The Impact Of Tax Cheats

The Internal Revenue Service estimates that, each year, about 16.3 percent of the nation’s federal taxes go unpaid — and that’s after the IRS takes whatever action it takes to try to achieve compliance.  This “compliance gap” leaves a pretty big hole in the federal budget.  In 2018, if all of the federal taxes that were owed were actually paid, it would have meant another $643 billion in revenue for the federal goverment — which would have covered about 83 percent of our ridiculously large federal budget deficit.

celebrity_tax_cheats-624x300Why don’t people just suck it up and pay what they owe?  That’s not a self-answering question.  The Government Accountability Office says there are three main reasons for non-compliance:  third-party reporting issues, reduced IRS budgets and staffing, and the complexity of the Internal Revenue Code.  The first and third reasons involve mistakes — where third parties don’t correctly report what a taxpayer has earned, or has received in a taxable transaction, or where a taxpayer has legitimately tried to figure out what they owe, and simply been wrong — but the second category clearly relates to the ability of the IRS to ferret out, audit, and penalize those who are knowingly cheating.  In short, if you had perfect compliance, reduced IRS budgets and staffing wouldn’t make a difference.  And the lines between the three categories may be blurry, too.  If a taxpayer professes confusion about how to treat a particular source of income but adopts a stretched reading that dramatically minimizes their taxes, is that cheating, or a product of tax code complexity?

So, what can we do to improve the compliance numbers, recognizing that getting perfect, 100 percent compliance is an unattainable goal?  The answer to that question seems to turn on political inclinations and your view of human nature.  Some people, like the author of the article linked above, think that simplifying the tax code would result in a higher compliance rate — an argument that presupposes that people honestly try to figure out, and pay, what they actually owe.  The flip side argues that increasing the IRS budget for oversight and compliance is the best way to promote compliance.  In short, if more people fear they’re going to get caught, it will have a prophylactic impact on a wider group of taxpayers who will choose to simply pay their taxes rather than risk audits and penalties.

There’s undoubtedly merit in both arguments, although being somewhat cynical about human nature, I tend to agree more with the latter camp — but it’s also true that neither of these solutions has much promise in the short term.  Tax simplification has been the Great White Whale of politics for as long as I’ve been filling out 1040 forms, and it never quite happens.  And campaigning for office on a platform of increased IRS funding and more aggressive tax enforcement doesn’t seem like the ticket to political success.

So we’re likely to bump along as we have been, with many people accepting their federal tax burdens, a segment of the population consciously cheating on their tax obligations, and a continually growing deficit because we can’t actually do something about the “compliance gap.”  It makes you wonder:  at some point, is that “compliance gap” going to grow even larger?

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Congestion Taxes

It sounds like an April Fool’s Day joke, but it isn’t:  New York lawmakers have approved a budget that will impose a tax on drivers who venture into Manhattan — one of the most congested driving areas in the world.  Drivers in New York City not only will be cursing the gridlock, now they’ll be paying extra for the privilege, too.

maxresdefaultThe budget deal will create a six-member commission that will set the fee to be paid by drivers who cross into Manhattan below 61st Street.  Because the idea is to use the tax to reduce congestion, pricing is expected to be variable, with higher rates during the peak periods and lower rates at night and on weekends.  Electronic readers will assess the tolls, which are expected to be between $11 and $12 for cars during daylight periods and about $25 for trucks.  The tax is forecast to generate about $1 billion in revenues, which New York lawmakers promise to use to address desperate repair needs in New York City’s subway and commuter rail systems.

Congestion taxes are used in other congested cities of the world, like London, but New York City will be the first U.S. city to adopt them.  And if the taxes work as planned in the Big Apple, it isn’t hard to foresee other congested areas of the country, like southern California, adopting them, too.  After all, local governments are always looking for new revenue sources, and this particular approach can be pitched as a method of using taxes to achieve a virtuous result — reduced road congestion and, if the tax revenues are earmarked, improved mass transit.

I’ve driven through New York City exactly once, in a rental car on a Saturday morning when the roads weren’t bad.  I can’t imagine what how nerve-wracking it would be to drive there on a daily basis — and now to pay special taxes for that added stress.

And here’s what’s interesting, too:  if congestion taxes are, in fact, designed to reduce congestion, that reflects an acknowledgement that taxes influence behavior.  That is, such taxes presuppose that some drivers will forgo taking their cars into the congested zone in order to avoid the tax — otherwise, the tax would have no effect on congestion.  But if taxes do in fact affect behavior, and people take action to avoid taxes, what does that mean for New York and New York City generally, which have some of the highest income taxes and other taxes in the U.S.?

Voting With Its Wallet

Seattle is home to some of the largest corporations in the world, with one — Amazon — growing like crazy and fueling a boom in downtown construction.  But when Seattle politicians decided to impose a tax on large employers in the city to deal with a homelessness crisis, Amazon very publicly decided to pause work on a new downtown office building until after Seattle City Council votes on the tax.

03062018_amazongrowing_132746-780x513The proposed tax would have a real impact on businesses.  It would be a “head tax” of $500 per employee on approximately 500 businesses that gross at least $20 million annually in Seattle.  For Amazon, which currently has about 45,000 workers in Seattle, the tax would cost more than $20 million in 2018 and 2020, with that tab increasing when the form of the proposed tax would shift to a .7 percent payroll tax in 2021.  Even for a company that is highly profitable — Amazon recently reported quarterly income of $1.6 billion — $20 million a year isn’t chump change.

Amazon typically doesn’t mess with local politics in Seattle, so its pause in construction planning until after the City Council vote has had a real impact.   One City Council supporter of the tax accused Amazon of attempting “blackmail,” but other voices in city hall and in the real estate development community shuddered at the thought that the company might stop its investment in Seattle.  The concern is only heightened by Amazon’s announced search for a new city in which to build a second headquarters — a process that is already underway, in which Columbus and other cities have made the first cut.  Some people are concerned that Amazon might just direct its growth exclusively to the new home of “HQ2,” leaving Seattle in the dust.

Why should large employers, alone, pay a tax to address Seattle’s growing homelessness problem?  Supporters of the tax say that the large tech companies have contributed to the problem by bringing in highly paid workers who have caused a spike in home prices and rents — the median price for a house in Seattle is a whopping $820,000 — and that has contributed to the homelessness problem.  The sponsors of the tax also note that Seattle doesn’t have an income tax or tax capital gains, and claim that the city has few options to raise funds to address homelessness.  It’s curious, though, that the tax would be limited to only  large employers, as opposed to all employers, or that it doesn’t target various forms of real property transfers.  After all, a lot of people have presumably made a lot of money selling property that dramatically increased in value due to Amazon’s growth — why shouldn’t they contribute some of that profit to address the homelessness problem?

The reaction of the City Council member who characterized Amazon’s decision to pause construction as extortionate reminds me of the hubris that caused cities like Detroit to assume (wrongly) that large employers wouldn’t move away — or the story of the goose that laid the golden eggs.  As Amazon’s experience in its “HQ2” search proves, other cities would welcome a large employer that offers thousands of workers high-paying jobs.  The reality is that Seattle needs Amazon more than Amazon needs Seattle.  Does it really want to risk killing the goose?

Why A “Windfall”?

If you’ve been following the aftermath of the tax reduction legislation passed by Congress and signed into law by President Trump, you’ve seen stories about how some corporations have reacted to the new law by giving their employees bonuses or cutting their charges to consumers, and other, more critical stories noting that many of the companies are giving their employees one-off bonuses, rather than more permanent raises.

windfall-money-manBut while different articles about the tax cut legislation may make different points about how the tax cut legislation is affecting companies, workers, and the country at large, the coverage does seem to have one curious common theme and descriptive element:  the tax relief provided by the new law is typically said to have produced a “windfall” for companies and individuals alike.

It’s a very interesting choice of words — and one that conveys a deeper message, too.  The Merriam-Webster Dictionary defines “windfall” as “something (such as a tree or fruit) blown down by the wind” or as “an unexpected, unearned, or sudden gain or advantage.” The key underlying concept is that the “windfall” is a lucky gift and an unearned surprise — like an inheritance from your mother’s rich second cousin whom you’d never met.

“Windfall” is a telltale choice of words in this context because tax payments necessarily have been earned by whoever is making them; companies and individuals wouldn’t be paying taxes if they hadn’t sold the products or done the work or made the investments that generated the revenue in the first place.  By calling the proceeds of a tax cut in which individuals and companies pay less a “windfall” for them, you’re really suggesting that the taxpayers aren’t entitled to their own money, the government is — and taxpayers should consider themselves lucky that, for a time at least, they get to keep more of it.

Income earned as the fruit of labor or investment isn’t like fruit blown down from a stranger’s apple tree.  You can argue about whether the tax cut was good economic or social policy, but when taxpayers get to hold on to more of the money they’ve already earned it can’t reasonably be characterized a “windfall” for them.  The fact that so many news articles nevertheless present the issue in that way says a lot about how the news media, at least, views the respective entitlements of taxpayers, and government, to the money taxpayers earn.

A Blunt Instrument

As of January 1, 2018, Seattle has placed a tax — it’s officially called a “sweetened beverage recovery fee” — on sugary sodas and “sports drinks” like Gatorade.  Costco, the big box membership club retailer, has responded by placing signs showing consumers the specific impact of the tax on the Costco price for the product — and it’s a whopper.

video__sugar_tax_sticker_shock_0_10405324_ver1-0_640_360The Costco signs show that the Seattle tax adds $10.34 to a Gatorade 35-bottle variety pack — the kind you might buy if you were responsible for buying refreshments for your kid’s sports team to consume after a practice.  The price of the product was $15.99, but with the new tax the price is now $26.33.  The tax added $7.56 to a 36-can case of Dr. Pepper, bringing the price from $9.99 to $17.55.  Costco also helpfully added signage to explain the tax-related increase to its customers and remind them that they can avoid paying the additional cost simply by going to a nearby Costco located out of the city limits.  Some customers have told local TV stations they plan on doing just that.  There’s also been lots of social media chatter about the Costco signs and the impact of the tax on prices.

What’s the point of the tax?  Seattle evidently is concerned about obesity, which some studies have linked, at least in part, to the consumption of sugary soft drinks.  Seattle hopes that by imposing a substantial tax on soft drinks and “sports drinks,” it will incentivize people to make healthier choices.  But get this:  the tax exempts sweetened products from certified manufacturers with annual worldwide gross revenue of $2 million or less, and products from certified manufacturers with gross revenue of more than $2 million but less than $5 million pay a much smaller tax.  That exemption is a purely political decision that doesn’t make sense as a public health issue, because the size of the producer obviously doesn’t change whatever the impact of the product might be.  Seattle’s approach also focuses only on sweetened drinks, and doesn’t address products like ice cream, candy bars, “snack foods,” or frozen pizza that might also be said to contribute to “unhealthy lifestyles.”  And, of course, it doesn’t begin to address other issues that contribute directly to obesity, such as lack of exercise.

Other cities, like Chicago, have tried soft drink taxes and dumped them in the face of business opposition.  Costco is providing a salutary service by alerting its customers to the specific cost impact of the tax so they can factor it into their decision-making.  The Seattle experiment, as illuminated by the Costco signs, reminds us, yet again, that taxes are a pretty blunt instrument when it comes to trying to change behavior and achieve broader policies — and that taxes are always going to be affected by political considerations, too.

Hang On To Your Wallets

Here’s some news that should cause all taxpaying Americans to feel a cold, hard lump in the pit of their stomachs:  Congress has decided to focus on “tax reform.”

ap17306662049220Congress’ decision to pivot to tax reform has produced all kinds of news stories, most of which have headlines that can only stoke the angst.  What does the proposed tax reform bill means for the value of your home?  What kind of hidden tax brackets might be found deep in the dense language of the proposed bill?  How will small business owners be affected?  What company’s stock price took a dive because the bill proposes repealing a crucial tax break?  All of these stories, and more, can be found simply by running a google search on “republican tax bill.”

The stories are indirectly reflective of the key problem with the federal tax code, because the many different areas of potential concern they address shows just how wide and deep is the reach and impact of our federal tax structure.  Virtually every company, industry, form of property, job, trade, college, technology, and concept is affected by some form of federal tax or federal tax break.  At the founding of the republic, Alexander Hamilton may have devised a simple approach to raising revenue to fund the federal government, but those days are long gone.  Now, the tax code is a complicated morass far beyond the ken of the average citizen, with special rates and breaks and benefits and exclusions and surcharges that only experts and lobbyists understand.

So, given that reality, why should the average citizen be concerned that Congress has decided it’s time to mess around with the tax code?  Because our political class, Republicans and Democrats alike, have shown they are primarily interested in raising lots of money so they can be reelected . . . which means the risk that some special provision written specifically to help a large donor will be inserted in the dead of night simply can’t be ignored.  And with the Dealmaker-In-Chief in the White House, who’s going to really dive into the details of whatever gets passed, trying to make sure that the average citizen doesn’t get gored while the special interests get their perks and sweetheart deals?

Maybe it all will work out, and the tax code will be made more fair and equitable and easy to understand, and we’ll be able to file our tax returns on postcards like the photo op pictures are indicating.  Maybe — but I’ll believe it when I see it.  Until then, I’m hanging on to my wallet.

A Giant Insurance Company With An Army

With Tax Day now behind us, it’s worth looking, again, at where our tax dollars come from and also how our tax dollars are spent.  The Brown Bear helpfully sent me an article reporting on the Taxpayer Receipt prepared by a nonpartisan group called the Committee for a Responsible Federal Budget.  While the original article is behind the Wall Street Journal website paywall, a Fox Business reprint of the article’s text is available on-line.

ss-recipientThe Taxpayer Receipt shows how every $100 in federal taxes was spent in 2016 — and, to give a sense of the trend lines, how that same $100 was spent in 2011, too.  The result supports the conclusion memorably expressed by the line I’ve used as the headline for this piece:  the United States has become a “giant insurance company with an army.”

Why?  Because half of all federal spending goes to Social Security, Medicare, Medicaid, and health programs, and that number is growing, with Social Security spending up 17% since 2011, Medicare up 15.1%, and Medicaid up 25.4%.  Social Security gets by far the biggest piece of the federal spending pie, receiving $23.61 of every $100 in tax dollars.  Medicare places second, with $15.26.

And what about that army?  National defense comes in third, with $15.24 of every $100 in taxes paid.  That amount dropped 22.3% from 2011 to 2016, incidentally.

On the spending side, the lesson from these numbers is clear:  we’ve become an enormous social welfare state, with benefits continuing to expand.  As the percentage increases from 2011 to 2016 indicate, the growing spending on such programs is crowding out our ability to fund other programs, like transportation infrastructure, federal parks, space exploration, and every other federal initiative you can name.  And the increased spending isn’t helping the nagging problem of Social Security solvency, either.  The program is underfunded by at least 20 percent, and under current projections the Social Security Trust Fund (not exactly an accurate moniker) will run out of money in 17 years.

Oh, and here’s another interesting data point — fully $6.25 of every $100 in tax revenue goes to pay interest on the national debt.  That number is growing, too.

On the tax generation side, the individual income tax provided 47% of the $100, with payroll taxes producing 34%, corporate income taxes 9%, and customs duties and excise taxes another 9%.

Now, get back to work!