A Stitch in Haste

Tomorrow is the deadline for cheating on your tax returns contributing to the "tax gap."

The "tax gap," to review, is the euphemism for the fact that individuals under-report their income, overstate their deductions and exemptions, or both. There has been much recent grumbling, mostly by Democrats, about the "tax gap." As I demonstrated in a previous post, this is actually somewhat counterintuitive, since the "tax gap" is mostly attributable to blue-collar, low-skilled and unskilled workers (and small businesses), and not to the "rich," or to "greedy" corporations (such as Hillary Clinton's favorite "undertaxed" entity — Big Oil).

A major article in today's Washington Post reinforces this empirical truth:

Judging from his tax returns, Dinh Kim Huynh wasn't getting rich in the manicure business. In 2000, Huynh and his wife claimed taxable income of just $7,578 from their two nail salons in Southern Maryland — so little that they qualified for a tax credit for the working poor. Their tax bill was $195.

But like millions of American business owners who trade primarily in cash, Huynh was not altogether honest with the Internal Revenue Service. When IRS agents poked around, they discovered four cars in Huynh's name, including a $77,000 Mercedes; receipts for diamonds and Rolexes in a closet at his Waldorf home; and a videotape of Huynh flashing a five-carat ring during the purchase of yet another vehicle at a local Honda dealership, court records show.
...
In 1985, taxpayers were told to name dependents on whom they wanted to claim deductions and list their Social Security numbers. "Lo and behold, we lost five million-plus children who never existed," said Donald C. Alexander, IRS commissioner at the time.

Neither Microsoft nor Berkshire Hathaway can significantly under-report their income — that was true even before Sarbanes-Oxley. And I seriously doubt that Bill Gates or Warren Buffett ever considered listing phantom children on their tax returns. These are the shenanigans of the middle class, the working poor, and the small business owner. People whom the Democrats claim to champion — when they're not siccing the IRS on them.

It's quite simple, really: Keep taxes low, and the "tax gap" will take care of itself. Remove the incentive to cheat, and the cheating will stop.

In Part One I noted that Democrats in Congress are calling for greater effort by the IRS to close the "tax gap," a euphemism for people and businesses under-reporting their income and overstating their deductions and exemptions.

But what, exactly, does "greater effort" mean?

Middle-class Americans, listen up: the I.R.S. is much more likely to audit you this year. Those caught cheating can expect to pay about $4,100 more on average in income taxes.

Since 2000, authorities at the Internal Revenue Service have nearly tripled audits of tax returns filed by people making $25,000 to $100,000 as part of a broad change in audit strategy.
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For taxpayers with incomes above $100,000 the odds of being audited in 2006 were 1 in 59; above $1 million, the odds increased to 1 in 16. People in lower income brackets -- those reporting incomes below $25,000 -- faced a 1 in 94 chance of being audited.

But this is, of course, pretty much how it should be. Most tax cheating occurs among the middle class, the working poor, and small business owners. Generally speaking, the rich can't easily cheat on their taxes (too much mandatory disclosure), and the very poor have no income to hide in the first place. It's the cash-based, off-the-books blue-collar and unskilled workers who can -- and do -- under-report their income. It's the nail salon owners, not Exxon, who can under-report their cash-based revenue, and it's the retired police officer who can claim a phantom $250 in charitable donations.

Meanwhile, what exactly does a visit from the IRS entail?

When IRS agents poked around, they discovered four cars in Huynh's name, including a $77,000 Mercedes; receipts for diamonds and Rolexes in a closet at his Waldorf home; and a videotape of Huynh flashing a five-carat ring during the purchase of yet another vehicle at a local Honda dealership, court records show.

"Poked around"? That's a worse euphemism than "tax gap."

Although IRS audits are often simple and even unobtrusive, they can also be government at its most nightmarish. The federal government has recently unleashed the IRS upon the Internet (in more ways than one). The IRS can and does seek warrants for any and every kind of record, financial or otherwise. They can easily intrude upon a business or farm -- or even a private residence. All in the name of "closing the tax gap."

And as Congress, the President or both grow ever more shrill in their demand that the "tax gap" be closed, the IRS will inevitably become ever more intrusive and more draconian in their tactics. It's axiomatic.

Wouldn't the better alternative simply be to shrink the size of government, and with it the tax burden, the "tax gap" and the need for ever more intrusive tax surveillance?

It's quite simple, really: Keep taxes low, and the perceived need for a new audit mania will evaporate.

One last thought today on income taxes -- a reiteration actually.

I have repeatedly noted on this blog that the federal income is steeply progressive, despite the protestation of radical liberals that "the rich don't pay their fair share." Indeed -- only the rich(er) pay income tax at all -- the lower 50% of households have no net federal income tax burden. How much more progressive than "some pay all while others pay none" can a tax system be?

Which is not to say, of course, that the lower middle class and working poor don't pay taxes -- they of course pay, directly or indirectly, sales taxes, property taxes, a whole gaggle of taxes. Point conceded.

And, more importantly, they also pay the other federal tax -- Social Security tax (and Medicare tax).

Here is the latest information on comparative federal taxes from the Urban Institute -- and important information it is:

About two-thirds of taxpayers owed more payroll taxes (including the employer portion) than individual income taxes in 2006. Many households (including most retirees) do not have any wage income and thus pay no payroll tax. Among households with wage earners, 86 percent have higher payroll taxes than income taxes, including almost all of those with incomes less than $40,000 and 94 percent of those with incomes less than $100,000. If only the employee portion of payroll taxes is considered, 44 percent of taxpayers and 56 percent of wage earners pay more payroll tax than income tax, including nearly 80 percent of earners with incomes less than $50,000.

So again, it's not about "tax cuts for the rich" -- you can only cut income taxes for those who actually pay income taxes in the first place. All else on that front is sophistry.

No, if you truly care about the middle class and the working poor -- which Democrats incessantly insist they do -- then your efforts should be on reforming Social Security and returning to them some portion of that obscene, crippling 15.3% tax under which they are being crushed.

Think any Democrats -- especially Clinton, Obama, Edwards, Richardson, Biden et al -- will see these data and suddenly call for reviving discussions on any aspect of Social Security reform, let alone voluntary partial privatization?

Me neither.

More thoughts at Tax Policy Blog.