Two Senate hearings last week focused on how America's wealthiest people avoid taxes in ways that are unimaginable to ordinary Americans.
All of the experts brought in to testify said House Republicans' recent tactic of “funding” spending proposals by cutting IRS funding makes no sense because it reduces revenue collection and increases the deficit. It seems they agreed.
They also seem to agree that much of the problem with wealthy people avoiding or evading taxes stems from the complexity of the tax code.
Nevertheless, witnesses called by Republicans laid out complex arguments against President Biden's policies that address these very issues.
The debate over IRS funding is a case in point. The Inflation Control Act provided $80 billion in additional funding to the IRS over 10 years, $46 billion of which was earmarked for enforcement (meaning, among other things, increased auditing). The president said this additional enforcement would go to people with incomes above $400,000. Estimates from the Congressional Budget Office suggest that $180 billion in new revenue would be generated during this period, with a payback ratio of about 4 to 1.
Nathaniel Hendren, a professor at the Massachusetts Institute of Technology, testified before the Senate Budget Committee that the revenue impact would be much larger, in part because the CBO has been reluctant to estimate the indirect effects of increased enforcement. (Indirect effects include, for example, fewer taxpayers attempting to evade taxes because they know they are likely to be audited.) The company focused on high-income earners, and found that their returns were 12x. To 1.
Chris Edwards of the Cato Institute agrees with other witnesses that, contrary to House Republicans' claims, cutting IRS funding does not “cost anything” and actually increases the deficit. did. Still, Edwards still made a complicated argument for the IRS funding provided by the Inflation Control Act.
“Enforcement is a blunt weapon,” Edwards said. This is a surprising statement for those who believe that Congress enacts laws in the hope that they will be enforced. Edwards noted that the IRS wins cases against taxpayers about half of the time and has only recovered about 48% of disputed dollars in recent years. Given this, he argued that stronger enforcement is not optimal and that tax compliance could be strengthened through other means.
There are many problems with this argument. First, Congressional Republicans have not offered any other proposals to strengthen tax compliance and are simply trying to water down the IRS (just like they did in the 2010s). Second, while the dollars raised in IRS enforcement operations are an obvious benefit from these efforts, there are less tangible benefits that Mr. Edwards ignores, given the possibilities faced today. And all tax evasion that taxpayers don't even attempt because it's not worth the risk. audit. Third, his statements do not imply that enforcement efforts will yield fewer benefits than costs.
And Natasha Salin, a former Treasury official, testified that the IRS has historically been unprepared to take on some of the large, highly complex business structures that are often used to hide income. She explained in her written statement:
“As an example, the most recent in-depth examination of pass-through avoidance by the IRS was conducted in the 1980s. Over the intervening 40 years, the importance of these structures has increased; for example, partnership income as a percentage of business income has increased from less than 5% to more than 35% today. However, the IRS does not have the resources to devote to measuring partnership avoidance, much less consider how best to address it. The audit rate is approximately 0%.”
She said a web of entities can include a long chain of partnerships owned by other partnerships owned by foreign entities that are owned by other domestic entities, and typically investigates it. A single IRS official appointed to do so would need to disentangle it. Increased IRS funding will allow the agency to hire more highly skilled professionals needed to get to the bottom of these structures.
A Senate Finance Committee hearing the next day focused more on tax avoidance, a legal, or at least arguably legal, tactic to reduce taxes. This includes individuals and businesses taking advantage of special holidays and other loopholes enacted by Congress to minimize payments.
Witnesses, including William McBride of the Tax Foundation and Douglas Holtz-Eakin of the American Action Forum, agreed that the complex transactions and schemes used by the wealthy to avoid taxes are a result of the complexity of the tax code. It seems like it is. Chris Edwards of the Cato Institute said the same thing at a Budget Committee hearing the day before.
Nevertheless, it's strange to hear this from supporters of the Tax Cuts and Jobs Act of 2017, which introduced brand new Byzantine provisions that arbitrarily favored certain types of income over others. is. This is the perfect recipe for encouraging taxpayers to twist their operations to fit within certain tax reduction rules. One example is the law's 20 percent deduction for certain pass-through business owners. Another example is the provision that allows companies to pay much lower amounts for the profits they record offshore, clearly allowing offshore tax avoidance by companies to flourish.
Upon the passage of this law, a group of lawyers wrote a lengthy article titled “The Game They Play” about how these and other provisions can be brutally abused. . It is surprising that some people support this law while criticizing the complexity of the tax code.
While there was little consensus on a solution among witnesses and lawmakers, everyone watching this hearing was reminded that wealthy people seem to live under completely different tax laws than everyone else. You can't overlook the fact that this is the case.
Chae-Chin Huang of the New York University Tax Law Center says that the very wealthy are able to generate income thanks to complex tax rules that are said to “promote growth” and the highly paid lawyers and accountants who help them do so. , explained how there are many opaque ways to structure commerce. they. All these provide ample opportunities for tax evasion and tax avoidance. On the other hand, the typical middle-class American earns her income at a job where her employer reports her income to the IRS, and there are few opportunities, if any, to avoid or avoid taxes.
He also explained that many of the tax breaks on income earned from wealth are clauses that create a type of complexity that can be used to avoid taxes. For example, taxes on capital gains can be deferred for years until the taxpayer sells the asset, but the income earned is still often taxed at a lower rate and the asset is inherited. The income may be permanently exempt from taxation because it is left to the person and the person receives the benefit. The assets are eliminated from the tax system.
All of this creates further complications as it encourages individuals to jump through hoops to recharacterize their income as the type eligible for these breaks. One of his most famous examples is the carried interest loophole. This allows fund managers to characterize the compensation they receive for their work (managing other people's money) as capital gains, defer taxes and enjoy lower tax rates.
A direct solution to this is to sharply limit these tax cuts, as President Biden is proposing. But that is clearly not the “simplification” that Republican members of these committees and the witnesses they supported spoke of.
