May 16, 2002 | Commentary on Taxes
Take, for instance, the Earned Income Tax Credit. It was
Congress that created the EITC-essentially an income-redistribution
program-not the IRS. But rather than provide this wage subsidy
directly to lower-income workers, lawmakers dubbed it a tax benefit
and put the IRS in charge of operating it. The result: a
complicated mess that is riddled with fraud.
It's unfair to condemn the IRS, as The New York Times
recently did, for investigating a high number of suspicious EITC
claims. With fraud rates as high as 25 percent, what choice does
the agency have?
Well, the Times says, the IRS can audit more rich
taxpayers. Statistics show that corporations and upper-income
taxpayers face a relatively small risk of being audited (about 1 in
145 of those making more than $100,000 a year, versus 1 in 47 for
those who claim the EITC). But those who think this would cause tax
revenue to rise are confusing tax avoidance with tax evasion.
Tax avoidance is the legal use of shelters, loopholes,
preferences, credits, deductions and exemptions to reduce tax
liability. Not surprisingly, rich people and corporations make
extensive use of these provisions. Indeed, there's an entire army
of Washington lobbyists who earn six-figure incomes getting these
goodies placed in the tax code on behalf of well-heeled clients and
Many of these provisions are horrible tax policy. They
complicate the tax system and encourage taxpayers to ignore
economic fundamentals and make decisions on the basis of tax
considerations. But it's perfectly legal for taxpayers to use these
provisions to lower their tax bills. As such, the IRS frequently is
unable to collect much money when it audits corporations and the
This isn't the IRS's fault. It's the result of almost 90 years
of social engineering and back-door industrial policy by Congress.
Politicians from both parties have used the tax code as a tool to
reward friends and punish enemies. The IRS, meanwhile, is left with
the unenviable task of trying to enforce one of the world's most
complex tax codes.
It's not that the rich are less likely than the poor to scam the
system. There are many ambiguous provisions in the tax code, and
some well-to-do taxpayers do stretch the law well beyond its
breaking point. But wealthy taxpayers aren't easy targets for the
IRS. Armed with lawyers, accountants and financial planners, they
have the resources to fight -- and often win -- a battle with the
There are two ways of increasing tax compliance. One is to
create a more intrusive government by giving the IRS more power to
snoop into our affairs. A good example: the IRS's recent proposal
to examine the credit-card records of Americans who have foreign
bank accounts. This fishing expedition would violate privacy and
run roughshod over civil liberties. Yes, it likely would catch some
taxpayers who aren't reporting income from foreign accounts, but do
we really want to give the IRS that much power?
The second way is tax reform. Ironically, America can learn much
from Russia on this topic. Two years ago, the former communist
state had a Western-style "progressive" income tax. But high tax
rates drove capital out of the country and encouraged workers to
accept income under the table. So Russia's leaders decided to junk
the tax code and replace it with a 13 percent flat tax.
The results have been spectacular. Russia's flat tax has been in
effect since January of last year, and inflation-adjusted tax
revenues have jumped by nearly 30 percent. And now that President
Vladimir Putin and his band of reformers are beginning to tackle
the problem of punitive payroll tax rates, there is every reason to
expect that tax revenues will continue to rise. Russia faces other
challenges, of course, but it's taken a huge step in the right
And if former communists can implement a flat tax, maybe there's hope for the U.S. Congress. It certainly would mean less tax evasion, as lower tax rates and tax simplification reduce both the incentive to evade and the opportunity to avoid. And while it may not be good news for the thousands of IRS bureaucrats and the legions of well-paid tax lawyers, lobbyists and accountants, it would make life better for the American people.
Daniel Mitchell is the McKenna senior fellow in political economy at The Heritage Foundation (www.heritage.org), a Washington-based public policy research institute.
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