The writer is an investor and author
President Joe Biden needs to raise tax revenues to help pay for his “build back better” plan to revive the US economy after the pandemic. Increasing revenues by raising tax rates requires congressional action, which is possible but far from certain. There is an easier way to get the necessary revenue, however: increasing compliance with laws already on the books.
This latter path, which is manifestly fairer to those who already pay what they owe, has been mapped out by Charles Rossotti, former head of the Internal Revenue Service. It balances pressing national needs with fairness and the art of the possible. The Biden administration and Congress should take it seriously.
The Rossotti plan would produce a significant increase in tax revenue by reducing non-compliance by those with incomes from partnerships and partnership-like S corporations. These businesses do not pay tax directly but pass the income on to their owners.
Only half the top quartile of earners report all their income. In recent decades, the wealthy have derived an increasing portion of their income from partnerships, S corporations and other “pass-through” entities. This “low visibility” income is easy to hide from the IRS, and it is the largest portion of the “tax gap”: taxes owed but not paid.
America’s tax gap is enormous: $574bn in 2019 alone. That is a conservative estimate, and it is only getting bigger. In the past 10 years it has doubled in size and over the next 10 years the tax gap will be nearly $7tn.
If even a modest fraction of this unreported income, say 20 per cent, was collected, over 10 years, it would just about equal Biden’s plans to increase revenues through higher tax rates.
Meanwhile, the IRS is a shadow of its former self. Over the past 25 years, the number of its agents (and examinations) has declined by 30 per cent, or 30,000 agents. This is in stark contrast to the increase in the IRS’s workload: tax returns are up nearly 30 per cent over the same period, and the number of returns from pass-through corporations and partnerships are up by nearly 80 per cent.
One might think IRS staff reductions are offset by big investments in information technology. But this is not the case. By comparison, large commercial banks invest 15 times as much each year in IT as does the IRS, which has to gather and manage far larger quantities of complex information.
Simply put, the IRS is understaffed, overwhelmed and outgunned.
The federal budget, meanwhile, is a disaster. Annual outlays outstrip revenue by the trillions — exacerbated by Covid-related spending, certainly — but there is no end in sight to the torrent of red ink. And the US national debt now exceeds gross domestic product. This is not prudent governance, fair tax policy or sustainable budgeting.
The Rossotti plan is attracting increasing interest among serious observers of the tax system and public finances because it is modest, fair and practical.
Focusing on three areas — information, technology and resources — if implemented the plan would collect $1.4tn in taxes owed but not paid over 10 years. First, collecting more information about the income of taxpayers in the top quartile of income would result in taxpayers filing more accurate returns and allow the IRS to better identify those who do not.
Second, IRS technology should be upgraded to make full use of all the information it has, improving the efficiency and speed of the compliance process. And third, expanding and reforming the IRS audit process would make it better targeted and more efficient. It would also be faster and easier for taxpayers to deal with.
The pay-off on the proposed investment in people and technology is huge: at least 20 times the cost. I am an investor, and that rate of return appeals to me. I am also a conscientious taxpayer and believe it is high time that those who fail to pay what they legally owe are held accountable. The essence of a democracy is that we all pay our fair share.
Central to Biden’s conception of democratic governance is the recognition that, whether seeking accords on climate change or increasing social justice, we are all in this together.
By obliging non-payers to fulfil their lawful responsibilities, Biden would have a triple win. First, he would have no need to struggle with a divided Congress to change tax levels or rates. Second, he would collect a large proportion of the money needed to support his major reform programmes. And third, he would be able to remind voters that his administration takes seriously what most Americans want most to see in government: fair play.