If there was any doubt that our tax system is broken, ProPublica put an end to it by publishing a trove of data about the 25 richest Americans, showing just how little the likes of Jeff Bezos, Elon Musk, and Michael Bloomberg actually pay even as their fortunes have swelled.
I was an IRS supervisor for many years and the news did not surprise me, though I felt a profound sense of disappointment that certain in-house secrets are now public and that so many hardworking IRS employees will be stained by the perception that they are part of a rigged system. But we live in a world where someone must be scapegoated when severe wrongs can no longer be hidden in the basement cupboards. Where should we point the finger?
For decades, IRS management has proclaimed that the American tax system is the finest in the world—a model from which many countries could learn. They can no longer do so. Such proclamations belong in the circular file right next to “Give unto Caesar what is Caesar’s.”
While the IRS has long maintained that taxpayers voluntarily comply with the tax laws because not doing so might bring the dreaded audit or even a criminal investigation should they intentionally evade their tax responsibility, voluntary compliance with the tax code, the bedrock of our tax system, has been slipping for some time as the so-called tax gap between what is owed and what is actually collected has grown.
A system based on deterrence or the threat of punishment breaks down when the wealthiest aren’t deterred, recalling Leona Helmsley’s famous boast: “We don’t pay taxes; only the little people pay taxes.”
Years ago I took a taxi from O’Hare to my residence in Chicagoland, and my driver was a recent immigrant from Afghanistan who possessed a bright and lively mind. He wanted to know all about what I did for a living. It was to be a long ride out to the suburbs, and I found myself straining to explain the American tax enforcement system to Ali. He told me that during a recent library visit he came across volumes of text that made up the Internal Revenue Code. He couldn’t believe how voluble and complex our tax code was and wanted to know just how that could be.
I took a long whiff of the sweet incense permeating that cab and started to bloviate on the single largest provision of the tax code at the time—the oil depletion allowance. Ali cut me off and said it was just like his country, with special provisions for special interests and privileged people.
Ali smiled and proceeded to ask why rich people seem to get away without paying their fair share of taxes while hardworking folks like himself are so closely scrutinized. I responded that such inequity is a matter of how the tax laws are enforced and how they are made.
The enforcement problem comes down to return on investment of resources. Each year IRS management would strategize about how to reduce the tax gap and increase compliance with the law with the resources at hand. And each year it seemed like there were fewer resources available even as more responsibilities—identity theft, PPP, cryptocurrency, and on on—were heaped upon the sagging system. The IRS service centers, the nerve center of enforcements, still contain computers and program language from the ’50s. Parts literally could not be found.
The enforcement solution management settled on year after year was to go after the low-hanging fruit. Pick on the tip income of waiters and bartenders in no position to push back. Examine firefighters’ and teachers’ second jobs to ensure they were reporting the income they needed to pay their monthly bills. Now and then a small brigade would be put together to go after a Helmsley or a Studio 54 and make a splash. But rich folks have lawyers and accountants and financial consultants located offshore who interact with bankers in tax havens like the British Virgin Islands and Switzerland. We all know the drill.
Warren Buffett and Carl Icahn would rather pay expensive tax consultants huge fees in lieu of paying their fair share to Uncle Sam. And IRS enforcement has remained essentially powerless to combat the armies of experts, offshore and on, who get paid so handsomely to facilitate complex tax strategies that explore the nuances of the tax code and push to the limits of the law and beyond for their wealthy benefactors.
Consider Caterpillar. The farming manufacturer behemoth booked a bunch of its billions in income to a dinky little subsidiary in Switzerland and repatriated the billions in a shady way that allowed it to escape paying taxes. When caught, Caterpillar got a slap on the hand via a Deferred Prosecution Agreement (DPA) from the Department of Justice under Bill Barr. Robert Mercer’s hedge fund RenTech purchased something called “basket options” from Deutsche Bank, which was selling this tax shelter despite a previous do-not-prosecute agreement constraining such transactions. RenTech applied these contrivances, converting millions of buy/sell transactions conducted in nanoseconds to magically transform the transactions into long-term capital gains and save billions in the process. So far it’s worked, as Mercer has hired a past IRS commissioner and past IRS chief counsel to argue his case in tax court. Does anyone dispute that the IRS was outgunned here?
While the above examples illustrate internal enforcement issues, some would say the root of the tax enforcement problem is the way tax law is made. Voluntary compliance is simple when a working stiff gets a W-2 containing taxes withheld by the employer. It breaks down when the wealthy drive down avenues of avoidance involving carried interest, accelerated depreciation, and former President Donald Trump’s personal favorite, net operating loss carryforward, where one year’s losses can be set against future years’ profits.
When an IRS auditor confronts such elaborate avoidance strategies, they often tap out and cry no más. There’s not much else we can do when the law is constructed specifically for an industry or a situation. The committees in Congress that are responsible for writing the tax law, such as Ways and Means, are among the most desirable ones for a reason and thus the largest. Everyone wants a seat at a table where wealthy contributors can offer a quid of campaign contributions in exchange for the exponentially larger quo of working specialized tax treatment into the code itself.
That special treatment for the wealthy is not the fault of dedicated IRS employees. Ali is right: Special interests get special treatment by the government in almost every country. But it wasn’t always that way here, and it doesn’t need to be that way. If Trump, who boasted about his own avoidance strategies, had an ounce of conscience, he would have reviewed the situation that he has so benefited from and declared that the burgeoning tax gap favoring the rich is just sad!
Only by directing substantial increase in resources to the IRS will basic tax enforcement begin to redress the current sad situation and make the needed repairs. Changing the way the tax law is made will require a political sea change that would even make Ali smile because it would mean that special interests would not be treated in a special way by the government.
Oliver Wendell Holmes famously stated that taxes are the price we pay for a civilized society. The voters can see to that if they have a mind to.