State of the Union: Tax Administration a Small But Important Part of the Speech

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Tax procedure and administration are generally not on the radar in Presidential State of the Union addresses. Yet in this week’s State of the Union the President implicated both when he spoke about offshore evasion and expanding tax benefits for childless workers.

In this post, I will connect the dots from the speech and offer some thoughts about both offshore evasion and compliance issues relating to lower-income taxpayers.

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President Obama’s State of the Union revolved around four main questions, including his first question:

How do we give everyone a fair shot at opportunity and security in this new economy? [the other questions dealt with technology, security and partisan rancor]

In discussing opportunities in the new economy, the President addressed some broad trends that have contributed to greater inequality and concentration of wealth, including how technology and the mobility of capital can contribute to job disruption. President Obama reached across the aisle to Speaker Ryan and noted his interest in tackling poverty and that he’d “welcome a serious discussion about strategies we can all support, like expanding tax cuts for low-income workers without kids.”

In an effort to frame the discussion away from blaming the poor, the President assigned some blame to those at the top of the income pyramid:

But after years of record corporate profits, working families won’t get more opportunity or bigger paychecks by letting big banks or big oil or hedge funds make their own rules at the expense of everyone else; or by allowing attacks on collective bargaining to go unanswered. Food Stamp recipients didn’t cause the financial crisis; recklessness on Wall Street did. Immigrants aren’t the reason wages haven’t gone up enough; those decisions are made in the boardrooms that too often put quarterly earnings over long-term returns. It’s sure not the average family watching tonight that avoids paying taxes through offshore accounts.

Offshore Evasion

Offshore evasion is one of the biggest issues in tax administration of the past decade. While we have discussed offshore evasion only occasionally, it has been covered heavily by others, including one of our blogging inspirations, Jack Townsend at Federal Tax Crimes.

I recently read an interesting article on offshore evasion by Professor Cass Sunstein in the New York Review of Books, called Parking the Big Money. The article reviewed Professor Gabriel Zucman’s The Hidden Wealth of Nations: The Scourge of Tax Havens as well as a film called The Price We Pay. Zucman’s book takes a crack at putting a price tag on offshore evasion, using an approach that compares the world’s liabilities to the world’s assets, noting that “as far back as statistics go, there is a ‘hole’; if we look at the world balance sheet, more financial assets are recorded as liabilities than as assets, as if planet Earth were in part held by Mars.”

Sunstein continues:

In 2015, for example, the nations of the world reported $2 trillion as mutual fund holdings in Luxembourg; this is the total of recorded liabilities. But Luxembourg’s own statisticians calculated that worldwide, $3.5 trillion in mutual fund holdings were kept in Luxembourg; that is the total of recorded assets. What happened to the missing $1.5 trillion? In global statistics, that amount had no owners. For Zucman’s purposes, the anomaly is a revealing one: the amount by which assets exceed liabilities is a measure of wealth hidden in offshore accounts.

Using some detective skills, Zucman estimates that the effects of offshore evasion are severe, with the cost annually at $200 billion in lost revenues, with the US out about $35 billion.  Zucman’s proposal to address the problem is a far-reaching international registry of ownership, though he is a big fan of our own FATCA and that law’s requirement that foreign banks identify their US clients and disclose them to the IRS.

At around the same time I read the Sunstein review, I also received via email a report by the American Citizens Abroad that was based on a survey it and researchers at the University of Nevada Reno conducted on Americans abroad.  The survey revealed how overseas Americans believe FATCA should be reformed to address some of its negative consequences. Those consequences include some overseas financial institutions no longer dealing with Americans and among those that still do, higher costs of doing business.

FATCA, as Sunstein notes, is a blunt tool and to the Americans abroad who are complying or who are small fish, the law imposes heavy costs.  But as the State of the Union reflects, there should be little sympathy for Americans who stash cash and the like in tax havens. Given the extent of the problem that Zucman via Sunstein lays out, I suspect that FATCA will not be going away soon though there are proposals that minimize costs without giving away too much in terms of the law’s effort to bring accounts into the sunshine.

The issue is politicized. FATCA and the IRS for that matter have been part of the presidential campaign, with Senator Paul for example suing to stop FATCA (see a post in Forbes by Robert Goulder discussing that unusual approach) and Senator Cruz noting that recent laws have contributed to the “weaponization” of the IRS leading to his calls to abolish the agency.

Expanding EITC

Primary season is usually not the time for reasoned discussion of many issues, and I do not put much stock in candidates’ IRS-bashing.  I put some more stock in the across the aisle call that President Obama noted when he referred to Representative Ryan and his support to alleviate poverty and in particular tax cuts for childless workers. I take that reference in the speech to the Administration and the Speaker’s support for expanding the EITC for childless workers (the current maximum EITC for childless workers is about $600 compared to $6,000 for families with three or more kids).

It seems like there is some momentum for the idea of expanding the EITC for childless workers.  Calls for EITC expansion invariably are accompanied by attention to the EITC’s overclaim rate.  In the recent PATH legislation one cost for the expanded EITC and credits generally for families was a series of compliance measures I wrote about last month, including a ban for reckless and fraudulent claimants, additional civil penalties and greater summary assessment powers.  If Congress expands the EITC for childless workers, I suspect that it may consider extra powers the IRS might need to ensure that any expansion does not lead to additional overclaims.  Yet as I discuss below, expansion in this context might in fact lessen an incentive for noncompliance.

In an article in the Kansas Law Review called Poor and Tax Compliance: One Size Does Not Fit All based on research originally done by sociologists Kidder and McEwen, I argue that the EITC compliance problem is best thought of as a series of distinct problems with varying categories of noncompliance.  In the article I set out eight differing categories connecting the overclaim to the likely source of the problem.  In other words, the overclaim rate reflects varying sources of overclaims, including for example overclaims relating to 1) errors that stem from preparers (brokered noncompliance) and 2) when people just do not know the complex and changing EITC rules or their circumstances change (unknowing noncompliance).

In the article I refer to symbolic noncompliance, noncompliance that is rooted in a sense that the law is unfair.  Consider now a single father who is current on child support and who spends considerable time with his kids, but who does not spend more than half the year with those kids.  Current rules treat the noncustodial parent as effectively childless, so the EITC is not worth much for that parent.

Just a few weeks ago a joint report of the right leaning American Enterprise Institute (AEI) and left leaning Brookings Institute called Opportunity, Responsibility, and Security noted how current laws fall short in providing incentives for single non-custodial parents (primarily fathers):

[A] single mother with two children working 30 hours a week at an $8-per-hour job is likely to receive annual benefits of $5,495 from the Supplemental Nutrition Assistance Program (SNAP) [food stamps], $4,990 in federal EITC payments, up to $2,000 through the Child Tax Credit (up to $1,422 is refundable through the Additional Child Tax Credit), and health care coverage that could reasonably be valued at $4,101 depending on her state of residence. Child support collections, school lunch and breakfast, and child care subsidies can provide additional resources.

By contrast, a nonresident father working the same job and living in the same area is likely to receive only $1,655 annually from SNAP, $179 from the federal EITC, and possibly some help with health insurance depending on where he lives.  But he also is likely to have a child support obligation that would reduce his income and increase the mother’s. Collectively, the benefits provided to the single mother can almost double what she earns, while the nonresident father is eligible for little more than SNAP and a minimal EITC benefit.  Discussions about family and poverty must focus more attention on encouraging more work among poor, nonresident fathers—not just among the single mothers of their children.

Changes to the law to allow a greater benefit to a noncustodial parent might shift the perception that the current benefit regime is stacked against single noncustodial parents and reduce the incentive for the noncustodial and custodial parent to collude and agree to a sharing of a child.  To be sure, some might argue that an expansion of the childless EITC may just encourage other types of noncompliance.  Yet it is not the presence of refundable credits that creates noncompliance.  If Congress expands the EITC for childless workers, rather than legislate knee-jerk approaches to increase penalties and reduce procedural protections, Congress might tether an expansion to the credit with more targeted eligibility requirements backstopped by IRS compliance efforts to ensure that an individual claiming an EITC in fact does have earned income.  Any action should be backed by research as to what is likely effective and also recognize that the IRS will need resources allocated to allow it to effectively administer the law.

Leslie Book About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Comments

  1. Bob Kamman says:

    I just noticed that one provision of last July’s tax legislation requires lenders to show on Form 1098 mortgage interest statements the principal balance owed on loans. This starts for 2016 forms issued in 2017.

    The change was made so that IRS can identify taxpayers who owe more a million dollars on their mortgage, and therefore must limit their interest deduction. Apparently IRS has not been able to identify such taxpayers, until now.

    Obviously, high-income taxpayers present no compliance problems to IRS. That’s why they haven’t worried about this lack of data for the last couple decades, right? Far more productive, to go after those low-income abusers of EIC and CTC.

  2. Once more this blog’s posters and commenters chatter about income tax compliance, more compliance, and still more compliance. But they address only the symptoms, not the disease.

    If income tax compliance is so problematic at both ends of the economic spectrum, then it must be for good cause. That good cause must be the people dislike the income tax. In a free Republic, the correct response to the people’s income tax dislike is not to institute further “compliance” measures. Instead, the correct response is to repeal the income tax.

    What the next President should say in the State of the Union message is:

    “Many say that the main part of our federal tax system is based on voluntary compliance. I say it is not voluntary enough. I will therefore propose that Congress enact a law that will base our federal tax system on true voluntary compliance. My proposal would repeal the federal income tax laws. The United States government will instead collect its revenue through voluntary contributions made by the people that it serves.

    Each of this government’s many component parts will host an annual telethon during which its head will present to the people a report on the functions it performs. After that presentation, he or she will request that the people fund those functions with their voluntary contributions, in an amount that the Congress shall determine in advance.

    If the people respond positively to the contribution plea, then the government component will receive its funding, with any excess funds either returned to the contributors or, at their prior direction, applied to the national debt. Should the government component not receive its requested contribution, its functions will be either reduced or eliminated.

    Americans are a generous people. If, as they have often said, they love their country, then they will certainly support their respected or favored federal government components with their voluntary contributions. Should my proposed bill pass the Congress, the people will supply the United States Treasury with funds based on true voluntary compliance. That is the only compliance appropriate in this great land where a free people dwell and labor.”

    Wouldn’t such a system be far better than is our current, and decrepit, federal income tax system?

  3. Barry Goldwater says:

    In my experience, high income taxpayers who take a mortgage deduction are taxpayers who hire professionals to prepare their returns. The taxpayer, in many cases, has no idea there is a limit. The tax return preparer is too busy to notice or to ask and so plops the number on Schedule A, hands it to his supervisor for review and out the door to the client it goes.

    This provision will help tax preparers to prepare better returns. No poster has said that the tax return preparer or taxpayer has done anything intentional, but in my decades of experience, I have never seen a taxpayer or tax return preparer try to get away with anything with respect to the home mortgage deduction. In fact, when the IRS audits it, the taxpayer is usually upset the preparer missed it, and the preparer is embarrassed to have missed it. Then the taxpayer wants the return preparer to eat the penalty.

    In no way should noncompliance with the mortgage deduction be compared to EIC fraud.

  4. Bracket Creep says:

    Bob Kamman, per the 2016 instructions the Form 1098 will now require the principal balance at the beginning of the year, the address of the property, and the mortgage origination date. Like you say, these are each pieces of information that would enable the IRS to identify compliance with the mortgage interest deduction limitations. I am curious why the IRS/Congress does not attempt to require banks to include the amount of property taxes paid if the homeowner does so through an escrow account. It’s a $29 billion tax deduction annually that comes with no mandatory third-party reporting requirement. The “other” box/line on the Form 1098 is completely optional.

    • Bob Kamman says:

      Mostly, because information return reporting is meant to help IRS, not to help taxpayers. Reporting the mortgage interest deduction prevents ineligible taxpayers from inflating the amount, or claiming a phantom deduction. Having a box for property taxes paid, with no entry, might lead some taxpayers to believe they can’t deduct property taxes they paid outside of escrow. Or, it might cause them to deduct taxes paid for periods when they did not own the property. (Not that this doesn’t already happen.)

      Most lenders report the amounts voluntarily — otherwise, they have to field phone calls from borrowers. Some credit unions don’t have the software to do it.

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