The voices of Tax Policy Center's researchers and staff
Last week, a group of prominent academic and government economists published a study that estimated the top 1 percent of Americans hide more than 20 percent of their income from the IRS. The key takeaway is that with more enforcement resources the agency could close the income tax gap for the top 1% and collect another $175 billion of taxes annually. The study does not specify how much more money the agency would need to spend to collect the $175 billion.
It is true that, with more funding, the IRS could do a better job identifying unreported income. But it still would not be easy. Much of the low hanging fruit from enforcement already has been picked and returns to additional enforcement may be modest.
Instead, the real solution to tax avoidance and even evasion is better tax law. If Congress enacted simpler laws and required additional reporting, the IRS would do a better job collecting taxes owed by businesses and investors.
The new study, published by the National Bureau of Economic Research (NBER), focuses on “sophisticated” tax evasion in 2007, which it defines as coming from undisclosed foreign accounts and pass-through businesses such as S corporations and partnerships. The report finds that the rich disproportionately engage in these abuses.
That remains true today. But since 2007, the year the authors study, the IRS has aggressively pursued offshore accounts. The IRS initiatives included a voluntary disclosure program through 2018 and stringent mandatory reporting rules for taxpayers and financial institutions that have been in place since 2014.
As a result, in today's environment, I expect few US taxpayers are willing to risk increased detection and stiff penalties for investing offshore to avoid tax. They could more easily and safely lower their tax bills through US investments that earn tax-free returns such as growth stocks and municipal bonds, or low-taxed returns such as capital gains and dividends.
By contrast, the IRS has long struggled to audit pass-through businesses. A major reason is that these firms are not subject either to third-party reporting of income and expenses or self-reporting of aggressive tax positions. Thus, the IRS must devote a lot of effort to finding unreported income or overstated losses.
No doubt, more money would help the IRS hire and train skilled auditors to track these abuses. But at what cost? And would the return on investment exceed other enforcement initiatives?
The new study emphasizes the difficulty of auditing complex pass-through structures, which are difficult to pierce and where the tax rules are hard to apply. When partnerships own other partnerships, the tax rules often are ambiguous and contradictory: A partnership, for example, can be treated both as a separate entity and as an aggregate of its members. Of course, opaque structures should be investigated by the IRS. But, if IRS examiners cannot catch abuse today, how would more auditors, even skilled auditors, help? It’s not as black and white as finding unreported income from foreign accounts.
Take former President Trump's tax returns which, for decades, reported little income (and little tax) from a sprawling enterprise of interlocking pass-through businesses, according to the New York Times. Trump also has been under continuous examination by the IRS since 2002, according to his lawyers. And the IRS’ ongoing struggle to sort out Trump’s low taxes, and its apparent failure to collect any additional taxes, undermines confidence in the fairness of our tax system.
For partnership arrangements, the IRS needs new audit tools, such as wider disclosure of uncertain tax positions by partnerships, as now required for corporations. New information reporting for partnerships also could help the IRS track cash flow.
But, most importantly, the IRS needs Congress to write better tax rules that measure and time income accurately and do not create ambiguities that aggressive taxpayers and their highly-paid advisers can exploit. Congress ought to write partnership tax rules that sacrifice taxpayer flexibility for administrative simplicity.
Unfortunately, recent history is not promising. Congress continues to head in the wrong direction, with poorly designed tax add-ons for businesses like the Tax Cuts and Jobs Act’s opportunity zones and a new 20% deduction for pass-through businesses. These rules complicate the tax law and open holes that aggressive taxpayers exploit. We can't look to the IRS to salvage bad tax law.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.
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