegrown
tax shelters being used to dodge taxes. In 2003 and 2004, the Permanent
Subcommittee on Investigations conducted an in-depth investigation into
the widespread involvement of accounting firms, banks, investment
advisors, and lawyers in the development, marketing and implementation
of abusive tax shelters. We held hearings and reports laying out how
these tax shelters are developed and sold to Americans across the
country.
Again, Congress can crack down on these abusive tax shelters and
offshore schemes if it has the will to do so. One big step would be
enactment of S. 1565, the Tax Shelter and Tax Haven Reform Act, which
Senator Coleman and I introduced last year. This bipartisan bill would,
for the first time, impose real penalties for those who promote abusive
tax shelters or knowingly aid and abet taxpayers to understate their
tax liability. It would enable the IRS to work with the SEC and bank
regulators to clamp down on bankers, securities firms, and lawyers
involved with tax haven and tax shelter scams. It would also authorize
the Treasury Secretary to issue a list of tax havens that don't
cooperate with U.S. tax enforcement and eliminate U.S. tax benefits for
income in those jurisdictions. The ability to tax profits that are in
fact attributable to U.S. taxpayers but have been camouflaged using
these uncooperative tax havens would hand our government a mighty club
to combat tax haven abuses.
Adequate IRS Enforcement
Another key step to reducing the tax gap would be to give the IRS
the funds it needs to go after tax dodgers. For every dollar invested
in the IRS's budget, the service yields more than $4 in enforcement
revenue. Beyond the additional revenues collected, increased IRS
enforcement deters those who might otherwise have dodged their tax
obligations and reassures honest taxpayers that compliance with the law
is not a chump's game. I hope that Congress will follow the Senate
Appropriations Committee's lead and enact the President's full request
for the IRS's 2007 budget. I also encourage Treasury and the President
to consider asking for more IRS enforcement dollars in the 2008 budget
request. I can't think of many better investments to recover revenues
wrongfully lost to the U.S. Treasury and to build respect for the law
and respect for the honest Americans who play by the rules and meet
their tax obligations.
Again, I commend Chairman Coburn and Ranking Member Carper for
their efforts on this important topic. I look forward to the testimony
today.
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