April 2006 | EPI Book
Bridging the Tax Gap
Addressing the Crisis in Federal Tax Administration
Max B. Sawicky, editor
Max B. Sawicky, Economic Policy Institute
Chapter 1: Do-it-yourself tax cuts: The crisis in U.S. tax enforcement
by Max B. Sawicky
Chapter 2: Interview: Former IRS Commisioner Sheldon S. Cohen
by Max B. Sawicky
Chapter 3: Interview: Former IRS Commissioner Donald C. Alexander
by Max B. Sawicky
Chapter 4: Tax cheats and their enablers
by Robert S. McIntyre
Chapter 5: Closing the international tax gap
by Joseph Guttentag and Reuven Avi-Yonah
Chapter 6: Tax simplification and tax compliance: An economic perspective
by Wojciech Kopczuk
The ability to finance public services at a low financial cost with minimal social dislocation is a precious national asset. The United States is blessed by a tax system with these attributes—the vast bulk of taxes owed are paid voluntarily and on time. In a $13 trillion economy, our federal government taxing authority costs about $10 billion—less than one dollar out of a thousand—to run. A nation squanders such an asset at its peril, but that is what is happening now.
Compliance with the federal tax system is eroding. The Internal Revenue Service estimates that as much as $350 billion in taxes are not paid voluntarily and timely. On a bare-bones enforcement budget, about $50 billion is eventually recovered. The remaining gap means that tax rates must be higher than necessary to collect the revenue that comes in, and moreover, that such rates penalize the honest taxpayer for the sake of the evader. The absence of a tax cop on the beat demoralizes those who pay their correct amount and encourages evasion, further adding to the enforcement burden and the revenue loss.
Current federal deficit levels are widely recognized to be unsustainable in the long run. The Bush Administration has proposed and ratified spending increases as rapid as any presidential administration in history, and it has added to future spending with a new, unfunded prescription drug benefit under Medicare. In about a dozen years, the Social Security program will begin to require cash transfers from general revenue. Tax cuts of the past four years have made an untenable situation worse, rather than better. Under all plausible circumstances, tax increases will force their way back onto the policy agenda. One important leavening factor will be the willingness of policy makers to improve enforcement of taxes already owed, not just the legislation of literal tax increases.
This book provides a survey of the compliance problem in language the non-expert can understand. We also discuss a broad gamut of remedies. Contributors to this volume include eminent practitioners in the field of tax enforcement, as well as scholars in tax policy.
The opening chapter by Max B. Sawicky provides a comprehensive overview of the topic. It begins by summarizing research on the extent of non-compliance, and on the magnitudes of potential pay-offs from more vigorous enforcement measures. It includes a critique of policies that have debilitated the Internal Revenue Service, which include excessive constraints on IRS personnel, inadequate funding, increasing complexity in the tax code, misplaced focus on low-income taxpayers, and unsuccessful technology modernization. It also surveys possible remedies.
The second and third chapters feature interviews with former commissioners of the Internal Revenue Service.
Sheldon Cohen worked for the IRS in the 1950s and served as commissioner under President Lyndon Johnson. Cohen describes the process of building the modern IRS and the problems in running it.
Donald Alexander served as commissioner under President Richard Nixon in the 1970s. He discusses the shortcomings of potential tax reforms from the standpoint of tax administration. He also provides a window into the political pressures facing the IRS.
Robert McIntyre describes the burgeoning business in illicit tax shelters. Limited IRS resources place the government at an increasing disadvantage in dealing with wealthy taxpayers who can afford to buy expert tax planning that amounts to custom-made tax-cut schemes tailored to the individual. These schemes typically dance back and forth across the boundary of the law, but the issues raised are sufficiently complex as to permit guilty parties to win compromises from the government, rather than pay their rightful share of tax.
Joseph Guttentag and Reuven Avi-Yonah lay out the increasing difficulties of levying the income tax in a globalizing world economy. They reveal some of the mechanisms of high-level tax evasion and propose remedies to recover the huge sums lost to off-shore financial shenanigans.
Finally, Professor Wojciech Kopczuk argues that tax simplification could ease the enforcement problem and, to some extent, preclude the need for heightened enforcement measures. He reviews research on the determinants of tax compliance behavior, and he evaluates alternative strategies to improve compliance from the standpoint of equity and economic efficiency.
The aim of this volume is to alert policy makers to the growing problem of tax compliance, and to feasible solutions. The costs of inaction are great, but so too are the potential rewards of reform. Alternatives to closing the budget deficit are usually unpleasant. When the day comes that the Congress decides to face up to its fiscal responsibilities, it will find that increasing the rate at which taxes are paid voluntarily and on time is one of the best deals we can get in economic policy.
Max Sawicky is institute economist at the Economic Policy Institute. He is a member of the National Executive Board of Americans for Democratic Action and the editorial board of Working USA. He also runs the Weblog MaxSpeak at www.maxspeak.org/mt.
About the Authors
Donald C. Alexander is a partner in the law firm of Akim, Gump, Strauss, Hauer, and Feld. He served from 1973 to 1977 as commissioner of the Internal Revenue Service, from 1984 to 1989 as director of the U.S. Chamber of Commerce, and from 1993 to 1996 as a commissioner of the Martin Luther King Jr. Federal Holiday Commission.
Reuven S. Avi-Yonah is the Irwin I. Cohn Professor of Law and director of the International Tax LLM p
rogram at the University of Michigan. He is a graduate of the Hebrew University (B.A. 1983, summa cum laude), Harvard University (Ph.D. in history, 1986), and Harvard Law School (J.D., 1989, magna cum laude). He is married with two children and lives in Ann Arbor, Michigan.
Sheldon S. Cohen was a partner in the law firm of Morgan, Lewis & Bockius. He served as chief counsel of the Internal Revenue Service in 1964, and as commissioner of the Internal Revenue Service from 1965 to 1969.
Joseph H. Guttentag was deputy assistant secretary for international tax affairs in the Clinton Treasury. Previously, he was a senior tax partner in the law firm of Arnold & Porter in Washington and Tokyo. He served as chairman of the Fiscal Committee of the Organization for Economic Cooperation and Development in Paris and as chair of the international tax groups of the U.S. Chamber of Commerce, the American Chamber of Commerce in Japan, and the American Bar Association.
Wojciech Kopczuk is associate professor of economics at Columbia University and faculty research fellow at the National Bureau of Economic Research. He obtained his Ph.D from the University of Michigan in 2001 and has published articles in leading academic journals on topics such as estate taxation, wealth inequality, tax avoidance, and the cost of income taxation.
Robert S. McIntyre is director of Citizens for Tax Justice. For the past three decades, he has helped lead the fight for fair and adequate taxes at the federal, state, and local levels.
This book is the culmination of a project that benefited from the advice of leading scholars and practitioners in the field of tax administration. We would like to thank Henry J. Aaron, Donald C. Alexander, Reuven S. Avi-Yonah, Leonard E. Burman, Sheldon S. Cohen, Joseph Guttentag, Wojciech Kopczuk, Robert Kuttner, Robert S. McIntyre, Ronald A. Pearlman, Charles O. Rossotti, and Eric Toder for their assistance. They are of course not responsible for the views expressed here.
We would also like to commend Rebecca Ray and Ellen Levy of the Economic Policy Institute for valuable assistance in preparing the interview transcripts.
We are grateful to the Popplestone Foundation for its generous support of this project.
The views expressed by individual authors in this volume are not necessarily those of the Economic Policy Institute.