Presidential candidates' tax administration proposals raise policy concerns.
Proposals emanating from the major political parties have recently provided much grist for the tax policy mill. The Democratic, Republican, and Reform parties have all surfaced proposals to change not only the Internal Revenue Code's substantive provisions (including Senator Dole's proposed tax rate reduction and President Clinton's proposal to modify the Code's sourcing rules), but also to make major changes in how the tax system is administered. Although Tax Executives Institute is studiously nonpartisan and generally refrains from taking positions on contentious tax policy issues (such as tax rates, the merits of a capital gains differential, and a whole multitude of individual tax provisions), the Institute has analyzed the possible effects of several administrative proposals offered by the major candidates for President. This position paper sets forth TEI's concerns about the feasibility, fairness, and long-term effects of the proposals on sound tax administration.
Tax Executives Institute is the principal association of corporate tax executives in North America. TEI is a nonpartisan, not-for-profit membership association that represents approximately 5,000 in-house tax professionals employed by 2,700 of the leading companies in the United States and Canada. The Institute sponsors numerous educational programs for its members and meets frequently with government officials at all levels to discuss tax issues of common concern. TEI is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. Because of the diversity of our membership, TEI focuses its attention on broad-based administrative issues, such as making the tax system work more efficiently for both taxpayers and the government.
Members of Tax Executives Institute deal with the Internal Revenue Service on a daily basis, and most members work for companies that are under continual audit by the IRS. We know from experience that the tax laws are mind-bogglingly complex, and are convinced that both the tax laws and their administration can be improved. Nevertheless, we have serious reservations about the untempered attacks that many officials and candidates have launched on the IRS. No one likes to pay taxes, but the orderly collection of taxes and the efficient administration of the tax laws are in the best interests of the country. What is not needed is an emotion-laden vendetta against the IRS, an agency charged with enforcing the laws that Congress enacts. To demonize the IRS for the flaws in the tax system is misplaced. To the extent responsibility needs to be assigned, it rests with the members of Congress from all parties who enact the tax laws in the first place.
To be sure, there are design and management problems at the IRS that must be addressed. For example, the IRS's tax systems modernization program has not proceeded as well or as quickly as necessary in today's ever-changing technological world. For all its faults, however, the American tax system continues to operate more efficiently and effectively than comparable systems in other countries. Recent attacks on the legitimacy of the U.S. tax system and on the IRS seem to ignore this, and when they come from respected government leaders, they cannot help but breed disrespect for and undermine public confidence in the fairness of the system. They may well lead to greater noncompliance to the ultimate detriment of all individuals and businesses who pay their fair share of taxes.
In connection with the Democratic National Convention, the Clinton Administration in late August released several campaign-related tax proposals, including a proposed revision of the substantial understatement penalty. TEI believes that the revision is ill-advised and represents poor tax policy.
Section 6662 of the Internal Revenue Code imposes a 20-percent penalty for understatements of income tax that are "substantial," i.e., the amount of the understatement for the taxable year exceeds the greater of (i) 10 percent of the tax required to be shown on the return, or (ii) $10,000. Under the Clinton proposal, any understatement of tax that exceeds $10 million would be automatically considered "substantial" for purposes of the penalty.
President Clinton's proposal reflects a failure to learn from Congress's extensive reform of the penalty provisions just seven years ago. The Improved Penalty and Compliance Tax Act of 1989 revised and streamlined several penalty provisions of the Code, consolidating them into a new section 6662. The legislative history of the new law demonstrates that changes were made because Congress believed that the Code's myriad penalties caused confusion among taxpayers and led to difficulties in administration by the IRS. Underlying the new statutory scheme was the principle that civil tax penalties should exist for the purpose of encouraging voluntary compliance and not for other purposes, such as the raising of revenue.
TEI wholeheartedly endorses the principle that penalties should be assessed only to punish culpable behavior. The tax law should not punish "foot faults" or good faith efforts to comply with tax rules that are hopelessly complex and, in many instances, ambiguous. Taxpayers - especially large, multinational enterprises that are subject to constant IRS scrutiny - struggle to comply with vague statutes and verbose regulations, and despite their best efforts either sometimes substantially underpay - or overpay - their taxes. These companies do not play the audit lottery, and they should not be subject to still another penalty where, after audit, they must pay additional taxes (plus interest). We acknowledge that the dollar threshold in the Clinton proposal seems high in the abstract, but in today's global economy the threshold could be exceeded by a multinational business acting entirely in good faith. That such good faith, nonculpable errors are possible is evidenced by the Internal Revenue Service's own mistakes in asserting huge tax deficiencies. Even with the benefit of hindsight denied taxpayers when they filed their returns, the IRS frequently loses multi-million dollar cases.
Burden of Proof
Under current law, a taxpayer is generally required to maintain records substantiating the calculation of his or her income tax liability. As part of his Presidential campaign platform, Senator Dole has proposed to shift the burden of proof from the taxpayer to the Internal Revenue Service. In support of the proposal, the argument is made that elsewhere in America citizens are presumed innocent until proven guilty and that the same standard should apply to dealings with the IRS.
With due respect, the foregoing argument, while facile, really misses the point. It is true that the innocent-until-proven-guilty rule generally applies to criminal matters. It is also true, however, that in criminal tax matters - and, indeed, in matters involving civil tax fraud and certain other penalties - the government already has the burden of proof. It is in civil tax matters where the burden is placed on the taxpayer. This standard comports with the common law principle that the burden should generally rest with the party who has control of the facts and records - in this case, the taxpayer. Otherwise, the party with the facts (but not the burden of proof) could prevail, simply by concealment.
Consider this example: On his tax return, a taxpayer claims a deduction for donating $200 a week to his church, but in fact only donated $20 a week. The return is then audited and the IRS agent asks for substantiation. The taxpayer replies that he has no substantiation because the donations were made in cash. He challenges the IRS to disprove his claim. How does the IRS demonstrate that the donation was not made? Under current law, taxpayers must document their contributions (and other deductions) because they shoulder the burden of proof (and have access to the records - if any - substantiating their claims). Under the Dole proposal, a dishonest taxpayer would have an incentive to stonewall the IRS and escape paying his fair share. Hence, honest taxpayers would suffer under this proposal because there will always be a few who will try to "game" the system. For example, if shifting the burden were to reduce voluntary compliance by as little as one percent, there would be a $10 billion annual decrease in tax revenues - revenues that would have to be made up by honest taxpayers.
Ironically, if the burden of proof were shifted to the government, the IRS'S enforcement efforts might well have to be intensified as the agency tries to sustain its heightened burden. If the taxpayer had no burden to come forward with the facts, the IRS would have to undertake to discover them itself "Economic reality" and "life style" audits may well increase as the IRS struggles to reconcile reported income with expenditures. More summonses - including those issued to third parties - would undoubtedly be issued and more issues litigated, particularly in the Tax Court where there is no prepayment requirement. While we support giving the IRS sufficient resources and tools to do its job, we question whether support currently exists for expanding the agency's compliance activities. (Indeed, Senator Dole has also proposed to curtail sharply the use of life-style audits.) The end result of this misbegotten proposal could well be a more intrusive IRS, a decrease in tax revenues, and a less efficient tax system
As part of his Presidential campaign platform, Senator Dole has called for a federal tax amnesty that would permit individual taxpayers a one-year window in which to pay back taxes without penalty or interest. Although the amnesty proposal is intended to ease the transition to tax reform, TEI believes that such a proposal would reward those who have not obeyed the laws and send the wrong signal to those of us who have struggled in good faith to comply. The proposal raises questions of fundamental fairness - questions that have persisted since at least the Fifth Century when the Roman Empire unsuccessfully toyed with amnesties as a quick fix. The problem is that amnesties do not significantly encourage future compliance, but rather provide an incentive for noncompliance. In ancient Rome, citizens did not come forward to pay their taxes voluntarily; rather, they temporized and stalled the tax collector, waiting for pressure to build for the next amnesty. And history teaches that, across America and throughout the world, such pressure for one more amnesty "fix" will rise, almost inexorably.
Accordingly, a federal amnesty may not raise new revenues. Proponents say that, based on the states' experience with such proposals, a federal amnesty will generate considerable revenue. Such a philosophy ignores several issues: First, because the federal compliance level has always been much higher than the state compliance level, the potential revenue gain from a federal amnesty is more modest.
Second, state amnesties have always been followed by tougher enforcement activities. At the federal level, however, enforcement efforts already outstrip those in the states. Ironically, too, Senator Dole and others have called for reducing enforcement activities as a means of "getting the IRS out of the lives of the American people." In other words, the "carrot" of the amnesty (even if it were a good idea - and we do not believe it would be) would under current proposals seemingly not be accompanied by the "stick" of enhanced enforcement efforts. Hence, noncompliant taxpayers might well feel emboldened not to mend their ways, but rather to simply wait for the next amnesty. Again, the losers in the process would be the individual and business taxpayers who take seriously the laws that Congress enacts and who strive diligently to comply with those laws.
Privatization of IRS
Senator Dole, Mr. Perot, and others have called for the privatization of many functions of the Internal Revenue Service. Although it is unclear precisely what functions would be outsourced under these proposals, there have been proposals to privatize the IRS's collection - and possibly its examination - activities.
Although there may well be some activities of the IRS that can be outsourced, TEI has serious reservations about privatizing the agency's core examination and collection functions. These concerns would be heightened if the proposal permitted private sector contractors to be compensated on a contingency fee basis. (Such proposals are currently pending in Congress). The Institute believes the use of outside contractors in such a manner would threaten taxpayer rights and undermine the confidentiality of taxpayer records.
Most important, the use of so-called bounty hunters would chip away at taxpayers' perception of the tax system's fairness. The IRS has long eschewed the use of quotas or compensation arrangements based on the level of audit adjustments to ensure the integrity of an agency whose mission is to determine the proper - not the highest - amount of tax. To invest private collection agencies with the power to determine their level of compensation by tying it to the level of tax adjustments is to ignore the lessons of history and to open the door to abuse.
Suggesting that the IRS outsource its enforcement activities is like suggesting that the FBI outsource its manhunts and the Pentagon outsource its wars. It has been said that there is always an easy solution to every human problem - neat, plausible, and wrong. Wholesale privatizing of the IRS's core functions is one such solution.
Tax Executives Institute appreciates this opportunity to present its views on the administrative tax proposals set forth by the Clinton, Dole, and Perot campaigns. Any questions about the Institute's views should be directed to either Michael J. Murphy, TEI's Executive Director, or Timothy J. McCormally, the Institute's General Counsel and Director of Tax Affairs. Both individuals can be reached at (202) 638-5601.
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|Date:||Nov 1, 1996|
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