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US needs a coordinated fix for tax and budget

Jim HamillThe election is over.

I write my columns in advance so I do not know the outcome. It felt safest to write about factual things that might affect the future and hope these facts matter.

The Congressional Budget Office released the final figures for the budget year ended Sept. 30, 2020. The deficit checked in at $3.1 trillion. That’s 15.2% of GDP.

This was a downward adjustment to the initial CBO forecasts. Yay! Of course, COVID-19 was the biggest culprit. But not the only one.

The expected deficit for the fiscal year, that is the one expected before COVID existed, was $1 trillion. And that was in what everyone said was a good economy. Relative to expectations revenues for the year were down $44 billion and expenses were up $2.1 trillion.

These numbers have to impact future fiscal policy – tax policy and budget policy. We’re not even out of the woods yet, and the stimulus that was put off pre-election involved more a debate of particulars than magnitude.

Whatever mess is happening at the federal level is replicated at the state and local level, with the added nuisance of the inability to deficit finance. For those who think government doesn’t matter, you have either learned what it does or you will soon learn.

Well, pick your head up off the floor and let’s discuss something else. The Taxpayer Advocate’s report is in, and it, too, isn’t pretty. Turns out there are problems in our tax administration function.

For one thing, the audit rate continues to drop. Many think this is a good thing. You shouldn’t if you are one of the vast majority of honest taxpayers. Compliance with the laws continues to drop.

The audit rate is not the only factor impacting tax compliance. The form of the audit also matters. Once upon a time an audit meant meeting with an IRS agent. Now 81% of audits are correspondence letters.

A correspondence audit is efficient in utilization of scarce resources. It can also be appropriate when increased 1099 and W-2 reporting allows the IRS to compare what is on a return with the information that IRS received.

But there is a psychological aspect associated with a face-to-face audit that helps future (post-audit) compliance. And I am certain there is information value in meeting with an agent.

One benefit of an audit to the system is helping compliant taxpayers to understand how the law works and what is and is not allowed. Face-to-face interaction helps realize the full measure of this benefit.

IRS has studies that show that post-audit compliance with the system is enhanced when the audit was face-to-face rather than by a correspondence letter. The greater is compliance with the law we have, the less is the need to change the law to extract more tax.

And the law is complicated. The complexity is often more the cause of compliance failures than is dishonesty. Even the top tax experts in the government fail to understand how the laws baffle the ordinary taxpayer.

I have written about the new “qualified business income deduction” (still in the toddler stage) and the fairly young (just finishing the first semester of second grade) “net investment income tax.”

Working with both provisions requires knowledge of what a “trade or business” is. Treasury regulations for both provisions adopted the “Section 162” definition of a business because they said that definition was “well known.”

The Taxpayer Advocate’s report includes a list of the 10 most litigated tax issues. No. 1? The Section 162 definition of a trade or business. So much for well-known.

Many people know I like song lyrics. The best ones are subject to self-interpretation. Bob Dylan was once asked what the lyrics of one of his songs meant. He answered, “What does it mean to you?” The questioner was offended.

Dylan answered properly. Great lyrics, like great artwork, say something or mean something different to each of us. Great laws cannot. We need clarity on the laws. Sometime, even the clarity of good laws has to be explained to laypeople.

Our budget is a mess. Our tax laws are a mess. A solution must consider the linkages between the two.

James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.

 



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