The Latest Convoluted Arguments in Favor of Rich People Not Paying Taxes

Two Senate hearings last week focused on how the richest Americans are avoiding and evading taxes in ways that ordinary Americans could hardly imagine.

All the experts brought in to testify seemed to agree that the House GOP’s recent tactic of “paying for” a spending proposal by cutting IRS funding makes no sense because it reduces revenue collections and increases the deficit.

They also seemed to agree that a lot of the problems with well-off people avoiding and evading taxes stem from our tax code’s complexity.

And yet, the witnesses called by the Republicans nonetheless produced convoluted arguments against President Biden’s policies to address these very problems.

The debate over IRS funding is a case in point. The Inflation Reduction Act provided $80 billion in increased funding to the IRS over 10 years, and $46 billion of that was for enforcement (meaning increased audits, among other things). The President has stated that this additional enforcement will be directed to those with income of more than $400,000. This would produce $180 billion in new revenue over this time, the Congressional Budget Office estimated, suggesting a return on enforcement funding of roughly 4 to 1.

MIT professor Nathaniel Hendren testified before the Senate Budget Committee that the revenue impacts are much greater than this, partly because CBO is reluctant to estimate the indirect effects of increased enforcement. (Indirect effects include, for example, fewer taxpayers even attempting to evade taxes because they know they may be audited.) His research focused specifically on the high-income people who would be subject to the increased enforcement and found that the return would be 12 to 1.

The Cato Institute’s Chris Edwards agreed with other witnesses that cutting IRS funding does not “pay for” anything and that it actually increases the deficit, contrary to what House Republicans claim. Yet Edwards still provided convoluted arguments against the IRS funding provided in the Inflation Reduction Act.

“Enforcement is a blunt tool,” Edwards said—a startling statement to anyone who believes that Congress enacts laws with the expectation they will be enforced. Edwards pointed out that the IRS wins litigation against taxpayers about half the time and that in recent years it only collected about 48 percent of the dollars in dispute. Given this, he argued, increased enforcement is not optimal and other steps could increase tax compliance.

There are many problems with this argument. First, Congressional Republicans are not offering any other proposals to increase tax compliance, they are simply trying to gut the IRS (much as they did in the 2010s). Second, the dollars collected in IRS enforcement efforts are an obvious return on these efforts but a less visible return, which Edwards ignores, is all the tax evasion that taxpayers are not even attempting because it is not worth the risk given the current chances of facing an audit. Third, nothing he says suggests that the enforcement efforts bring in less than they cost.

Also, Natasha Sarin, a former Treasury official, testified that the IRS has until now been ill-equipped to take on some of the large, vastly complex business structures that are often used to hide income. As she explained in her written statement:

“As one example, the IRS’s most recent detailed study of pass-through evasion was conducted in the 1980s. In the intervening four decades, these structures have grown in importance: For example, partnership income as a share of business income grew from less than 5% to more than 35% today. But the IRS has not had resources to devote to measuring partnership evasion, let alone thinking about how best to address it, and indeed, today the agency’s partnership audit rate is approximately 0%.”

She pointed out that a web of business entities could involve partnerships owned by other partnerships that are owned by foreign entities that are owned by other domestic entities, in a long chain that must be disentangled, usually by a single IRS agent assigned to examine it. The increased IRS funding can make it possible for the agency to hire more of the highly skilled experts needed to get to the bottom of these structures.

A hearing of the Senate Finance Committee the following day focused more on tax avoidance – tactics that are legal, or at least arguably legal, to reduce one’s taxes. This involves individuals and corporations using the special breaks enacted by Congress and other loopholes to pay as little as possible.

Witnesses, including William McBride of the Tax Foundation and Douglas Holtz-Eakin of American Action Forum, seemed to agree that the type of complicated transactions and schemes used by the wealthy to avoid taxes are the result of complexities in the tax code. Chris Edwards of the Cato Institute said the same thing the day before in the Budget Committee hearing.

And yet it is strange to hear this from supporters of 2017’s Tax Cuts and Jobs Act, which introduced brand new byzantine provisions that arbitrarily favor certain types of income over others. This is a perfect recipe for encouraging taxpayers to contort their affairs to fit within the rules of particular tax breaks. One example is the law’s 20 percent deduction for certain pass-through business owners. Another example is the provisions allowing corporations to pay far less on profits they book offshore, which have clearly allowed offshore tax dodging by corporations to flourish.

Upon passage of the law, a group of lawyers wrote a long article titled “The Games They Will Play” about how these and other provisions could be exploited relentlessly. How anyone could support this law and then decry complexity in the tax code is mindboggling.

While there was little consensus on solutions among the witnesses or the lawmakers, no one watching these hearings can miss the fact that well-off people seem to live under a completely different tax code than the rest of us.

Chye-Ching Huang of the NYU Tax Law Center explained how very well-off people have many opaque ways of generating income and structuring business transactions, thanks to complicated tax provisions that allegedly “promote growth” and the highly paid attorneys and accountants who can assist them. This all provides ample opportunity for tax evasion and tax avoidance. Meanwhile, the typical middle-class American receives their income from working at a job where an employer reports their earnings to the IRS, leaving few if any opportunities to evade or avoid taxes.

She also explained that many tax breaks for income from wealth are provisions that create the kind of complexity that can be gamed to avoid taxes. For example, taxes on capital gains can be deferred for years until a taxpayer sells an asset, even then the income generated is often taxed at a lower rate, and sometimes the income escapes taxation forever because an asset is left to heirs and the gains on the asset are erased from the tax system.

All this in turn creates more complexity because it encourages individuals to leap through hoops to recharacterize their income as the type that is eligible for these breaks. One of the most famous examples is the carried interest loophole, by which fund managers can characterize the compensation they receive for work (for managing other people’s money) as capital gains so that they can defer tax and enjoy the lower tax rate.

Sharply limiting these tax breaks as President Biden has proposed is a straightforward solution to this. But that is apparently not the “simplification” that Republican members of these committees or the witnesses they called favor.

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