More data from banks can fight tax evasion

A man walks past the U.S. Capitol in Washington on June 25, 2020.

Al Drago | Reuters

The head of the IRS believes that stricter disclosures by the country’s banks could help fill a yawning tax gap and recoup billions in owed revenue.

In a letter viewed by CNBC, IRS Commissioner Charles Rettig told Senator Elizabeth Warren, D-Mass. That relying on banks to report basic information about their customers’ deposits and withdrawals could seriously affect annual tax evasion.

The IRS chief told Warren on Friday that after years of budget cuts, the agency was unable to prosecute those who fail to pay their fair share of federal taxes.

“Every measure that is important for effective tax administration has suffered massively,” wrote Rettig, referring to years of budget cuts.

President Joe Biden’s American Families Plan and the bipartisan infrastructure deal would “generate significant amounts of new data on financial transactions,” said Rettig, a holdover from the Trump administration. “The new data will give the IRS insight into otherwise opaque sources of income with historically lower reporting accuracy.”

In particular, Rettig has touted a provision in the American Families Plan that aims to reduce the tax gap by requiring banks to report on their customers’ withdrawals and deposits rather than relying on taxpayers themselves. The tax gap is the difference between taxes paid and taxes owed by law.

Rettig noted that for every 1% improvement in tax compliance, annual federal revenue is expected to grow by about $ 30 billion per year. Overall tax compliance – defined as voluntary, accurate, and punctual – is estimated by the IRS at 82% to 84%.

Sens. Bernie Sanders, I-Vt., And Sheldon Whitehouse, DR.I., joined Warren last month in calling on the IRS and its commissioner to provide a detailed report on how better enforcement could help the federal government Generate billions in taxes owed.

“This new information from the IRS makes it clear that wealthy tax evaders and large corporations can still avoid paying their fair share of billions of dollars a year if we don’t significantly increase IRS funding while everyone else suffers,” said Warren said of Rettig’s reply letter. “Because of this, the Congress leadership needs to add significant, multi-year funding to the budget reconciliation package for the IRS to drive enforcement and generate billions of dollars in revenue each year.”

The IRS analysis “makes it clear that we need new reporting requirements to improve tax compliance for the richest Americans and ease the burden on honest taxpayers,” she added.

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At the center of Rettig’s argument is a simple behavioral problem: Few people like to pay income taxes.

That statement is probably even more relevant for Americans with an annual income greater than $ 1 million. These high income earners must pay a larger percentage of their income to the IRS and therefore have a greater incentive to find ways to bypass the tax officer.

The banking industry, which would shoulder the burden of providing more data to the US government, protested the provision in May.

In their spring letter, the American Bankers Association, the Bank Policy Institute, the Consumer Bankers Association, and others argued that the “new reporting requirements for financial institutions would add costs and complexity that are not justified by the potential and highly uncertain benefits. “

“Additionally,” added the trading groups, “we believe that additional reporting requirements driven by subjective criteria have implications for privacy and fairness and have the potential to place financial institutions in an untenable position with their account holders.”

The collective suggested that financial institutions’ reporting was “already robust” and that allocating more funding to audits would be a more efficient and fairer approach.

Making matters worse for the ailing IRS is the fact that wealthy earners have access to a variety of ways to hide the true value of their income or otherwise obtain more complicated tax returns. An entrepreneur’s tax return, for example, is far more complicated than that of an employee whose hourly or annual salary can be verified through third-party reports.

While the specific disclosure requirements would ultimately be worked out by the Treasury Department, they could inform the IRS of the size and frequency of deposits and withdrawals from these accounts.

On the flip side, more thorough communication between U.S. banks and the IRS could alleviate the problem if the tax gap is caused by human error – honest or deliberate -.

Currently, anyone who earns $ 10 or more in interest from an account with a US bank, brokerage firm, or mutual fund is required by law to report such earnings to the IRS. This document is known as Form 1099-INT.

If banks themselves are forced to provide the IRS with information about their customers’ deposits and withdrawals, these customers are more likely to correctly fill out their returns. And if not, the IRS would now be armed with information to prosecute those who are not being honest.

That, says Rettig, could be of great benefit to the customs officer.

“Taxpayers are more likely to be compliant with the law knowing that the IRS has the information they need to prosecute them if they fail to meet their tax obligations,” the IRS chief told Warren. “Our research shows that compliance is only 45 percent when income is subject to little or no information reporting or tax withholding. When extensive information is reported, compliance increases to over 95 percent. “

Using banks to crack down on unreported revenue would likely be just one step to fill the void. Simply knowing how much money is in an account doesn’t necessarily warn the IRS about unreported earnings. Individuals can receive non-taxable gifts or spend on deductible business expenses that the tax collector would need to consider.

Nonetheless, the benefits of continuing the provision could offset the hurdles.

This fact has not escaped the notice of some of the most respected economic authorities in the country. Former Treasury Secretary Tim Geithner, Jacob Lew, Henry Paulson Jr., Robert Rubin and Lawrence Summers all defended President Joe Biden’s efforts in a recent New York Times commentary.

“It is a sensible way to rely on financial institutions to provide some basic information about account holders,” they wrote in June after the White House released the American Families Plan. “With better information to the IRS, voluntary deterrence compliance will increase as potential tax evaders recognize that there is a risk of tax evasion.”

The IRS’s letter also noted that the richest taxpayers are also most likely to have accounts with international banks that may not give U.S. regulators regular access or adhere to the same standards.

“Increased technology funding is essential to link overseas assets to their beneficial owners and to uncover potential non-compliance,” wrote Rettig. Additional resources will enable the IRS to “build analytical systems that use information reporting to identify unreported earnings and when account holders or foreign financial institutions may be engaged in non-compliant or fraudulent behavior”.

Rettig advocated additional funding and reiterated the need to modernize IRS technology not only to counter “increasingly sophisticated cybersecurity attacks,” but also to speed the agency up, reduce errors, and keep operations going all day instead of itself to rely on the availability of staff.

The years of budget and staff cutbacks have left the IRS with roughly 74,000 full-time employees, a level not seen since 1973. But the challenges that the agency faced, especially in the last 16 months, have only grown, said Rettig.

There maybe no better way to document demand for IRS services than by counting the number of customer service calls. In 2021 alone, the IRS received over 199 million calls, about 400% more than the agency receives in an average calendar year.

The agency has answered nearly 50 million of these calls between live “assistants” and automated providers. According to Rettig’s letter, the IRS received 42 million calls in 2018, 40 million calls in 2019, and 55 million calls in 2020.

Overall, such fixes could generate hundreds of billions of billions in owed revenue over time.

The Treasury Department’s own analysis shows that efforts to close the tax gap will generate $ 700 billion in additional tax revenue in the first 10 years of budget relief and an additional $ 1.6 trillion over the second decade.

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