I first published my three-part recommendation for a Biden tax plan when his nomination looked assured last July. This is an update to first part of that recommendation. If you have any contacts in this new administration, please pass this post on.
Joe Biden has long been honest about the reality of raising taxes to offset the reckless and economically disastrous 2017 cuts. “You all know in your gut what has to be done,” he told a group of fundraisers a couple years ago. Now is the time to make some aggressive moves that might even find some bipartisan support.
My CPA certificate is in retirement status, but I still know how to count. The numbers on corporate stock buybacks and skyrocketing federal debt even before the current crisis should forever dispel the myth that big tax cuts will convince large investors and corporations to re-invest in industrial America. They will not dispel that myth, of course, because the river runs deep, but they should.
This first post will focus on things a new Biden administration can do right out of the chute, even if he fails to overcome a Senate filibuster. The second one focuses on guiding principles for making the tax code much simpler and objectively more fair, while at the same time picking up a few trillion dollars in much needed new revenue over his term. The third part looks at the issues of taxing business.
Quick Hit #1 – Hire a lot more tax auditors
Think of this as a very profitable jobs program. The number of IRS revenue agents declined by almost 40% from 2010 to 2019. Only five out of every ten thousand returns for filers earning between $1 million and $5 million were audited in 2018. And that drops to only three in 10,000 for incomes above that. In short, the rich just do not get audited anymore, and they know it.
In fact, the people most likely to get audited are the poorest filers who claim the Earned Income Tax Credit. I contend that the reason for this is that it is very easy to train a new body to audit EITC, and the government usually has more documentation on these people’s income than they do themselves, a condition with which we will deal shortly. This is not an audit problem. Rather it is a tax system design problem turned into a training ground for auditors. They must be moved to weightier stuff to preserve some semblance of equity in the tax system.
Back in 2016, the annual “tax gap” of uncollected U.S. taxes was estimated to be over $450 billion dollars. Every new auditor worth her salt and given proper resources quite easily becomes a “net win” for the government, bringing in revenue far more than her salary. A disclosure here: my spouse once had this job for one state’s taxing authority and pulled in several big “wins” worth far more than her salary. The tax auditors are themselves easily “auditable” to determine their worth.
There are some audit areas that are quite complex and may take years of expertise to build a case (cough, cough, The Trump Organization). But the key benefits of these “tough cases” are twofold. First, when the audit percentage gets higher, taxpayers and their accountants who are “playing the risk game” are much more likely to comply without audits. Whop a few of the “big kids on the block” with a bigger stick and the smaller kids will often snap into line.
Second, fairness really demands more audits. When tax compliance its low, and audits are focused on the bottom of the money scale, this feeds more non-compliance and distrust of the system. “Honest” taxpayers pay the price here.
Quick Hit #2 – Pilot a pre-filled tax return option
More than once I have received one of those dreaded pre-audit letters from the IRS telling me that I underpaid my taxes. The usual culprit was a 1099 interest income form for which they had a record, but I did not, because of a change in address. This is a crazy game, and it hits poorer people especially hard. The IRS has information on you that you yourself do not have, and if you do not guess correctly as to what they have, then you pay a penalty. And you use up a lot of IRS agent time, as well as your own, unnecessarily.
It is an old story. We know the IRS does not pre-fill tax returns for filers mostly because Congress, in the pocket of H&R Block, TurboTax and the rest, does not want to hurt their gravy train. Tax preparation costs are, especially for many poorer Americans, an unnecessary additional “tax” that can certainly be reduced significantly.
There are several benefits to sending out basic pre-filled returns. Every person would now know “what the government knows” and can then start their tax return preparation from a position of good information. Computational errors are also still common; our math skills are simply not very good, and the rules are often complicated. For millions of Americans, the numbers on a pre-filled form will be “good enough,” and they can send the computationally accurate form back in for an early refund.
The most commonly audited area, as noted above, is the Earned Income Tax Credit. It is simply very prone to mistaken calculation and missing data. Far too much auditor time is spent hounding these taxpayers when the same money could have been retrieved without an audit with a pre-calculated form.
For those taxpayers who dispute that calculation and have documentation that the government does not have, there is always the option of taking that information into a tax preparer or software and massaging it with additional supporting data that could lower your taxes. Nobody loses except the tax preparer firms. And we do not owe them a business.
Quick Hit #3 – Publish the data on the worst special interest deductions and credits
The huge majority, by count, of tax deductions, credits, intricate calculations, and special forms, are used to reduce taxes for fewer than one in 1000 taxpayers, and sometimes even fewer than one in a million. These are called “tax expenditures” and shift the tax burden back upon those “normal people” who just pay their taxes on normal income. How many times have you waded through a form’s complex calculation only to find at the end that you are not the “special interest”?
Pick your point at which the tax expenditures become “special interest.” Is it one in one thousand, or 1 in one million people and businesses, or somewhere in-between? These rules almost all came about in closed Congressional committees where corporate lobbyists sometimes even write the exact language going into the bill. They have the lobbying money, and you do not. I have estimated that there is at least $500 billion in annual tax revenue at stake here.
Not only that, but these “rich guy favors” are responsible for likely at least 90% of the tax code by word count. As my spouse would tell audited taxpayers, “Everything is taxable unless the government says that it is not.” The first part of that statement is by far the shortest part of the tax code; the rest fills many books and court case transcripts, often needlessly. It is far past time to “de-clutter” the code and start treating ordinary taxpayers the same as special interests.
The IRS likely already knows how many individual and corporate taxpayers get benefit from each line on each tax form. If not, statistical sampling can generate “good enough” numbers quickly. An industry I once worked for contracted with highly paid K Street lobbyists working on just a few of these tax code lines, and they knew exactly what they were worth to their clients.
And so, the new Biden Administration could “prepare the field for plowing” by publicizing the “1 in xxx thousand” beneficiary numbers for hundreds of tax expenditures and bring them into the open. Every day a new number, perhaps, released from the Biden Treasury Department. These special deductions and credits become an important basis for effective tax reform and simplification, as will be discussed in Part Two.
Quick Hit #4 – Restore tax rate progressivity
In 2019 the New York Times produced a shocking animation of what has happened to tax rate progressivity over the past decades:
Many right-wing pundits continue to advocate for a “flat tax” as the best approach to tax fairness. Just from a practical point of view, this is unnecessary. Any tax code reform you create just needs a simple stepped calculation at the very end to put in progressivity. But we have lost any semblance of that step function through the many “special favor” tax expenditures noted above that rich people get and that you do not.
The primary argument for progressivity is this: almost every other tax that people on the bottom half of the socioeconomic scale pay is regressive. In other words, it hits them much worse, percentage-wise. Take the payroll tax for Social Security, which is a flat rate charged only on the first $142,800 (in 2021) in income that you make. Rich people, in effect, pay next to nothing into the Social Security system. Likewise, state and local sales taxes. These are usually flat rates on consumption, and poorer people consume nearly all of their income. The effective sales tax rate for Mark Zuckerberg is close to zero.
The tax code changes of 2017 squashed these brackets and rates even more. The good news is that, separated from any complex reform bill and passed through Congress by an emergency “budget reconciliation” process, the progressivity table could easily be re-calibrated to a much better level of effectiveness. And billions of dollars in new revenue could likely be picked up in the process.
Well, that is my advice for “quick hits.” The tax code needs much more work, and my longer-term principles for this are discussed in Part Two of this post, which has now been published.
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