© 1974, The Philadelphia Inquirer
The Internal Revenue Service, long considered a world model for efficient tax collection, annually fails to collect billions and billions of dollars in taxes owed the government.
And if everything goes as it has the last few years, tens of thousands of individuals and businesses will have filed erroneous or fraudulent tax returns by midnight Monday, depriving the government of more money than at any time in history. Very few will be caught.
Additionally, the IRS is concentrating its enforcement efforts among low- and middle-income wage earners, instead of upper-income individuals and large corporations where taxpayer error is most likely to be found.
This is not a new situation. While President Nixon's tax problems have aroused fears that Americans will either cheat or look for questionable deductions this year, the fact is that the nation's tax-collecting system has been in trouble for years.
Income tax cheating and avoidance, long popular pastimes in some European countries but never considered much of a problem in the United States, have become very big problems – although ones kept carefully quiet by Federal officials.
Kept just as quiet has been the spotty enforcement of the tax laws by the IRS. Indeed, this situation has reached the point that the additional tax levied against similar taxpayers after an audit will vary wildly from one section of the country to another.
These are but a few of the findings to emerge from a nationwide investigation conducted by The Inquirer into the administration of the Federal income tax laws – a probe that was started in May 1973 and reached from New York to Los Angeles, Chicago to Miami.
While IRS officials publically maintain that all is well with the country's voluntary tax-assessment system – "we think the taxpayers are cooperating very well this year with their responsibilities," says Commissioner Donald C. Alexander – the Inquirer investigation produced some sharply conflicting findings.
ITEM. In the last several years, the amount of tax revenue lost through error and fraud has reached staggering proportions. (Taxpayer error is any kind of unintentional mistake from incorrect addition to improper deductions while fraud involves a deliberate intent on the part of the taxpayer to evade payment of taxes he lawfully owes.) As one former top IRS official puts it: "They (IRS) are losing their pants."
EXAMPLE. Inquirer projections based on a secret IRS study of tax returns show that the agency failed to collect an estimated $23 billion that was owed by individual taxpayers in 1971. Over the last two years, the amount uncollected has totaled an estimated $49 billion. And it is growing each year.
ITEM. As individual income increases, so does the likelihood that the taxpayer will file an incorrect return. In turn, persons with higher income avoid paying larger amounts of taxes they owe than persons in low- or middle-income groups.
EXAMPLE. That same secret IRS study indicates that in 1971, taxpayers with an income under $10,000, who itemized their deductions, owed on the average an additional $178 after they were audited. By contrast, for taxpayers with an income over $50,000, the average sum owed was $8,631. Of all the returns examined in the under-$10,000 income category, 49 percent contained errors. Of all the returns examined in the $50,000-and-over income class, 82 percent contained errors.
ITEM. The IRS seemingly has a dual set of standards for enforcing the tax laws, dealing swiftly and often harshly with low- and middle-income taxpayers, while moving leisurely and leniently against upper-income and corporate taxpayers.
EXAMPLE. In Reno, Nev., the IRS attached the bank account of an ailing real estate saleswoman, who was recovering from a heart attack, taking the proceeds of her disability checks. The agency said she owed $3,200.04 for the years 1968-1970. Less than five months after filing a lien, IRS collected its money.
In New York City, the IRS wrong off as uncollectible the $375,129.12 owed by the company of a Wall Street stockbroker who managed to maintain homes in Manhattan and Florida. A personal lien against the stockbroker for $112,382.73, filed Nov. 5, 1970, remains outstanding.
ITEM. After an IRS agent conducts an audit and recommends payment of additional taxes, upper-income individuals and corporations receive yet another break. As a general rule, the more an IRS agent says you owe, the smaller the percentage you ultimately will have to pay if you appeal within the agency.
EXAMPLE. In 1972, taxpayers found to owe from $1 to $999 in additional taxes eventually were required, after administrative appeal, to pay 67 percent of the agent's recommendation. Taxpayers found to owe from $50,000 to $99,999 had to pay 44 percent. And taxpayers said to owe more than $1 million had to pay 34 percent.
ITEM. There is very little consistency in IRS audit and collection procedures around the country, whether the taxpayer happens to be a corporation or an individual.
EXAMPLE. In fiscal year 1973, corporations that appealed the additional tax recommendations of agents in the Philadelphia district office of IRS, finally paid 71 percent of the original amount proposed. In Boston, it was 51 percent; Newark, 47 percent; Miami and Los Angeles, 34 percent; Detroit, 28 percent, and Chicago, 22 percent. Over the last three fiscal years, the average chance for an audit of an individual taxpayer's return in Delaware was 1 in 26. In Massachusetts, it was 1 in 62. In Colorado, 1 in 82. The average amount assessed after an individual audit was $326 in New Hampshire, $815 in Louisiana and $1,264 in Florida.
ITEM. IRS generally has failed to concentrate its audit manpower where fraud and especially substantial error are most likely to be found – on the complex individual and corporate returns. Instead, the agency has spent proportionately more time on the tax returns of low- and middle-income age earners.
EXAMPLE. In conducting field audits during fiscal year 1973, IRS agents averaged 1.35 hours for each return examined from an individual with income under $10,000, who itemized deductions. At the same time, agents averaged just 19.5 hours for each return examined from an individual with an income over $50,000.
None of this is to suggest that the IRS alone is responsible for the break-down in the nation's tax-collecting and enforcement machinery. In fact, much of that responsibility rests squarely with Congress and the President.
There are two reasons: First is the incredible complexity of the IRS Code and regulations, and the failure of Congress or the executive branch to substantially increase the agency's auditing manpower.
Second is that it is up to both Congress and the executive branch to determine exactly how much taxpayer fraud and error will be tolerated.
Each year, when the Federal budget is drafted, the amount to be spent is tied to the projected income from all tax collections with the IRS advising the executive branch of how much tax revenue the agency expects to collect – rather than how much is should collect.
Know Where to Look
In the past, whenever additional revenue has been needed, both Congress and the President have urged higher taxes, rather than collecting unpaid taxes already on the books.
Interestingly, the IRS has a pretty good idea where to look for those unpaid taxes.
For the last 10 years, the agency has been conducting secret studies, using computers and a specially designed Taxpayer Compliance Measurement Program (TCMP), to assess compliance with the tax laws.
While the agency has refused to make public the results of the studies, the Inquirer has obtained computer printouts relating to the most recent survey. These figures indicate that in 1971, individuals paid about 83 percent of the taxes that the IRS said they owed.
In other words, the IRS failed to collect 17 percent of the tax money owed – or about $23 billion.
Under the compliance survey, tax returns are pulled from a variety of categories – such as persons earning less than $10,000 or more than $50,000, and certain kinds of businesses – and then subjected to a thorough audit.
On the basis of the audit results, the IRS can detect patterns of error within a broad range of taxpayer categories, and come up with working estimates of the amount of money lost through noncompliance.
Why So Secretive?
Compliance is measured as a percentage of the tax reported on returns against the tax owed. Thus, a 98 percent compliance level means that the government is collecting 98 percent of the tax money truly owed.
In an interview with the Inquirer reporters, Albert Y. Sze, who last year served as acting director of the planning and analysis division of the IRS, the office in charge of making the compliance surveys, was asked why the agency insisted on keeping the compliance data secret.
He offered this explanation: "It is difficult for me to say. It is the problem of impact on voluntary compliance. If one group knows that another group is not complying, they will say, 'Why should we?' The executive branch does not want to take this risk."
What Sze means is this: If taxpayers with an annual income under $10,000, for example, find out they are paying a higher percentage of the tax they owe than persons earning more than $50,000, there might be problems.
Pressed further about which taxpayer categories were posting the lowest compliance rates, Sze said: "I'm sorry, I cannot reveal that to you. But as a matter of common sense, the more complex returns mean more errors."
The IRS computer printouts obtained by The Inquirer and relating to the most recent compliance study – based on an audit of 1971 tax returns – confirm what Sze was fearful of saying publicly: The higher the income bracket, the larger the amount of tax that goes unpaid.
The data indicate that in 1971 taxpayers with an income under $10,000, who itemized deductions, failed to pay a total of $1.8 billion.
At the same time, persons who were earning more than $30,000 a year, and had income from a small business or profession – such as lawyers, doctors or accountants – failed to pay $8.6 billion.
The total unpaid for all income categories was a projected $23 billion. But that does not include tax money lost as a result of error and fraud by corporations. And for the most part, serious, in-depth audits of multinational corporations and certain other large businesses are nonexistent.
The IRS has neither the manpower nor, in many cases, the expertise to audit most of the complex business and corporate returns.
Johnnie M. Walters, the former IRS commissioner, conceded in testifying last spring before a subcommittee of the House Committee of Appropriations, that "a corporation that plans its affairs, and has a whole corps of people working on it all year long, can handle its affairs in a way that we are not apt to pick up, in audit, easily."
An Awesome Sum
Interestingly, taxpayers in the under $10,000 category pay a total of 20 percent of the nation's personal income tax, but they account for only 8 percent of the unpaid $23 billion.
The $23 billion figure does not include lost revenue in other Federal tax-collection area, such as excise and alcohol and tobacco taxes. Thus the total tax revenue lost would be many billions higher.
If just part of that money was collected – keeping in mind that the figure is growing each year – Congress could implement a substantial across-the-board tax-rate cut for every taxpayer.
Former IRS officials, in interviews with Inquirer reports over the last several months, say there has been a serious dropoff in taxpayer compliance.
The first compliance study was made in the early 1960s – a survey is conducted every two or three years – and it showed a compliance level around 92 percent, says a former IRS official.
83% Compliance Now
A study at the end of the 1960s, he said, showed that compliance had fallen to about 88 percent. Now the latest data indicate a compliance level around 83 percent.
The IRS statistics also reflect extreme variations in the percentage of individual tax returns in which agents found errors in different parts of the country.
Agents in the Buffalo, N.Y., district office found errors in 80 percent of the returns filed by persons with income between $10,000 and $49,999.
In the Parkersburg, W. Va., district office, agents found errors on only 23 percent of the returns. In Detroit and Philadelphia, it was 49 percent; Chicago, 42 percent; Boston, 37 percent; Los Angeles, 36 percent, and Manhattan, 33 percent.
There are several possible explanations for these variations.
One is that taxpayers in some parts of the country are more prone to making errors than taxpayers in other parts of the country.
A second explanation is that agents in different IRS offices around the country apply different standards in auditing returns. If that is the case, then taxpayers in some areas quite possibly are paying taxes they don't legally owe.
A third explanation is that the IRS Code has become so complex that even the agency charged with administering the tax laws can no longer interpret, with any degree of exactness, what the laws mean.
A former top IRS official, who declined to be interviewed unless granted anonymity, says there have been both political and practical reasons for keeping the compliance survey results confidential.
If the material was made public, he said, then during an election such groups as "labor unions, for example, might make it a political issue."
The fear of a political issue is well-grounded. The majority of tax returns are filed by low- and middle-income wage earners. With a few exceptions, they have the highest compliance levels.
They also account for the largest chunk of revenue collected from individual taxpayers. And they happen to make up a majority of the voters at election time.
IRS statistics for 1971, the latest year for which complete figures are available, show that of the nearly 75 million individual returns filed, 70 million, or 93 percent, were submitted by persons with an adjusted gross income (income after deductions) under $20,000.
Of the $85 billion in taxes paid by individual taxpayers, $51 billion, or 60 percent, was paid by persons with a yearly income under $20,000.
While one set of IRS statistics shows a dropoff in taxpayer compliance, another set shows a decline in the agency's enforcement activities, as well as uneven enforcement.
Fewer Field Audits
For example, the chance that an individual tax return will be subjected to a field audit – usually a more thorough examination than the more frequently conducted office audit – has declined steadily over the last decade, slipping from 1 in 157 in 1964 to 1 in 303 last year.
Even though taxpayer error and fraud are known to be increasing, assessments for additional taxes made by IRS agents after audits of individual returns have remained unchanged.
In the five-year period from 1964 through 1968, assessments on individual returns averaged $814 million a year. From 1969 to 1973, this figure rose to $818 million – an increase of only less than 1 percent.
But during the same time, average tax collections from individuals climbed from $63 billion to $107 billion – an increase of 69 percent.
Over the last five years, the IRS has written off as uncollectible some $1.9 billion in income taxes owed by both individuals and corporations.
In theory, the IRS never stops attempting to collect delinquent taxes, but when the agency labels a taxpayer's account as "uncollectible" it ceases active collection efforts.
Not only have IRS enforcement efforts declined overall, but in the critical area of tax fraud, the number o investigations conducted by the agency's intelligence division has remained at about the same level for the last decade.
Although the compliance survey was not designed to measure fraud – and there are no programs for assessing the extent of fraud – some patterns of taxpayer error are intertwined with fraud and it is assumed any increase in error is accompanied by an increase in fraud.
While there has been no marked change in the number of intelligence investigations – there were 8,601 in fiscal year 1973 compared with 8,765 in 1963 – the number of cases in which intelligence agents recommended prosecution has gone up substantially. In 1973, that figure hit a high of 2,555, compared with 1,040 in 1963.
All of these things – growing rates of tax avoidance and evasion, a decline in audit coverage, an inability to adequately examine large corporations, a falloff in taxpayer compliance – these are the things that IRS knows about.
Perhaps a more important measure of the present state of the country's tax-collecting system is what the IRS does not know.
For example, the agency does not know the extent of taxpayer delinquency for the taxpaying public as a whole. The agency does not know how widespread tax fraud is. The agency does not know how many individuals and corporations required to file tax returns are not doing so.
To assure the taxpaying public, though, that all is well with the system, IRS officials and politicians periodically assert that just about every penny collected by the IRS comes voluntarily from the American taxpayers. The figure usually cited is 97 percent.
Faith in Tax System
When asked about taxpayer compliance, John F. Hanlon, the assistant IRS commissioner in charge of compliance, glowingly told Inquirer reporters:
"I say look at what people pay us. The American people have great faith and trust in the American tax system; 97 percent of our money comes in on voluntary compliance."
In truth, the 97 percent figure has little value other than as a public relations gimmick. It means only that of all the revenue the IRS receives, 97 percent is paid voluntarily and the remaining 3 percent comes after audits and other enforcement procedures.
Says a former IRS official:
"The figure (97 percent) has nothing to do with compliance. If all enforcement were eliminated today, whatever tax money would be collected would be 100 percent voluntarily paid. This is just a platitude."
Where did the platitude originate?
"Usually," he said, "a public relations person would be writing a speech for the commissioner. He would put this in and the commissioner would read it."
Another statistic used by IRS officials to show how well the agency is performing relates to audit coverage, the number of tax returns examined each year.
IRS officials are fond of saying that they examine most returns filed by persons with incomes over $100,000 and that this year, your chance of being audited will be about 1 in 55. But the frequency of audit has nothing to do with the intensity of the audit.
A Great Unknown
A former IRS official says the intensity of audits – especially among upper income taxpayers and large corporations – is one of the great unknowns within the agency.
Although there are internal guidelines for audits, he said, no one knows the extent to which they are followed.
There is no better example of the audit intensity problem than President Nixon's own tax returns.
In a letter to President and Mrs. Nixon, dated June 1, 1973, William D. Waters, district director of the IRS office in Baltimore, wrote:
"Our examination of your income tax returns for the years 1971 and 1972 revealed that they are correct. Accordingly, these returns are accepted as files.
"I want to compliment you on the care shown in the preparation of your returns. Thank you for the cooperation of your representatives."
As it turns out, the President made a $432,787 series of mistakes on his returns for 1969-1972 – those same returns that the IRS previously found acceptable.
In a nationwide television interview last Sunday, IRS Commissioner Alexander acknowledged that the IRS "didn't do as thorough an audit as it should have done."
While the audit might not have been so thorough as the commissioner thought it should have been, it probably represented the typical IRS audit of an upper-income or corporate taxpayer.
The only difference was that an outside body – the staff of the Joint Committee on Internal Revenue Taxation – made its own audit of the President's tax returns and found all the mistakes that IRS had overlooked.
In addition to the question of audit intensity, another unknown factor within the agency is the extent of tax-return baiting.
"How much salting or baiting you've got, nobody knows," says a retired IRS official. "But you've got some." Here is how it works:
The taxpayer, his accountant or whoever prepares the return, "salts" the return with errors that will be easily discovered.
This is done with the expectation that the examining agent will assess the additional taxes for the obvious errors and close out his audit – never looking for the carefully concealed fraudulent entries by which the taxpayer hopes to cheat the government of substantial sums.
"This works especially well when there is an agent who is overly conscious of the time spent on an audit, or who is on a production quota and under pressure to product," says the former IRS official. "The more pressure the agent is under, the more successful the salting."
If anything, this pressure has become more intense in the last few years because of the growing practice of Congress and the Nixon Administration to assign IRS agents to duties totally unrelated to the tax-collecting system.
Hundreds and hundreds of IRS employees, including some of the bureau's most skilled agents, were moved to other government programs. Their new duties have included everything from monitoring wage and price controls to visiting service stations to check on the price of gas and diesel fuel.
Former IRS Commissioner Johnnie M. Walters called attention to the agency's manpower problems when he testified before a Congressional subcommittee last spring, saying that the IRS' "capability to check adequately indications or suspicions of tax fraud among the general population has declined.
"Last fiscal year," he asserted, "we shelved more than 1,100 cases of indicated tax fraud because of lack of agents."
Some tax authorities believe the well-publicized deductions taken by Mr. Nixon – like the $5,391 tax deduction for Tricia Nixon's masked ball in 1969 – will inspire other taxpayers to take some calculated risks of their own when it comes to itemizing deductions or reporting income.
The IRS, however, has gone to great lengths to downplay the potential effects of Mr. Nixon's tax-avoidance devices. A typical comment was published in a Washington Post article in Mary 17 that began:
"There is no sign so far this year of any 'revolt' by taxpayers outraged by the low-Federal income taxes paid by President Nixon according to Internal Revenue Commissioner Donald C. Alexander.
"Early returns from taxpayers show, if anything, fewer indicators of a popular uprising than IRS analysts had projected for this stage of the tax year, Alexander said in an interview."
The fact is, the IRS will have no general idea if there has been a marked decline in taxpayer compliance until sometime next year, when audits of 1973 returns are completed.
For years, the plight of the small taxpayer, whose earnings or belongings were seized by IRS agents, has been documented over and over again in the press or before Congressional committees.
Last week, for example, a subcommittee headed by Sen. Joseph M. Montoya (D., N.M.), resumed hearings into IRS audit and collection practices – expecially the agency's treatment of the small taxpayer.
After similar hearings last year, the subcommittee received hundreds of letters from irate taxpayers who were incensed over the way the IRS treated them, by seizing bank accounts or paychecks and creating hardships when they were unable to immediately pay the taxes the IRS said they owed.
However, while Congress often has aired the problems of the little taxpayer, it has largely overlooked the casual way in which the IRS deals with the upper income and corporate taxpayer, the double standard by which the tax laws are administered.
Over the last two decades, the only serious questions ever raised about IRS audit and collection practices were posed by former Delaware Sen. John J. Williams, often referred to as the conscience of the Senate.
Sen. Williams requested and received each year from IRS detailed reports showing the amount of delinquent and uncollectible taxes owed in each IRS region and district, along with the names of individuals and corporations owing more than $25,000 and whose accounts were labeled as uncollectible by IRS.
In later years, the reports listed the names of individuals and corporations owing more than $25,000 and whose accounts were labeled as uncollectible by the IRS.
Sen. Williams retired in 1971, and no other elected official – either in the Senate or the House – has shown any inclination for monitoring IRS operations.
No longer does the IRS prepare the uncollectible reports, citing the delinquent taxpayers by name. And the agency insists that data relating to audits and collections must be kept secret.