feature-2011-07-taxgap

Solutions for the “Tax Gap”

July 18, 2011 | by | Topic: Economics & Political SystemsPrint Print

In 2010, there was a “tax gap”—i.e., the difference between federal taxes owed and those actually paid—of $410–$500 billion.

Some of the gap stems from the complexity of the tax code. Much of it, though, is deliberate­­: self-employed individuals working for cash, table-servers under-reporting tips, taxpayers claiming unauthorized credits and deductions. And don’t forget the highly paid White House, congressional, and federal agency staff (including some at the Internal Revenue Service) who, according to reports last year, collectively underpaid their taxes by tens of millions of dollars.

Unpaid taxes are unfair to the millions of taxpayers who pay their full tax obligation. What can be done?

Some suggest beefing up the IRS’s budget and manpower. Many oppose this out of concern that an enlarged IRS would be like the Transportation Security Administration, making life miserable for millions of law-abiding citizens.

President Obama estimates that increased enforcement would capture 10 percent of the tax gap. That sounds accurate. Completely eliminating the tax gap is no more possible than completely eliminating waste and fraud from Medicare. When systems become as gigantic and convoluted as our tax code and the Medicare system, all the king’s horses and all the king’s men can’t extirpate fraud, waste, and loss.

Since the tax gap is so intractable, we should investigate alternatives to the reflex political “solution” of hiring more government workers. I do not condone breaking the law, but if millions of otherwise law-abiding Americans are defying a law, then maybe something is wrong with the law itself.

Millions of Americans despise our tax laws. They believe that taxes are excessive and that the tax regime is arbitrary, discriminatory, and oppressive. One potential reform is to adopt a low, flat tax rate, such as those that Russia and other erstwhile communist countries now have. Low, flat taxes reduce the incentive to cheat. Fewer people risk criminal prosecution for 12 or 15 percent of their income than when 28 percent or more is at stake. In addition to greatly simplifying the tax code (which would also reduce the portion of the tax gap resulting from miscalculations), a flat tax lessens the rebellion fueled by discriminatory progressive taxes.

An even more effective way to eliminate the tax gap would be the appropriately labeled “fair tax,” which would replace all federal taxes on income with a national tax on consumption. The fair tax would restore taxpayer privacy, save the colossal amount of time spent calculating (or miscalculating) one’s tax liability, and would bring the vast underground economy above ground into the taxpaying realm.

Either a flat tax or a fair tax would be better than the existing tax code, but the problem underlying the tax gap goes beyond our crazy, convoluted tax code. The fundamental problem is the widespread perception that our political system itself is immoral, dishonest, and corrupt.

Is it any wonder that taxpayers are cynical and demoralized when politicians routinely break promises; the government’s own accounting watchdogs refuse to vouch for the accuracy of government’s official budget figures; rich people and businesses with expensive tax attorneys and accountants can legally avoid taxes; and well-funded, politically-connected special interests get billions in handouts and bailouts from government?

Citizens perceive that our democratic process has degenerated into what H.L. Mencken dubbed an “advance auction of stolen goods.” Trillions of dollars per year are redistributed according to who has power, connections, and lobbyists. American politics has become a never-ending donnybrook in which nearly everyone wants the government to make somebody else pay for the benefits they receive.

In the moral lawlessness that characterizes a redistributionist state, respect for property rights atrophies. When politicians, intellectuals, clergymen, the media, etc. demagogically denounce “the rich” and have the effrontery to call income that they grudgingly let a taxpayer keep “a tax expenditure,” it is not a good situation for property rights. In this “every man for himself,” “grab what you can get” culture, many individuals will defy the law.

The root cause of our elaborate, confusing, costly, maddening, and unfair tax system—and of the tax gap—is our delusional belief that we are entitled to a free lunch and our morally bankrupt insistence that government subsidize our lifestyles with wealth from others. Until we correct those errors and quit worshiping at the altar of Big Government, the tax gap will not go away.

Mark W. Hendrickson

Mark W. Hendrickson

Dr. Mark W. Hendrickson is an adjunct faculty member, economist, and fellow for economic and social policy with The Center for Vision & Values at Grove City College.

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