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IRS Scrutiny of Non-Profits: How Non-Partisan Is It?

The Washington Post today reported on the IRS's audit of a Texas nonprofit organization that played a critical role in publicizing information about Tom DeLay's campaign finances.  See R. Jeffrey Smith, Texas Nonprofit Is Cleared After GOP-Prompted Audit (Feb. 27, 2006) at A03.

It appears that Sam Johnson, a Texas Republican on the House Ways and Means Committee who is a long-term ally of Tom DeLay, wrote a letter dated Aug. 3, 2004 to ask the IRS to review Texans for Public Justice and an affiliated foundation and to report back to him "directly" on its findings.  Johnson said he "had uncovered some disturbing information" and had received complaints about tax violations.  When asked by the Post to specify the disturbing information he had uncovered as subcommittee chair responsible for IRS oversight, Johnson's staff did not come forward with information.  As for complaints, one (perhaps the only one) came from Barnaby Zall, also a close ally of DeLay.  Id.

The group publishes studies of campaign spending and corporate lobbying in Texas, with a budget of about $300,000 annually.  Its work includes a 2003 report alleging DeLay's use of corporate funding to underwrite the 2002 Republican takeover of the Texas legislature.  The IRS audit, lasting from January 2005 through February 2006 and involving review of "minutes, its files of correspondence, contracts, donor records and other documents," found no violations.  Id.

This, then, is another example of the lack of transparency in the IRS audit process for tax-exempt organizations. (See the earlier discussion of a need for checks and balances in the context of complaints about churches' involvement in political campaigns, here.)  Without knowing exactly what other organizations have been audited when requests were made by politicians, or what the outcome of those audits were, it is difficult to assess whether the audit was undertaken to satisfy partisan purposes.  Greater transparency regarding the process of selecting organizations for audit and the way the IRS responds to partisan requests for audits would benefit everyone.  The IRS would be above suspicion of using its power for partisan purposes, and citizens could rest assured that audit targets were selected using reasonable criteria.

The IRS and the SEC

Several years ago, I wrote an article published in the Iowa Journal of Corporation Law titled Putting SEC Heat on Audit Firms and Corporate Tax Shelters: Responding to Tax Risk with Sunshine, Shame and Strict Liability, 29 Journal of Corporation Law 220 (Winter 2004), available on the SSRN network, here.  I noted that the wave of accounting scandals like Enron's that led Congress to pass Sarbanes-Oxley and push for greater independence of auditors was similar to the corporate tax compliance problems that reduce revenues for the federal fisc as well as harming corporations and investors.  Sometimes tax and accounting gimmicks go hand in hand, and clearly the expansion of accounting firms into multidisciplinary practice facilitated companies' participation in tax shelters and undermined directors' and investors' assessments of tax risks.  I suggested that Congress had missed an opportunity when passing Sarbanes-Oxley to legislate even greater transparency about taxes.  I proposed that the SEC ban auditor provision of aggressive tax planning, defined by refernece to the IRS's reportable transaction categories.  Companies are already required to review their transactions to comply with IRS reporting, and could therefore use this same tax information to provide internal and external disclosure to their boards and investors.  I also suggested at the least that companies should be required to provide "tax risk profile" information to their boards and their investors, so that both groups would be better prepared to evaluate a company's reports and the credibility of its external auditor on tax matters.  The goal was to use the IRS's existing tax analysis to set appropriate limits on auditor provisions of tax services to establish greater independence.

Anna Bernasek, who regularly writes for Fortune, wrote a piece in the New York Times on February 5 raising a similar  question about transparency of tax returns as well as financial statement information.  The original column, Why Let the I.R.S. See What the S.E.C. Doesn't, is available here.  A reprint of the column is available here. 

Bernasek's point is that companies have already prepared tax returns using the federal income tax rules, which generally are less flexible in permitting companies discretion in deciding how much tax they owe and therefore may provide a more accurate picture of the company's overall financial situation.  The numbers on the tax return are kept confidential, however, while financial statements of reporting companies are publicly available through the SEC filing process.  Greater disclosure of selected tax information would provide both investors and analysts a better sense of a company's true economic condition.  It wouldn't be necessary to reveal the entire return, but perhaps at the least the "Schedule M-3" that reconciles tax and financial accounting numbers would be of interest. 

Bernasek notes that "there is good cause for trying to understand what is really going on with corporate taxes, company by company" because the numbers suggest a downward treend for corproate taxes relative to the overall gross domestic product.  That could be caused by new ways of minimizing taxes or new methods for overstating earnings.  Either way, it is of interest to investors and greater transparency may help to stop abuses.

More on Tax-Exempts: IRS Political Activity Report, T.Boone Pickens' KETRA Gift

The IRS has completed its report on political activity by tax exempt groups, finding that about 75% of the groups it examined had engaged in some kind of prohibited political campaign activity.  See this post on "Church Politics" on Prawfsblawg for more information about the report and the difficulties it will present for churches on both left and right in the upcoming 2006 election.  Articles highlighting the report appeared in Saturday's New York Times, here, and the Washington Post, here.

Another issue related to tax-exempt organizations and charitable contributions has drawn attention over the last few days. As I noted in a blog post last December, the new Katrina charitable contribution provision seemed mainly a tax giveaway for the wealthy, in that it removed the cap on the amount that could be used as a deduction against income.  T. Boone Pickens has now become a conspicuous example of the way the provision benefits the ultra-rich. See this New York Times story. Right before the end of the year, Pickens "gave" $165 million to a small charity that benefits the golf program at Oklahoma State.  The money stayed in the golf charity's account for little more than an hour, after which it went right back into a fund managed by Mr. Pickens.  As the Times article notes:

"To some, the question is whether a wealthy person should get a tax break now for money that has essentially not yet been put to charitable use. By giving the money before 2005 expired, Mr. Pickens was able to take advantage of a provision in Hurricane Katrina relief legislation that allowed him a deduction for a charitable gift equal to 100 percent of his adjusted gross income, double the normal limit of 50 percent. If he does not have that much income in 2005, he can carry the deduction into future years."

In other words, Pickens still controls the money and his fund still benefits from having the assets. In addition, Pickens gets the full benefit of the contribution, without any limitation based on a percentage of his gross income, under the temporary "Katrina" relief provision.  A considerable tax subsidy, provided to someone that doesn't need it without even providing much immediate benefit to the charity.  All in all, this is a predictable use of an ill-considered tax benefit that had very little to do with helping Katrina victims.

Tax Compliance

I have posted a brief report on the most recent taxpayer survey released by the IRS Oversight Board as a guest blogger on Prawfsblawg.  The good news is that a huge majority of American taxpayers believe that complying with tax laws is important.  The even better news is that the most important reason is not because of penalties or fear of being audited, but because of their sense of personal integrity.  You can read the full posting by clicking on the Prawfsblawg link above and scrolling through the February 22 entries.

eState Taxes

On the national level, the President's Tax Reform Panel has met, filed its report, and apparently faded from the scene.  But state tax efforts are continuing to percolate, especially in states that are under the gun to modify the funding of public schools to satisfy constitutional equal protection provisions.

Texas is one of the states attempting tax reform.  It will not be easy in the climate created by the national fixation on cutting taxes, ignoring deficits, and piling on debt.  Texans' long-time aversion to taxes will make it even harder to raise sufficient revenues to meet today's needs. But the Texas Tax Reform Commission (TTRC), a 24-member bipartisan commission made up primarily of representatives from business that was appointed by Governor Perry last fall, see TTRC announcement, has a July 2006 deadline set by the Texas Supreme Court.  The court concluded that the state's property-tax system for funding its public schools was unconstitutional.  See TTRC release.  The state legislature has been unable to reach an agreement on the best system for raising school funding, so it is hoped that the commission can provide a foundation for legislation.

There are, of course, a number of conservative voices in Texas that clamor for reduction in taxes as the only acceptable tax policy reform.  See this entry on the Texas Public Policy Foundation website, in which a Texas congressman rails against any U.S. tax policy that does not cut taxes.  His version of tax reform is simple, since it does not require any nuanced considerations about funding important programs.

"True tax reform is as simple as cutting or eliminating taxes. No studies, panels, committees, or hearings are needed. When reform proposals seem complicated, they almost certainly don’t cut taxes."  Id.

The Panel, however, appears to have a variety of ideas before it.  Chair John Sharp is apparently considering an "alternative margins tax" for businesses, which have been viewed as too easily escaping Texas' franchise tax.  See this description of a panel discussion at the Texas Association of Business conference.  The tax would have gross receipts minus either personnel costs or cost of goods sold.  According to the release, businesses are not entirely supportive of the proposal. Some want a consumption or sales tax, and some have reiterated a call for lowering tax rates.  Since Texas is already near the bottom of the states in its tax burden (41st out of 50, id.), it is difficult to see how lowering business taxes still further will benefit the state.  Critical infrastructure and investment in education and other projects that build human capital will be shortchanged without sufficient tax revenue.  As one of the panel discussants noted:

"Too often the statement is that a low tax is good for business and a high tax is bad for business. What business needs to understand is the economic consequence of taxes, especially when it comes to limits that must be placed on public infrastructure such as education." Id.

Another proposal would establish a Texas income tax.  See the Center for Public Policy Priorities description.

Yet another proposal apparently under consideration is raising the sales tax to 10%,  including services, and eliminating the franchise tax.  See this short piece on the Texas Society of Certified Public Accountants website.  The use of a sales tax, of course, will be more regressive than other forms of taxation.  See this criticism of relying on a modified Value Added tax and sales tax to replace the property tax.  The concern is that the system will be even more regressive than the current one.

The Texas Tax Reform Commission will not be able to satisfy everyone, so it should aim high from the beginning.  It should consider all the alternatives, including an income tax.  And it should try to season the business push for zero taxation with a reasonable measure of appreciation for the importance of the many programs that taxes fund, including education.

(Thanks to David Gamage at UT, Austin, for drawing this issue to the attention of TaxProf readers.)

Simple and Fair

Remember the Hall-Rabushka "Flat" Tax that was touted as a great simplification over the current tax scheme?  That tax moved most of the burden of taxation to wage-earners, letting capital go largely untaxed. 

Senator Ron Wyden (Oregon) and Congressman Rahm Emanuel (Illinois) have proposed a new take on simplifying the tax system.  In the February 17, 2006 Wall Street Journal, they suggest a "Simple Tax, Fair Tax."  Their version of the fair flat tax would have three personal tax rate brackets--15%, 25%, and 35%--instead of the current six brackets.  It would also eliminate the unfair discrimination between ordinary wage income and income from capital.  They describe this as follows.

"Under the current system, a police officer walking the beat pays a higher effective tax rate than someone who makes their money from capital gains and dividends.  the policeman who makes $70,000 in annual wages pays almost 25% of that salary to the federal government, while an executive who makes five times that in capital gains pays just 15%.  Today's tax code has not just become anti-middle class, but anti-worker.  Wealth and work should be treated equally."  Id.

Their solution is a good one.  It makes sense to eliminate the category distinction between capital income and ordinary income.  America has always believed that people should be treated the same whether they come from a rich family with several Mercedes in the garage or a poor working-class family that takes the bus to work each day.  Eliminating the category distinction between capital income and ordinary income would also greatly simplify the Code and reduce the opportunities for wealthy taxpayers to manipulate their income. 

One further change could help this proposal ensure that wealthy taxpayers pay their fair share of taxes upfront just like ordinary American wage-earners.  Congress should require information reporting for all capital gains realization events, just as is currently required for salaries, interest, and dividends. 

Eliminating the unfair discrimination against wage income in favor of investment income and ensuring that investment income gets reported to the IRS would go a long way towards simplifying the tax system and making it a fairer tax system.  As Wyden and Emanuel note, the "aim is not to soak the rich but to make the tax system fairer [so that e]very American has a right to build and grow wealth." 

More on HSAs

The Chicago Tribune ran an article on Sunday, here, about health savings accounts (HSAs).  It provides some further insight into the "new" health care mechanism, in that it looks at some of the ways individuals respond to the new accounts. 

One person, Al Meginnis, decided to take out a high-deductible health plan with an HSA and has saved $2,400 in premium in one year.  He looks at his health care provider's website to decide whether to have medical procedures.  For example, he recently rejected a recommendation for $600 worth of physical therapy for arthritis, and instead took a generic painkiller recommended by another physician. 

The report suggests he is happy with that result, but he didn't have much choice.  His employer dropped the standard health insurance plan and converted to HSAs with high-deductible insurance to save money for the employer.  Most of the employees are not happy, according to the human resources vice president.  They see it as more costly up front.

Another firm that switched, Godberg Kohn, reported that employees think the paperwork of HSAs is burdensome, and costs of drugs tends to be much higher. 

The article notes many of the problems pointed out in earlier postings here, and adds the concern, expressed by Karen Davis, presdient of a health policy organization called Commonwealth Fund, that people will end up delaying needed care in order to save money.  The high deductible ultimately reduces the use of essential services as well as less essential ones.

Consumption Taxes: Answer to Tax Evasion?

One of the arguments often put forward in support of changing to a consumption tax system is that it would be much simpler and therefore likely to result in fewer compliance problems.  The system most frequently proposed is a value-added tax (VAT) for business, and a wage tax (that could be progressive) for individuals.  Wealthy individuals whose income consisted in large part of capital gains and other investment income would pay little or no direct tax.

How does the claim about compliance hold up?  Bahro Berhan and Glenn Jenkins have written an article that looks at efforts to control VAT evasion.  They suggest that controlling VAT evasion may produce high compliance costs.  The article considers measures used to control VAT evasion in Northern Cyprus and Boligiva and concludes that the measures undertaken in those two countries have imposed significant costs on employers and employees--amounting to about one and one half times the total cost of administering the domestic tax system and 5% of the revenues collected by the VAT system. 

The following is an excerpt from the abstract of the paper (available from the authors).

"Although it is sometimes claimed that Canada's GST [equivalent of a VAT] is self-enforcing--vendors cannot evade tax on sales because purchasers will want to produce evidence that the tax has been paid in order to claim input tax credits--in reality GST fraud is big business.  Solutions to GST evasion generally involve increased audits and therefore increased complaince costs for taxpayers and increased administrative costs for governments, which represent a diversion of resources from more productive activities and an economic loss to the country."  [emphasis added]

FY 2007 Budget Proposal for Social Security Privatization, Again

As David Sanger of the New York Times wrote of the Bush FY 2007 budget proposals:

"The budget bears all the hallmarks of the Bush presidency, putting national security and tax cuts above all other considerations and gradually tightening or reducing spending on programs, including educational loans, farm subsidies and national parks." See Bush's $2.77 Trillion Budget Calls for Medicare Cuts.

Thus it should not be surprising to anyone that Mr. Bush has again trotted out  budget  breaking  privatization "reforms" for Social Security.  In spite of a State of the Union speech proposing a bipartisan commission to consider ways to ensure Social Security's solvency for years to come, the FY 2007 budget proposals include a plan to privatize Social Security at a cost of $700 billion (over the first seven years).  See this report on OMB Watch.  Although little noticed in the media, the plan would provide for workers to divert funds to private accounts beginning at $1,100 in 2009 and increasing by $100 increments through 2016.

Congressman Steny Hoyer (D-Md) had this to say about the reappearance of Bush's privatization plan.

“This is absolutely stunning. ... Last year, the country emphatically rejected the President’s effort to privatize this critical program. Instead of working in a bipartisan fashion to find a common sense solution to Social Security’s solvency, the President’s budget embraces an ill-advised, unpopular plan that would turn a guarantee into a gamble.”  Hoyer Budget Release.

For other commentary on Bush's "stealth" Social Security privatization proposal, see this Washington Post article; this report on SeniorJournal.com, which provides links to the Social Security section of the budget document; and this brief report at PAFCO education fund.

The FY 2007 budget also proposes reductions in Social Security benefits by $2.2 billion over five years and $6.3 billion over the ten-year budget period.  See this report on the FY 2007 budget from the Center for Budget and Policy Priorities.  If the budget proposals are carried out as planned, 1,900 Social Security Administration positions nationwide would be cut through attrition, possibly hampering the SSA's ability to respond appropriately to changes in status of eligible retirees.  See this report.  The CBPP report notes additional changes that could hurt vulnerable populations, including elimination of the lump-sum death benefit of $255 that can help families pay for funerals and an apparently rigid requirement that school-age children attend school in order to receive benefits, even if there were reasonable cause for the children to miss school, such as mental disability.  Grassley, Chair of the Senate Finance Committee, made clear that those heartless changes had no chance of passage.  See this Social Security News report and the linked AP report.

(The CBPP report, by the way, is well worth reading beyond its section on Social Security.  It provides a good overview of the budget proposals, and a noteworthy evaluation of the various ways in which these budget proposals are deceptive as to their ultimate impact on the U.S. economy.) 

The Bush Social Security privatization plan is old wine in new bottles.  The Cato Institute, of course, has been pushing privatization of Social Security for a decade.  See, e.g., this 1997 Cato Institute piece proposing that all workers 32 and under divert almost 50% of their Social Security taxes into private accounts, with the shortfalls in paying benefits to be made up by additional federal debt.

The solution to the health care and retirement needs of Americans will not be found in programs that merely transfer risk to workers while putting more money in the pockets of the wealthiest Americans.  Instead, Congress and the White House should work together to find a reasonable solution to fund the needs of Social Security beneficiaries in the years to come.  The most obvious one is to increase or eliminate the cap and to have it apply to capital gains as well as to ordinary wage income.  The choice is simple--reduce benefits for those who rely on Social Security as their primary income, or have better-off Americans pay their fair share of the tax burden for Social Security by paying  tax at the same flat rate proportionately on all of their income that ordinary Americans pay on all of theirs.  It seems clear that having wealthy Americans pay their fair share is the solution most in line with American values.

Tax Reform, 1926 Mellon Style

As Americans consider potential tax reform measures recommended by the Bush White House and congressional majority in 2006, it might be worth reviewing the measures undertaken in 1926 under Calvin Coolidge's Secretary of Treasury Andrew Mellon.  Here's an excerpt from Robert S. McElvaine's book, The Great Depression: America, 1929-1941 (Three Rivers Press, New York 1993) (formatting edited slightly).

"Mellon [was a] Pittsburgh banker and industrial magnate who was secretary of the Treasury in the administrations of all three Republican presidents of the twenties.  One of the richest men in America, Mellon strived unstintingly toward his major goal: the reduction of the tax 'burden' on the rich.  Until 1926 progressives in Congress were able to block Mellon's most generous proposals for his own class.  Of Mellon's bill Senator George Norris said without much exaggeration, 'Mr. Mellon himself gets a larger personal reduction than the aggregate of practically all the taxpayers in the state of Nebraska.'" 

"Under Mellon's Revenue Act of 1926, a person with an annual income of $1 million had his taxes lowered from more than $600,000 to less than $200,000.  Mellon's own income was considerably higher, and he benefited even more from his own program.  Small taxpayers received minimal reductions.  Nor did Mellon's munificence end there.  He and the few people in his income bracket also enjoyed clandestine administrative refunds of taxes.  Mellon was generous in granting tax credits, abatements, and refunds.  Between 1921 and 1929 (when his activities were exposed by House Speaker John Nance Garner), $3.5 billion was granted to corporations and individuals friendly to the Republican party."

"In the twenties, however, helping the rich was not a partisan issue.  Pierre S. du Pont, president of E.I. du Pont de Nemours & Co., was--for understandable reasons--of the opinion that the rich should not bear the burden of taxation.  Taxes, du Pont reasoned, ought to be paid by the working class, not the 'productive' class (which he defined as large employers).  This view was shared by John J. Raskob, an executive of Du Pont, General Motors, and other corporations.  In seeking a way to bring about their objectives, these two eminent gentlemen, along with some wealthy associates, hit upon a brilliant scheme.  They would seize control of the Democractic party and commit it to the repeal of prohibition.  When this was achieved, they would place a tax on beer, the workingman's drink.  Estimates indicated that such a levy could raise $1.3 billion.  This would allow a further 50 percent cut in corporate and individual taxes.  In short, Du Pont and friends would give workers beer, and with it they would also give them half the tax burden of the rich.  It seemed to them to be a reasonable trade-off."

***

"Thus by the end of the twenties, Raskob seemed to be close to the mark when he said the only difference between the two parties was that the Democrats were wet and the Republicans were dry.  He might have added that Republicans favored shifting taxes from the rich to the poor by means of a national sales tax (an idea that Mellon had been pushing since 1920), while the Democrats would try to achieve the same end by taxing beer.  The conservative era had reached its zenith--or its nadir, depending upon one's point of view."

Like Mellon's Republicans, today's Republicans are again pushing enormous tax cuts for the wealthy and sales taxes for ordinary Americans.  Today's tax cut advocates push the same worn argument about protecting those who are "productive"--they argue that capitalists are the entrepreneurs who must be protected from taxes so that they can fuel economic growth.   The greatest benefit of the tax cuts goes to the elite class that passes them--the millionaires in Congress and the owners and managers of corporate America who wine and dine them.  We seem to be in a kind of time warp, reliving the worn ideas from the twenties that fed the Great Depression.