© 1974, The Philadelphia Inquirer
In the Brooklyn, N.Y. office of the Internal Revenue Service, 79 percent of the tax returns filed in 1971 by persons earning more than $50,000 a year were incorrect.
In the Wichita, Kan., office of the IRS, 22 percent of the tax returns filed in 1971 by persons earning less than $10,000 who itemized deductions were incorrect.
Each statistic, taken from secret IRS studies measuring taxpayer compliance, tells who is more likely to pay the Federal income taxes he owes and who is likely not to pay the taxes he owes.
Taken together, the statistics show something else:
The nation's system of voluntary tax assessment is no longer working, and the government is losing billions and billions of dollars a year in revenue because of that failure.
Here are a few of the reasons:
PROBLEM. The tax laws and accompanying regulations have grown so complex that even the IRS no longer can interpret the code and its own regulations with any degree of uniformity or certainty.
EXAMPLE. One section of the tax code dealing with foreign income is so confusing that former Treasury Department officials say neither the IRS nor most tax lawyers has the slightest idea what the statute means. A typical tax law, it reads in part:
"The amount of previously excluded subpart F income of any controlled foreign corporation withdrawn from investment in less developed countries for any taxable year is an amount equal to the decrease in the amount of qualified investments in less developed countries of the controlled foreign corporation for such year, but only to the extent that the amount of such decrease does not exceed an amount equal to…"
PROBLEM. Another kind of complexity in the code which stems from efforts by Congress to use the tax laws for a variety of social or business objectives.
EXAMPLE. Tax laws are designed to do such things as encourage home owners, spur the drilling of oil wells, shelter persons from casualty losses to their homes or automobiles, provide for old age and encourage charitable contributions.
PROBLEM. Yet one further source of the complexity in the tax laws is the fact that there are two different tax systems mixed together – a half-rate tax system for capital gains, a full-rate tax system for wages.
EXAMPLE. It is estimated that one-half the wordage in the Internal Revenue Code – meaning millions of words – could be eliminated if capital gains were taxed the same as ordinary wages. Such a change also would cut down on compliance problems and simplify tax auditing procedures.
PROBLEM. Built into the tax code are provisions which result in uneven enforcement of the tax laws – assuring that low- and middle-income wage earners pay all the tax they owe, while allowing upper-income taxpayers to avoid paying any tax if they choose.
EXAMPLE. Income tax is withheld from the weekly paychecks of low- middle-income taxpayers – about 75 percent of individual income taxes are collected through withholding. But there are no similar withholding provisions covering investment income – income from stock transactions, dividends and interest.
PROBLEM. While tax returns are requiring more audit time than ever before, Congress and the Executive Branch not only have failed to increase IRS audit manpower, but they have assigned IRS agents to such non-tax-related duties as monitoring wage and price controls.
EXAMPLE. Over the last decade, the number of revenue agents has increased 5 percent, going from 12,365 in 1964 to 13,017 last year. During the same period, total revenue collections by the agency have increased 112 percent.
PROBLEM. While the IRS becomes involved in the lives of more citizens than any other single Federal agency, except perhaps the Census Bureau, and has authority to exercise enforcement powers accorded no other Federal agency, there is no independent monitoring of its operations. There is, in short, no audit of the tax collector.
EXAMPLE. The one Congressional group charged with overseeing IRS activities – the Joint Committee on Internal Revenue Taxation – has never conducted a study to measure the thoroughness and fairness of the IRS audit, collection and enforcement procedures.
Secrecy Is a Must
PROBLEM. There are a number of loopholes in the nation's tax laws which enable upper-income taxpayers, particularly those intent on avoiding payment of taxes they lawfully owe, to do just that without fear of ever having their personal property seized.
EXAMPLE. An Inquirer investigation turned up a number of cases in which delinquent taxpayers who owed upwards of $100,000 in back taxes placed their assets beyond the reach of the IRS.
The taxpayer's car was owned by a corporation. The taxpayer's house was placed in trust for his children. The taxpayer's real estate holdings were owned by corporations.
Further compounding all of these problems is the firm insistence of IRS officials that even the broadest statistical data relating to the way the agency administers the nation's tax laws must be kept secret.
The IRS churns out a variety of statistical reports every month, quarter and year assessing all facets of the agency's operations – reports that it guards closely and refuses to make public.
It should be emphasized that the reports in question do not concern individual taxpayers. They are composite statistical materials about taxpaying groups, such as persons earning less than $10,000 a year or persons earning more than $50,000.
For the last eight months, the Inquirer has tried unsuccessfully to obtain a number of these reports which contain the same kind of information that some other Federal agencies release to the public upon request.
Tax Analysts and Advocates, a public-interest law firm in Washington, D.C., has been waging a continuing legal battle with the IRS over just one aspect of the agency's secrecy: private rulings.
Says Thomas F. Field, executive director of Tax Analysts and Advocates and former attorney-adviser in the Treasury Department's Office of Tax Legislative Counsel:
"During the past two generations, the Internal Revenue Service has built up an enormous body of secret law which is simply unavailable to the public, the tax bar, or anyone else, except in the form of leaks.
Few Rulings Released
"Included in this body of secret law are hundreds of thousands of unpublished private rulings, tens of thousands of which are classified by the service as having precedential significance."
Rulings are official IRS interpretations of the tax laws which are furnished in response to requests by corporations and individual taxpayers.
A business, for example, advises the IRS that it is planning to engage in a particular transaction; then the IRS describes what it considers to be the tax consequences of that transaction.
Each year, Tax Analysts and Advocates says, the agency issues about 30,000 rulings, of which 500 to 600 are published. The agency refuses to make public the remaining rulings.
It was in a secret ruling that the IRS first advised that the ITT-Hartford Fire Insurance Co. merger would be a tax-free transaction for stockholders – resulting in a loss to the treasury of an estimated $30 to $50 million.
After considerable pressure, the agency has reversed itself – in another secret document – and the shareholders now much pay the tax, although ITT has said it will reimburse the shareholders.
Because the vast majority of rulings are kept secret, no one really knows how much money the government is losing as a result of the private IRS opinions.
Field calls the uneven enforcement activities of the IRS "the kind of real scandal that we ought to be worried about in this country.
"The tax laws," he says, "on the basis of the publicly available evidence – of which there is not a great deal – appear to be enforced more stringently against the poor and against wage earners than they are in fact enforced against the rich and against those whose income drives from property."
One Easy Solution
Field believes that one easy solution to the problem is to require the same kind of withholding and reporting procedures for property income that is applied to income from wages.
In other words, taxes would be withheld from dividend and interest payments and turned over to the government just as taxes are withheld from wages and turned over to the government.
At the same time, he said, stock exchanges should be required to report to the IRS all transactions over a certain dollar amount, say $1,000.
"Of course, the stock exchanges would complain that this was in some way infringing on their Constitutional rights, destroying their business and so on.
"And I have a very simple answer for that: If withholding is good for wages, then, by God, it's good for anything else. And if it isn't good for anything else, it isn't good for wages."
Field recalled that the Treasury Department back in the early 1960s suggested withholding on dividends and interest, but the proposal was rejected by Congress after some strenuous lobbying by savings and loan associations.
The lobbyists, he said, "trotted out all sorts of cases in which poor widows would starve to death if there was withholding on their dividends and interest, particularly their interest.
Lest Widows Starve
"The distributed a lot of scurrilous leaflets about how the government was going to confiscate bank accounts and so forth.
"The upshot was we never did get withholding on dividends and interest, lest poor widows should starve to death, even though for 30 years we have had withholding on wages without regard to whether poor widows would starve to death."
What did come out of Congress, though, was a law requiring banks, savings and loan associations and businesses which paid dividends and interest to report those payments to the IRS.
The idea was that the IRS would transfer all that data to computer tapes and run a comparison with the individual tax returns to determine whether taxpayers were reporting their dividend and interest income.
That is how the law was supposed to work. But the cost of keypunching all those numbers every year is prohibitive, so the information has never been transferred to computer tapes.
As a result, there still is no check to determine whether taxpayers are reporting all the dividend and interest payments they receive.
The importance of this failure is underscored by internal IRS studies showing that as income increases, so too does taxpayer error and underreporting of income.
The nation's tax system, says Field, "started off as a tax on the rich, and that was bad. But during and since World Ware II it has become a tax on wages primarily, and increasingly only on wages.
Congress Avoids Duty
"That was not the intention of the income tax. Furthermore, any tax system that operates in that way is bound to tax the poor more heavily than the rich, just because the poor depend more heavily on wages than the rich."
Not only has Congress failed to enact reforms that would facilitate the collection of additional revenue on income now excluded from withholding, but Congress also has avoided monitoring IRS operations.
Congressional committees periodically hold hearings relating to overzealous IRS enforcement or collection tactics among low- and moderate-income taxpayers. And some individual lawmakers occasionally object to what they consider to be the IRS's abuse of power.
But generally, Congress has failed to systematically review IRS operations. It has never delved into the subtle workings of the agency.
Indeed, Congress seems to have little realization of how seriously IRS's auditing, collection and enforcement practices have eroded, or of the extent to which taxpayer fraud and error are threatening to undermine the voluntary compliance system.
The Joint Committee on Internal Revenue Taxation, comprised of both House and Senate members, is charged with overseeing the IRS.
However, the committee's staff is more preoccupied with providing technical assistance on pending tax legislation to the House Ways and Means Committee and the Senate Finance Committee than with monitoring the IRS.
For years, the General Accounting Office (GAO), often described as Congress' watchdog over the executive branch, was eager to study collections practices and other phases of IRS operations.
But the IRS refused to allow the GAO to do so, saying that Federal law prohibits the IRS from releasing to the GAO information about individual tax returns.
A Favorable Report
In 1971, however, the Joint Committee, which does by law have access to such taxpayer information, authorized the GAO to make a study on the committee's behalf of the IRS's collection of delinquent taxpayers accounts.
The result was a 53-page report, issued on Aug. 9, 1973, and one of the few independent studies ever made of IRS operations.
It is also one of the most favorable reports ever issued by the GAO, which in the past has criticized a wide spectrum of government activity from military cost overruns to slipshod administration of environmental laws.
In short, the GAO study concluded that:
The Inquirer's investigation of the IRS and the nation's tax collecting system, however, produced sharply conflicting findings:
In short, the newspaper's probe concluded:
Audit Sought in 1951
The question of an independent audit of the IRS is not new.
Former Delaware Sen. John J. Williams, a one-man watchdog over the IRS during most of his 25 years in the Senate (he retired in 1972), called for an outside audit for the IRS in 1951.
The senator suggested the audit after he had disclosed sweeping irregularities in the revenue agency – then called the Bureau of Internal Revenue (BIR) – from New York to San Francisco.
Williams' disclosure rocked the BIR and touched off a full-scale Congressional investigation into theft, influence peddling and political favoritish.
The Delaware lawmaker became interested in the agency shortly after he was elected to the Senate in 1946. The Wilmington office of the BIR had informed him that his back taxes were not paid.
Williams searched his records and found that he had paid them. He demanded an investigation. A clerk at the Wilmington BIR office eventually was sent to jail for embezzling taxpayers' money and falsifying the records to camouflage his stealing.
As a result of the Delaware investigation, Sen. Williams received confidential reports and information from BIR intelligence agents on a wide variety of abuses, including lenient treatment of favored taxpayers by high officials and outright theft within the agency.
In 1951 and 1952, armed with that information. Sen. Williams took his case against the BIR to the Senate floor. He exposed one BIR abuse after another. Mass resignations and firings within the agency followed.
Scores of revenue agents were dismissed or retired; others were indicted for corrupt activities. Congress investigated the BIR for more than two years, and the House and Senate enacted reforms aimed at preventing similar scandals from occurring in the future.
But Sen. Williams' idea of an outside audit of the revenue agency – that idea was never adopted.