Tax Cheating: Surviving on Acceptability
Most Americans claim to be honest on their taxes. But it’s never hard to find cheaters:
* “I know a guy whose home is worth well over $250,000, he drives a Maserati, yet he only shows $30,000 a year in salary,” says a Los Angeles accountant. “That’s a lot of crap. That doesn’t even buy his lunch.”
* “Everybody cheats on their returns,” says a Los Angeles attorney, noting friends who routinely stretch deductions. “It’s a standing joke: If you can’t cheat the IRS, then who can you cheat?”
* About 338,000 employers nationwide last year failed to pass on to the government tax money withheld from workers’ paychecks, the Internal Revenue Service estimates. Total tax owed: nearly $3.73 billion, or $11,036 per employer.
* Some 1.1 million individuals were audited by the IRS in fiscal 1987. Total additional tax owed: $5.9 billion, or $5,375 per person.
As April 15 approaches and Americans complete a filing season under the most wrenching tax changes in decades, at least one thing hasn’t changed: Tax cheating is widespread, widely tolerated and, for some, a challenge to be bragged about at cocktail parties like great stock picks or big lottery winnings.
“I think in this country we still have an attitude . . . (that) it’s socially acceptable to cut a corner here and there” on taxes, says IRS Commissioner Lawrence B. Gibbs.
Such cheating is part of a so-called tax gap--what taxpayers owe but don’t pay--that remains stubbornly large, undermining confidence in the nation’s voluntary income tax system, despite showing signs of slowing its growth.
Americans don’t pay nearly $1 out of every $5 in taxes that they owe, resulting in a gap of nearly $85 billion, or about half of the U.S. budget deficit.
How to close the gap and boost revenue has become a focus of intense debate--and finger pointing--among members of Congress, IRS officials and tax policy experts. The debate has gained new importance amid efforts to shrink the budget deficit and worries that the complexity of new tax laws will frustrate the populace into greater cheating.
There is not always a consensus on what to do to shrink the gap. Many tax experts and legislators are urging greater enforcement activities, such as audits. Yet the rate at which taxpayers are audited continues to decline. And some lawmakers, contending that the IRS has abused its powers, are pressing for taxpayer “bill of rights” legislation that would curb the agency’s powers.
Similarly, Congress has boosted penalties levied on recalcitrant taxpayers. But IRS officials complain that the penalties are too burdensome and may trigger a taxpayer backlash. Others contend that higher penalties are unfair given that audit rates are so low--meaning that a smaller proportion of taxpayers are shouldering higher penalties.
Who to Blame?
There also is little consensus on who is to blame. The IRS, which views cutting the gap as a chief goal, nonetheless is criticized for contributing to the problem by making tax forms needlessly complicated and providing inadequate taxpayer services with poorly trained personnel. Respect for the IRS is further undermined, critics say, by such fiascoes as the release last year of a complicated W-4 form, or the IRS center in Fresno misplacing President and Mrs. Reagan’s 1986 tax return by routing it to the wrong department.
On the other hand, Congress--which often views cutting the gap as politically more acceptable than increasing taxes and curbing spending as a means to cut the deficit--nonetheless is blamed for under-funding the IRS while endlessly revising tax laws, making them increasingly complex and difficult to administer. Some tax provisions, critics say, are extremely difficult to enforce.
“The tax law has been changed almost every year for the last 20 years,” IRS chief Gibbs says. “I don’t think you should be surprised that people are confused about what are their tax obligations.”
Blame also is placed on the federal government’s budget and personnel policies that, when applied to the IRS, limit its ability to hire qualified and trained personnel, critics say.
Even honest taxpayers take their share of blame. “In the current moral climate of tax compliance, those who disapprove of tax cheating are often reluctant to say ‘that’s wrong’ to others they know are cheating,” contends a 1987 report by the American Bar Assn. Commission on Taxpayer Compliance. The report, among other things, called for a publicity campaign to encourage people to refuse to cooperate with tax cheating by others.
IRS Says Growth Slowing
To be sure, only part of the tax gap derives from cheating or from so-called tax protesters who refuse to pay any taxes. Some of the gap is due to honest errors, such as misunderstanding the tax laws, or to taxpayer negligence. Some of it is due to taxpayers who are financially unable to pay.
Some of it represents small sums owed by large numbers of taxpayers. These and other taxes can be collected “only through an invasion of privacy and a severity of enforcement not tolerable in this country,” concludes a 1987 report by a task force chaired by Rep. Byron L. Dorgan (D-N.D.), which examined the tax gap.
Nonetheless, amid the heightened debate and frustration, the IRS contends that the growth in cheating may have started to slow.
The IRS released a study last month showing that the tax gap for individuals and businesses for 1987 totaled $84.9 billion. While up from $28.8 billion in 1973, the figure was $15 billion less than the agency estimated five years ago that the gap would rise to by 1987.
Furthermore, the IRS said, the percentage of tax owed that was voluntarily paid last year grew to 83.2%, up from 81.1% in 1986 but virtually the same level as in 1973. That compliance rate is expected to continue rising through 1992 but still remain below 85%, IRS Commissioner Gibbs says.
Gibbs attributes the improvement in the compliance rate to tougher penalties and increased computer matching of tax returns with reports such as W-2 wage statements from employers and 1099 interest statements from banks. Also, Gibbs says, lower tax rates and reduced deductions under tax reform have reduced the incentives and costs of cheating.
However, many tax analysts, including Jerome Kurtz, IRS chief during the Carter Administration, caution against reading too much into the tax gap figures, noting that they are estimates based on small samples.
IRS officials acknowledge that they have no truly accurate way to measure taxes owed from those dealing primarily in cash or barter in the so-called underground economy.
Under-reporting of income--especially by businesses dealing largely in cash and by individuals moonlighting on second jobs--is by far the biggest source of non-compliance, topping the three other major sources: failure to file returns, failure to pay established liabilities and overstating of deductions, credits and adjustments.
The difficulty of monitoring cash transactions is a major reason why it is so difficult to close the tax gap much further, experts say. “It’s a very easy job (for small businessmen) to fail to record some sales,” says Stuart Brown, a Los Angeles accountant.
The IRS is currently studying a document-matching and reporting program for business returns that could be used under the same principle that bank 1099 forms are used to check taxpayers’ interest income against their returns.
But such a system won’t easily lend itself to transactions where no checks, computer records or third parties are involved. And businesses often operate on fiscal years instead of calendar years, further complicating reporting since 1099 and other third-party statements are typically filed on a calendar-year basis.
Another difficult challenge involves finding more sources of income to withhold. Further efforts to extend withholding may face considerable resistance.
Such was the case a few years ago, when Congress passed a bill ordering banks and savings institutions to withhold tax from depositors’ interest earnings. So much public criticism ensued that the bill was never enforced and was eventually repealed.
Also difficult would be applying more types of income to reporting requirements. “Can you imagine the screams that would go up if the IRS (required) the reporting of income derived from frequent-flyer programs?” asks M. Bernard Aidinoff, a New York attorney and chairman of the American Bar Assn. panel on tax compliance.
Even the job of improving taxpayer services, which nearly everyone agrees is a worthy task to help taxpayers better comply with tax laws and build respect for the IRS, has proven to be difficult. The IRS began preparing more than a year ago for this year’s tax-filing season by training more personnel, adding telephone lines and extending office hours. IRS telephone advisers and other agency employees were urged to be more courteous by thinking of taxpayers as “customers.”
“The image out there is that we tend to be bureaucratic at times, that at times we are insensitive and uncaring,” IRS chief Gibbs says in explaining the need for better service with a smile.
Yet while the courtesy level of IRS staffers does appear to have improved, wrong answers and long waits on telephone lines still plague the service. For example, a survey by the General Accounting Office, which oversees federal agencies for Congress, showed that IRS telephone advisers gave incorrect answers 39% of the time this year, up from 22% last year. (The IRS says its own survey shows inaccuracies only about 25% of the time this year.)
But wrong answers can be partly blamed on Congress. “The ability of taxpayers to comply with complex revenue laws, and the ability of the IRS to provide guidance to taxpayers, would be improved if those laws remained relatively stable,” says the American Bar Assn. report on compliance.
Wrong answers and other woes also can be partly blamed on low pay and inadequate training of IRS staffers, a problem stemming in part from budgeting and personnel policies throughout the federal government. The IRS, like other agencies, often loses out on attracting top-flight accountants, computer programmers and other professionals, who can make far more money in the private sector--without the public stigma often placed on IRS employees.
“How do you convince people to work for the IRS? There’s a psychological problem as well as a pay problem,” says Jennie S. Stathis, an associate director and head of tax policy analysis at the General Accounting Office.
IRS telephone advisers are paid as little as $13,000 a year, considerably less than many garbage collectors, says Donald C. Alexander, IRS commissioner between 1973 and 1977. “How can someone whose salary is so low as to be eligible for food stamps be expected to answer all the complex questions thrown at taxpayer assistance (employees) during the current (tax return) filing period?” Alexander recently asked a House subcommittee.
Many lawmakers, tax experts and IRS officials agree that giving the agency additional funding on top of recent budget increases would help it improve service and training. Greater funding also would boost the percentage of individual taxpayers who are audited, a ratio that in fact has steadily declined in the past two decades. It hit what is believed to be an all-time low of 1.09% in fiscal 1987, down from 1.12% in the previous year, 2.5% in 1976 and more than 5% in the mid-1960s.
Audit Rate Turning Around
Lower audit rates, many tax experts say, encourage cheating. Increased funding for more audits would produce far more revenue than it would cost, these experts say.
“The people who have an opportunity to cheat use paid tax preparers who are on top of trends in audit rates,” says Louis Wilde, an economist at the California Institute of Technology and expert on tax compliance issues. “Thus, people have learned that audit rates are nowhere near what they used to be.”
Audit rates, however, are expected to begin rising in fiscal 1989 as the IRS trains and absorbs 5,000 additional examiners provided under a budget increase already funded by Congress. Furthermore, thanks in part to improved computer techniques, the IRS is far better at choosing who to audit. The average tax of $5,375 assessed last year from each audit of individual taxpayers is nearly triple the level of 1982.
But just as the audit rate appears to be poised to turn around, some lawmakers and others--including Vice President George Bush--contend that the IRS’ powers should be curbed.
Concerned about horror stories of taxpayers forced into bankruptcy or children’s savings seized through IRS actions and of promotions for IRS personnel being based on property seizures and funds collected, support is growing for legislation to set up a taxpayer bill of rights.
Sen. David Pryor (D-Ark.), chairman of a Senate Finance subcommittee overseeing the IRS and sponsor of one taxpayer rights bill, says the agency has a “bounty hunter mentality.”
“We have in the IRS an agency that simply has too much power,” says Sen. Carl Levin (D-Mich.), who has been pushing for taxpayer rights legislation since 1980.
Last month, the Senate Finance Committee approved a version of a taxpayer rights bill that would make it illegal for the agency to use property seizures and revenue collections as a basis for promoting employees. Also, overzealous agents would face more severe punishments and taxpayers would have their rights read to them when called in for questioning and an audit.
As would be expected, Gibbs and other IRS officials vigorously oppose such legislation.
Ultimately, Gibbs and other experts say, closing the tax gap may require a basic change of attitude among taxpayers in much the same way that Americans now consider drunken driving unacceptable. That could take years, however.
Taxpayer surveys have shown that Americans are schizophrenic about tax enforcement, wanting others to pay their fair share but showing less enthusiasm for more auditors to catch cheats.
“It does not matter how effective and cooperative the (IRS) becomes if Americans view tax cheating as acceptable behavior and remain unwilling to make the efforts necessary to achieve compliance,” the American Bar Assn. report concludes.
“We’ve got to get back to the point where people feel an obligation not to cheat,” attorney Aidinoff says.
