Taxing The System

Paul Manafort pled guilty to hiding $30 million in income from the IRS in one case and conspiracy to commit tax fraud in another. Rick Gates similarly pled guilty to conspiring to commit tax fraud. Michael Cohen pled guilty to tax fraud and the Trump Organization has been implicated by Cohen and detailed NY Times reporting in a similar crime. It seems almost assured that all of them would have escaped notice by tax and legal authorities if Donald Trump had not become President.

Yesterday, I wrote about the failures of the global anti-money laundering system and how the professionals in the banking, legal, and accounting industry facilitate the criminal abuse of the global banking system. In a similar fashion, it is clear that the current system of tax collection here in the United States is equally stressed.

The IRS has long relied on the basic honesty of the majority of Americans in filing their taxes accurately. While it may have developed systems that can flag certain anomalies in relatively standard returns for investigation and possible audits, it has never had the capacity or manpower to accurately and extensively monitor high net worth individuals, and companies for that matter, with complex streams of income.

In 2009, the IRS attempted to rectify that problem, setting up a team of specialists, the Global High Wealth Industry Group (GHWIG), to focus on the tax avoidance and tax evasion of the ultra-wealthy. The IRS commissioner at the time described this team and its focus as “a game-changing strategy”. Because of the complexity of the returns, the IRS’ requests for information from high income individuals become far broader and far more detailed than the usual IRS request. A usual request might run to just one or two pages while GHWIG’s requests usually took up dozens of pages.

Needless to say, from the beginning, this team was under attack. One high powered tax lawyer at that time and who is currently Trump’s IRS commissioner declared the team was conducting “audits from hell”. Another compared the requests to a “a proctology exam, unearthing every aspect of their lives”. The Republicans in Congress also pushed back and began to cut the agency’s budget in response to pressure from their wealthy donors. From 2010 to 2018, the budget for the IRS has fallen by nearly 15%.The audit rate has fallen by 42% and audits of the richest Americans has fallen by over 50%. There are one third less auditors than there were in 2010 and fewer than the agency had in 1953. Investigation of taxpayers who don’t even file returns has dropped from 2.4 million to around 350,000. Because of the Republicans’ faux scandal about the EITC, the agency spends as much resources investigating taxpayers with income under $20,000 as it does on taxpayers making half a million to a million dollars. If the IRS does not pursue a tax obligation for 10 years, the obligation expires. In 2010, the amount of expired obligations was less than $500 million but by 2017 that number had incredibly risen to over $8 billion (yes, that’s billion with a “b”).

The GOP’s gutting of the agency’s budget severely crimped the GHWIG. The unit barely reached a third of the nearly 250 auditors it had hoped to have on staff and there was enormous turnover in that group as well. In addition, the wealthy targets of the group’s investigations had the resources to drag out cases interminably, all the while pressuring their contacts in government, the ABA, and the upper echelons of the IRS to rein the GHWIG in. When one target repeatedly delayed providing documents, an auditor suggested he might get a summons to force the document production. That prompted the target to claim to his agency superiors that he was being threatened and the auditor was duly reprimanded.

Even accounting firms refused to cooperate with the group. In one case, Ernst & Young refused to provide documents, arguing that they were privileged documents in anticipation of litigation. That litigation, of course, involved the advice it gave the target in question, exactly the information the IRS required. Ernst & Young litigated the request and won in court.

In the end, the GHWIG was simply underfunded, understaffed, outgunned and destined for failure. As one IRS official described it, “From the minute it [the GHWIG] went live, it was dead on arrival”. By the end of 2012, the team had only ended up auditing around a dozen taxpayers. By 2013, the IRS had instructed the group to cut down on the breadth of its requests. By 2017, top officials in the IRS were instructing the group to reduce penalties and abandon particular lines of litigation in particular cases. Today, the GHWIG still exists but its reach is minimal and the cases it brings are far smaller than was anticipated when it was formed in 2009. The ProPublica article from which most of this story about the GWHIG is worth reading in its entirety. It tells the story of how one taxpayer manipulated the system to whittle a $1.2 billion tax bill down to under $100 million.

The most recent estimates of the percentage of taxes actually owed that were paid covers they years 2008 to 2010. During that time of financial stress, the estimate was 82%. If that rate has stayed constant, it would translate into $667 billion dollars in unpaid taxes for 2017. That is nearly the equivalent of the entire FY2017 deficit. Yet no one at the IRS believes that number remained constant and many believe it has fallen far below that 82% level. And, if there is anything that these high profile convictions in the Russia investigation has shown us is that many of the ultra wealthy have abandoned coming up with intricate tax evasions schemes and simply feel they have the freedom to brazenly disregard tax laws. That message of non-compliance has and will surely filter down to middle and lower income filers as well.

In Japan, the tax agency automatically calculates the taxes owed for 80% of its citizens and then deducts or credits a designated bank account. Germany has a similar system. France recently emulated Britain and implemented the automatic collection of income taxes. Before the changes to the tax code this year, the majority of Americans used either the 1040A or the 1040EZ form, for which the IRS already has the vast majority of information required based on filings from other sources. In other words, it is well within the agency’s capability to calculate the taxes owed for the vast majority of Americans, sparing them the time and often expense to do it themselves. In addition, such an automated system would actually free up IRS resources to audit the more complex tax returns it receives.

In fact, Ronald Reagan proposed a system that would have the IRS send out a completed tax form that would only have to checked, signed, and returned by the majority of Americans. In 1998, Congress mandated such a system to be available by 2008. That never happened, primarily due the lobbying of the tax preparation industry and the bizarre Republican idea that making taxes easier to file would somehow make it easier to raise taxes. Instead, the IRS made a deal with the nation’s large tax preparation firms to provide their systems for free under the moniker of the Free File system. Each of the participating firms offers free tax filing under certain conditions covering income and age. In return, the IRS agreed to “not compete with the Consortium in providing free, online tax return preparation and filing services to taxpayers”.

The problem is that neither the IRS nor the tax preparation companies actually advertise Free File. While it is estimated nearly 70% of taxpayers could use the system, only a paltry 3% take advantage of it, primarily because no one knows about it. The tax prep companies won’t make money offering it and the IRS has no budget to advertise it. Reagan’s dream will officially die this years as it now appears that the earlier agreement that the IRS would not compete with the tax prep industry will actually be enshrined into law.

Our tax collection system may not be broken, but there are real cracks. More so than the global anti-money laundering system, there is an entire army of lawyers and accountants determined to exploit any gray area between the letter and the spirit of the law, often in stark contrast to the purported ethical goals of those professions. That army is often backed with resources that actually far outweigh the capabilities of the IRS and are able to exert political pressure on the agency from above to intervene in their individual cases. Budget cuts and GOP intimidation have allowed the wealthy to engage in massive tax avoidance and evasion, has left billions in owed taxes go uncollected, and wastes resources by targeting a small rural county in Mississippi for more audits than any other county in the country in search of miniscule EITC violations.

As with so much of our government today, the current tax collection system works primarily for the plutocrats. And, while it is hard to find a large constituency for robust tax enforcement, actually funding and empowering the IRS is a critical part of getting the rich to pay their fair share.

Originally published at thesoundings.com on April 11, 2019.

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