C Gopinath

Twiddling with the tax screws

C Gopinath | Updated on May 23, 2021

The US’ approach to boost tax compliance may not work

President Biden presented a wish-list economic plan to Congress (i.e., US parliament) that aims to spend $1.8 trillion on education, childcare, and family leave. He also has a $1.9 trillion plan for Covid-relief programmes and a $2.3 trillion plan for improving infrastructure that would cover bridges, roads, broadband infrastructure, and so on.

Taken together, this is a mega-intervention in the economy that if executed would be as significant as Roosevelt’s New Deal in the early 1930s. That’s a big ‘if’.

The president’s ideas are diametrically opposite to what the Republicans believe in and so negotiations and horse-trading have begun. It is perhaps good that the two parties are almost evenly divided in the two houses for they will come to a more broadly acceptable plan.

Biden aims to partly pay for his proposals by increasing the income tax and capital gains tax rates that would apply to the top brackets, and by auditing and collecting more taxes too. He has certainly reinforced the classic epithet about Democrats being a ‘tax-and-spend’ party.

Will rankle Republicans

Increasing tax would particularly rankle Republican beliefs about big government and bureaucracy. Over 10 years, the president wants to spend $80 billion on the Internal Revenue Service (IRS), the tax collection agency, to hire more employees such as auditors, upgrade software, require third-parties to report more information about dues, and so on.

The administration believes this will result in an increase in tax revenue of $700 billion by plugging loopholes, chasing tax evaders, and fighting court cases. More conservative estimates, including that from the independent Congressional Budget Office indicate much less revenue.

Aside from considerations about the investment and returns of the working of these agencies, we must reflect on what happens with such significant strengthening of a tax collection bureaucracy. Although the president’s intent is to encourage IRS enforcement against the wealthy who aggressively avoid the tax laws, they usually spread the net wide and end up harassing those who wish to comply, rather than snare the crooked. This goes to the issue of trust in systems.

Most post-colonial economies suffer from this syndrome. While colonial powers enforced strict rules to keep the natives in check, ironically, post-colonial independent governments continue with those systems which are based on a lack of trust.

A case at hand is the Foreign Account Tax Compliance Act (Fatca) passed in 2010 which required foreign banks to report assets held by Americans in their countries. The objective was to track down the small number of wealthy who keep their money outside the reach of the IRS.

Securing compliance

Research studies show very weak effects on tax compliance by such measures. There are ways of securing the compliance of the small number of high net worth individuals and reducing challenges and litigation from them, without throwing the net wide.

In India, after Fatca, many banks decided that they did not want to get into the record keeping and scrutinising clients to be Fatca compliant and asked their American clients to close their accounts. It was a part of former President Trump’s campaign platform to eliminate Fatca, which he did not get to.

Only the very rich have off-shore accounts. Surely, asking everyone with foreign bank accounts exceeding $10,000 to file a form is not aimed at snaring the very rich. Information exchange agreements with other countries would have been a sharper tool to catch those suspected of wealth sheltering.

Providing an IRS with more money and employees will result in more forms and policies making it an even more unpopular agency with little increase in tax collections.

The US tax code is already the most convoluted in the world, running into 6,550 pages. Simplifying it would generate more revenue by reducing the incentive to evade and improve the health of the citizens by reducing one major cause for raising blood pressure.

The writer is an emeritus professor at Suffolk University, Boston

Published on May 23, 2021

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