Category: income tax

Apologies to Sergio Leone

The Good

Last Thursday, the governor signed federal conformity changes into law (Laws 2023, chapter 1), less than two weeks into the legislative session, lightning speed by legislative standards. I can remember only two similar instances of the legislature acting almost as quickly on a conformity bill in the last 30+ years. In both cases the laws were signed on the last days of January (Laws 2005, chapter 1 on 1/27/05 and Laws 2009, chapter 12 on 1/29/09) and involved relatively inconsequential changes responding to end-of-the-year federal enactments. The 2005 law allowed an extended period to make charitable contributions for Indonesian tsunami relief.

Update and correction: Cynthia Templin, House Fiscal analyst, points out how defective my memory is. Early conformity bills passed in January of 2015, 2017, and 2022. I should actually look this stuff up. Of course, the 2022 legislation (after my retirement) was selective leaving important stuff for later. But things were not really as bad as I recalled.

The need for 2023 conformity changes before the start of the tax filing season was largely due to the previous legislature’s failure to act, of course. Congress did enact some modest changes after the legislature adjourned. Often in the past, it was Congress enacting “extenders” legislation retroactive for the current year. This time it is was self-inflicted by the 2022 political impasse.

The bill is scored as a tax cut of about $100 million for FY 2024 (mostly one-time, though), which I’m sure made it easier to pass and much more consequential than the two examples from the aughts. The Strib billed it as a COVID tax cut (print edition headline: “Walz signs COVID aid tax break”). But aside from the direct effect on state revenues (i.e., the explicit tax cut) it also is an implicit tax cut because of the vast time savings involved (time = money).

It will save tax preparers, taxpayers, and DOR staff thousands of extra hours of wasted time and effort – preparing returns under an out-of-conformity law and redoing them under a revised law that adopts the federal changes. I don’t think thousands is an overstatement when you consider the number of tax filers and how even those unaffected by the federal changes still must click through software questions or read instructions for those who still prepare their returns “by hand.” Even modest per hour assumptions of the value of the wasted time yield millions of dollars of savings.

All those hours wasted doing needless tax preparation and compliance when the legislature fails to pass a conformity bill are an implicit tax increase. It does not show up on legislative spreadsheets or revenue estimates, but it is just as real as an economic matter. That concept, however, was hard to convince legislators of – probably because it is not the sort of thing that shows up on campaign literature (explicit cuts and increases do) and is a long and complicated point to make to voters. Few legislators would attempt to do so during a campaign unless they were speaking to a group of tax preparers.

Delay or total failure has occurred so many times in recent years that I now expect it. That stimulated me to reflect on the why of past failures and whether this year could become the new normal, the real reason I’m writing this. I think the following factors are at play:

• The large surplus made life relatively easy, given chapter 1 is a big tax cut. In a tight budget, legislators become unwilling to take money off the table early in the process. $100 million is chump change relative to $17 billion. And since the cut is largely one-time, few permanent decisions are being made. That unusual combination is unlikely to reoccur.
• Unified party control helps. When the GOP controlled one or both houses of the legislature with a DFL governor, they would think (falsely in my opinion) that the governor was responsible for conformity (it was in his budget and the executive branch administers the tax) and, therefore, would make political concessions to get it in a final budget deal. That was rarely, if ever, true. Governors did not consider it much of a political priority as a good government responsibility. Thus, its trade value was minimal in budget negotiations. (Note that Pawlenty was governor with DFL control of one or both houses for the two other examples of early conformity passing. DFL legislators either recognized the value of conformity or the lack of trade or bargaining value, not sure which.)
• The tax chairs likely are on the same conformity page. During the Lenczewski and Bakk era, this became a factor. Representative Lenczewski was a big advocate for conformity, while Senator Bakk seemingly did not consider it to be big deal. He, being a master negotiator and deal cutter, naturally assumed he could get something for agreeing to conformity in a final deal, even if he favored it. As a result, decisions tended to be delayed. Again, he probably overvalued the trade value but why throw chips away if getting the maximum deal is your default frame of reference.
• A final factor that militated against passing multiple bills was tax chairs’ distaste for floor fights. Bringing tax bills up to the floor typically leads to the minority offering multiple gotcha amendments for various and sundry tax cuts (to get bad political votes on the record) and long debates for consumption by the viewers of legislative TV (who are those people and why don’t they have anything better to do?). This is an unpleasant process to go through once, much less twice. This distaste/pain looms larger if you think you probably can’t get a deal until May anyway. (As an aside, I always doubted the utility of getting two sets of the same bad votes on the record and why that would matter. But I have never been involved in campaigns.) In this case, the minorities apparently decided not to make the majority run that gauntlet twice. I have no clue why, but applaud the decision to forgo a meaningless exercise.

Is this likely to continue in future sessions? I hope so but would not put money on it. But even one-time victories are a cause for celebration.

The Bad

By contrast, the first action of the U.S. House of Representatives was to repeal the increased funding for the IRS that passed last year in the Inflation Reduction Act. House Republicans use first vote to gut IRS funding boost (Politico 1/10/23). It left in place the funding for increased taxpayer services and some of the IT improvements. (WaPo reports “a little over half [of the original $80 billion w]as targeted for enforcement.” The House GOP bill repeals 7/8^th of the funding, so well beyond the enforcement money.) Because Biden is president and the Dems control the Senate, it won’t be enacted into law but is nevertheless a bad thing.

• Since the big 2022 federal budget deal froze IRS funding (at the insistence of the Senate GOP), if enacted it would return the IRS to starvation funding for purposes of enforcement and system modernization. That is a recipe for more noncompliance and unfairness. One takeaway from the Joint Committee’s report (12/14/2022) on Trump’s tax returns is how under-resourced the IRS is in dealing with the complicated returns of high-income business owners (400+ PTEs to review, a fair number of which had a lot of revenue and magically identical expenses, and one auditor!).
• It would increase the deficit by more than a $100 billion according to CBO, money that is owed under current tax law. It reflects a common pattern in Congress – Dems enact new spending that is supposedly paid for with revenue increases – GOP feigns concerns about deficits but proceeds to advocate for and repeal the revenues (with support from Dems) without doing anything about the spending. That is what happened to much of the revenues that funded the ACA (remember the Cadillac insurance and medical device taxes?). The fact that the new House GOP rules replaced PAYGO with CUTGO (Politico) reveals that the GOP’s concern about deficits looks the other way when reducing revenues is the proposition. Deficits apparently don’t matter if you’re cutting taxes? Weird asymmetry calculated to curry political favor from those who want government services/benefits but don’t want to pay, contrary to Milton Friedman’s classic aphorism: “To spend is to tax.”
• It took 15 votes to elect a speaker. By contrast, all but one of the GOP members voted to repeal the IRS funding, and none voted against it. That is sobering (so much for the idea there are GOP moderates when it comes to taxes) and a clear message about where their priorities lie. It is easy to reflexively hate taxes but irrational. Everything (including government services) has a price that must be paid. A measure of honesty would reveal what spending they plan to reduce. Of course, they simply regard the CBO estimate as inaccurate if the past is any guide.
• Expect the 118^th Congress to travel a bumpy fiscal road. Let’s hope they figure out that the debt ceiling must be increased without the need for a financial meltdown lesson. It’s probably too much to expect them to remember what happened in 2011. According to the Council on Foreign Relations:

The protracted and politically acrimonious debt limit showdown in the summer of 2011 prompted Standard and Poor’s to take the unprecedented step of downgrading the U.S. credit rating from its triple-A status, and analysts fear such brinksmanship in late 2013 could bring about similar moves from other rating agencies. “Failure to raise the federal debt ceiling in a timely manner (i.e., several days prior to when the Treasury will have exhausted extraordinary measures and cash reserves) will prompt a formal review of the U.S. sovereign ratings and likely lead to a downgrade,” said Fitch Ratings, which maintains a “negative” outlook on the U.S. triple-A rating.

A 2012 study by the nonpartisan Government Accountability Office estimated that delays in raising the debt ceiling in 2011 cost taxpayers approximately $1.3 billion for FY 2011.

The stock market also was thrown into frenzy in the lead-up to and aftermath of the 2011 debt limit debate, with the Dow Jones Industrial Average plunging roughly 2,000 points from the final days of July through the first days of August. Indeed, the Dow recorded one of its worst single-day drops in history on August 8, the day after the S&P downgrade, tumbling 635 points.

U.S. Debt Ceiling: Costs and Consequences

I personally don’t think there is any credible case for the claims the Republican sponsors are making for the defunding (preserving the middle class from nasty IRS audits or some such). For what passes for supposedly thoughtful case for the defunding see here: National Review (Nate Hochman) and the counter from the left, New York magazine (Jon Chait). Attributing assertions from a GOP press release to the Tax Foundation is pretty low stuff, especially for a reputable publication like the National Review (Bill Buckley must be turning over in his grave). The Tax Foundation has a conservative tilt but (in my experience) does not make stuff up; they just make sure the stuff they put out skews right. You can trust their numbers but need to be careful about what’s missing or the spin they put on it – typical of most of similar beltway outfits, whether on the left or right.

The Ugly

According to Fox News, Kevin McCarthy has promised a floor vote on replacing the income, corporate, and estate taxes with the Fair Tax, which abolishes the IRS (states would collect the tax). This was apparently part of the deal to get him elected speaker and will obviously be purely symbolic.

The Fair Tax, a national retail sales tax, has long been a favorite among very conservative Republicans nationally and at the state level (versions have been introduced in Minnesota). But it’s largely a collection of talking points and not a practical proposal.

The U.S. does need a broad-based consumption tax to supplement (not replace) existing taxes. Every other major developed nation has one and none of them spend as much on defense as the US. That is the only way we will be able to continue funding our current level of government services. Since the turn of the century when the budget was last balanced, the deficit spending – due to the combination of tax cuts, two wars, and the baby boom tapping into social insurance – is simply not sustainable, even ignoring COVID relief spending. Cutting spending isn’t going to do it under any realistic political scenario (see this Committee for a Responsible Federal Budget piece on spending cuts; for example, 85% of discretionary spending would be cut if social security, Medicare, veterans, and the military are off limits; just imagine what the health care world would look like without Medicaid funding).

The consensus across the spectrum of experts is that it should be a VAT, rather than a retail sales tax with all its problems of enforcement and administration. The rest of the world abandoned retail sales taxes decades ago as suboptimal. For a full bore treatment of the flaws in the Fair Tax you can read this old Tax Notes article by Bruce Bartlett, Why the Fair Tax Won’t Work (available on SSRN). Bartlett is a former deputy assistant Treasury secretary for economic policy during the GHW Bush administration and an engaging and accessible writer.

Bulwark (a conservative, Never Trump site) questions the politics of bringing it up for a vote: Will the House GOP Really Walk the Plank for the Fair Tax?  It’s amusing reading (at least for me).

If one wants to stay optimistic, this could be a baby step forward in the conversation about the need for a national consumption tax. Obviously, it won’t be with the focus instead on abolishing the IRS, its artificially low tax inclusive rate, and other silliness.

The whole idea of turning tax collection over to the states is the height of foolishness. Do we want to rely on likes of Mississippi and Nevada, to take two examples, to collect federal taxes when inattention or outright corruption can curry favor with local voters and businesses? A sure recipe for undermining revenues and national unity. The founders discovered a similar problem with the Articles of Confederation, after all. The power to impose taxes (the prime reason for the Constitution) necessarily involves the ability to collect them, rather than relying on the good graces of semi-autonomous and occasionally hostile state governments (see, e.g., Texas when a Democrat is in the White House).

My sympathies go out to the nonpartisan Congressional staffers who will spend hours working to provide the symbol, complete with drafts, revenue estimates, summaries, explanations, etc. They will also likely be criticized and/or ordered to fix flaws that are revealed, as they inevitably will be by expert commentary and media coverage. If the underlying concept is unworkable – it is – fixing it technically is not possible. Explaining it accurately without implicit disparagement is not easy.

Refunds of PTE tax

MMB is out with its October report on revenues. They continue to come in above forecast, a modest $126 million. Of that, $53 million were from the individual income tax.  Most interesting to me, there still isn’t apparent evidence of the unwinding of overpayments as a result of the new pass-through entity (PTE) tax. The presumption is that taxpayers paid individual income tax on that income during 2021 and near the end of 2021 decided it was preferable (b/c it reduced federal tax) to pay the PTE tax, essentially double paying. The overpayment would unwind when they filed their individual returns and claimed refunds for the individual income estimated tax payments.

Extension filing is due in October. So, I presume that the returns are filed.  Because individual income tax revenues continue above forecast, a big uptick in payment of refunds does seem to have occurred.  That does not settle the issue for at least three reasons:

1. Taxpayers can apply their refunds to their tax year 2022 liability, rather taking the money as a refund. But if they’re going the PTE tax route, I would guess that is somewhat less likely since their payment obligations would be under that tax. You cannot credit overpayments of individual income tax to the PTE tax, which is an entity tax for which there are DOR separate accounts.
2. Some refunds may not be processed yet. Returns involving large amounts of PTE income are often among the most complicated returns, more of them may be filed on paper, and they take longer to process. So, refunds due the PTE tax switch may still be in the pipeline.
3. Other factors (actual economics) may be yielding individual income tax revenues to offset a rise in refunds attributable to the PTE tax.

We’ll have to wait until the November forecast to a get a fuller picture, but I’m guessing more of the revenues are real rather than timing related to PTE tax payments as MMB has reported thinking ($1 billion seems too high to me).

Doug Johnson

It is with sadness that I note the passing of former Senator Johnson. I never had the privilege of working in the same house of the legislature with him. He moved from the House to the Senate just as I started working for the House. But I staffed many conference committees of which he was a Senate member or chair. So, I had ample opportunity to observe him in public and private meetings, as well as one-on-one a few times.

He was my favorite Senate tax chair by a wide margin. He obviously cared about and showed respect for people, whether other members, lobbyists, staff, or the unwashed public, and he listened and was generally open-minded to policy, administrative, and practical concerns (not just political). He was very patient in listening and letting people make their points. That often paid off both in gathering support for and improving his proposals.

The published remembrances of him capture well that he was a very effective a legislator. Like most good legislators he was able to somehow juggle personalities, interest groups, competing partisan positions, etc. in putting together support for proposals that met his and his caucus’s policy priorities. This obviously required an ability to read people and convince them, as well as a willingness to bend, to compromise, a characteristic that now seems in scare legislative supply.

The published obits have made much of his bring home bacon for the Iron Range. I think that is somewhat overstated even though it has a sort of statutory recognition (more of a reflection of the widespread recognition and affection he enjoyed). Like most Range legislators, he was proud and protective of the region he represented. As the mining industry/sugar daddy’s local tax largess began to run low (starting in the 1950s), the DNA of Range legislators dictated they fight for state help to maintain the local public services to which they had become accustomed. Their pivotal political positions in the DFL Party and legislature often enabled them to accomplish that. My perception, though, was that Senator Johnson was more tempered and reasonable in that regard than many Rangers. But more importantly I always thought he was more concerned about what was good for the state than the Range. To be fair, in his mind the two objectives were likely in conflict only rarely.

His work in on the 1985 and 1987 tax bills that greatly simplified and improved the individual income taxes, expanding the base and lowering rates in line with the 1986 federal tax reform, were high points. These were balanced proposals that somehow, he (and Governor Perpich, to be clear) managed to pass, despite strong political opposition by various narrow interests who lost special provisions (pensioners, active military personnel, etc.) in the final deals. There was a good deal of political risk involved with the good policy the only payoff.

An underappreciated quality was his attention to and respect for technical, administrative, and practical issues. Many legislators ignore these important considerations when raised by DOR or legislative staff, pooh-poohing them as overstated or easy to overcome. Senator Johnson, to his credit, typically did not. After he retired, he would call me once or twice each legislative session regarding proposals he was working on as a political consultant. He didn’t do so because he wanted to know what I thought about the policy but to check out technical and legal issues, to make sure they would work and there wasn’t a better way to accomplish his goals. I suspect he did the same with DOR staff that he trusted.

Fundamentally, I will remember him because of the kind and delightful person he was, someone who generally cared about people and not just the famous, moneyed, or powerful with whom he had plenty of contact. He was funny and personable. RIP Doug.

Taxing Cannabis

The mid-term election results increase the prospects for legalization of recreational marijuana (beyond the half-measure passed in 2022). If that comes to pass, the legislature will need to decide how to tax it. Of course, it could ignore that and treat cannabis like any other consumption item, subject to the general sales tax. I assume that is unlikely because of the product (as with alcohol and tobacco) has perceived external social costs and because legislators want the revenue. (Colorado and Washington annually collect about a half billion in revenue from their taxes.) Proponents of legalization (e.g., former Governor Ventura) have touted legalization’s potential for generating revenues. I assume that is because they assume a differential (higher) tax will be imposed, not just the sales tax.

I have not formulated policy views on how to best tax cannabis and there is no consensus or conventional wisdom. Thus, it is a tricky area,

TPC has a report out on how other states do it, which provides good background information and policy advice. The House bill in the 2021-22 session had detailed provisions on taxation but (I suspect) no one really thought they would get enacted. My experience is that folks do not really focus on and get serious about the policy and practical issues until passage appears imminent. That was the case for the MinnesotaCare gross receipts tax back in the 1990s. If that is true, serious considerations and discussions will need to occur during the upcoming legislative session.

The TPC Report’s introduction frames the inherent tradeoffs as follows:

The underlying goal of marijuana legalization is reducing illegal sales, whereas the main goals of cannabis taxes are raising revenue, addressing the negative consequences of cannabis use not reflected in the purchase price (i.e., externalities), and discouraging the use highly potent products. The challenge of taxing marijuana is achieving those latter goals without creating an overly onerous or complex tax system that jeopardizes the underlying goal of legalization.

Richard Auxier and Nikhita Airi, THE PROS AND CONS OF CANNABIS TAXES, 1 (9/28/22)

In my view, raising revenues (beyond those resulting from avoiding illegal evasion of sales tax) should not be an important goal. Put another way, any special or higher tax should be justified by recovering or compensating for social or external costs of its use. (Broad-based general taxes should be relied on to raise general revenues.) That is the justification for alcohol and tobacco taxes. To me it is very clear that state alcohol taxes, including Minnesota’s, are too low to recover the social costs of alcohol abuse, which by many accounts (here, e.g.) are very large. (FWIW, according to the TPC Report both Washington and Colorado collect more in cannabis taxes than in their combined alcohol and tobacco taxes.) It is simply not politically feasible to do so, because the general population and the industry cast the taxes as burdening nonproblem drinkers who do not impose those social costs. The difficulty with cannabis taxes is, I suspect, that no one has a good fix on what the magnitude of the social costs are. If one assumes they are high and heavy special taxes should be imposed to recover them, you run the risk of simply driving sales back to the black market (i.e., where they are now) and thwarting part of the reason for legalization as well as not collecting the revenue.

As TPC points out, if the feds legalize national sales that will add a new dimension to appropriate state and local tax policy – i.e., the potential for a national market and the resulting tax competition. Its advice to stay flexible and constantly reevaluate is well taken. But once something is enacted, expectations are created and change becomes difficult. So, it is important to get it as right initially as possible.

City sales tax votes

Updating the city sales tax post, the Secretary of State’s website has the results of the city sales tax votes for taxes authorized by the 2021 tax bill. Of the ten new taxes on the ballot, nine were approved and one rejected (those with two votes were for separate project approvals):

1. Edina – approved (16,646 – 11,345; 14,605 – 13,224)
2. Grand Rapids – approved (2,457 – 1,746)
3. Litchfield – approved (1,431 – 1,139)
4. Fergus Falls – approved (3,375 – 2,230; 3,361 – 2,234)
5. Maple Grove – approved (18,739 – 15,060)
6. Moorhead – approved (8,782 – 4,861)
7. Oakdale – approved (5,766 – 5,425; 6,218 – 4,992)
8. Staples – approved (438 – 300)
9. Wadena – rejected (32 – 36)
10. Warren – approved (333 – 318)

Projects and taxes were on the ballot in cities with existing taxes, as well. Waite Park, which imposes a tax under the St. Cloud area tax, rejected imposition of an additional tax for a public safety facility project, but approved one for a regional trail connection. Voters in St. Cloud, which has a tax, also rejected a municipal athletic facility project. The voters in Cloquet approved two new projects.

Thus, the usual pattern of overwhelming voter approval for most of these taxes and projects continued to hold.

Senator Ann Rest

I don’t know if there is a previous example of an individual who served as chair of the tax committees in both the House and Senate, probably not. Ann Rest’s designation/election as Senate chair will make that happen in 2023. I worked with her for four years when she was chair of the House committee and two additional years as the ranking minority member. The Senate committee will be in good hands, someone who understands and cares about tax policy and administration.

Partisan affiliation as a COVID risk factor

I vowed to not go off topic and write (yet again) about COVID. But this NBER article (Jacob Wallace et al, Excess Death Rates For Republicans And Democrats During The Covid-19 Pandemic) striking findings on excess deaths by voter registration in Ohio and Florida was too interesting to pass on providing a link. I won’t comment beyond observing that data limits prevent robust statistical controls for relevant factors and wondering whether the results extend to other states (Minnesota?). The obvious question is whether this could affect very close elections?

IRA’s $80 billion in additional funding for the IRS is attracting media attention, in addition to and probably because of the partisan GOP opposition I’ve noted previously. That’s a lot of money and it should get some scrutiny.  Much as I think restoring agency funding to the 2010 level plus making up for deferred investment in the agency’s IT infrastructure is ample justification, public discussion and debate is in order.

The NPR 1A talk show hosted a program with an all-star cast – Nina Olson, the former Taxpayer Advocate who always has good insights and sensible things to say (and probably would have made a good IRS commissioner); Richard Rubin, a long time Wall Street Journal reporter on the tax beat; John Koskinen, former IRS commissioner (appointed by Obama), and Natasha Sarin, assistant secretary of Treasury (and the coauthor with Larry Summers of multiple articles about using IRS funding to raise revenue that I have blogged about). The show was a disappointment. I don’t think I learned anything new. It covered old ground and was basically pitched to the general public, necessarily a low common denominator audience. I don’t have any particular criticisms, but I felt I wasted a half hour.

By contrast, I learned a variety of stuff from Howard Gleckman’s TPC podcast interview of Koskinen. Of course, that is because TPC’s target audience is wonkish types like me who are interested in tax and fiscal policy. I don’t think Koskinen has inside information, so it’s unclear how reliable or authoritative he is. But he did head the IRS for one term. Some points and my reactions:

• Congress’s last-minute deletion of the Service’s authority hiring and compensation flexibility. He didn’t offer information on why this happened (like me, he probably doesn’t know or maybe doesn’t want to say) but opined that it was a big deal, especially the ability to hire more quickly.
• 87,000 new employees. This has been a headline and flash point for the partisan opposition (e.g., the erroneous implication that they will all be auditors and carrying firearms per Chuck Grassley and others). Since the IRS is projected to lose up to 50,000 employees to retirement, Koskinen suggested that it would really mean more like 25,000 to 35,000 new employees. That seems off to me. I assume that the base budget will cover replacing existing employees and the additional funding used for new employees. My guess is that some budget staffer(s) came up with the number and that it is not tied to a specific management/business plan and may not reflect reality. Although the partisan sniping about this is off base, it is what to expect when you put out specific numbers.
• Source of the $80 billion amount. Koskinen made the point that the $80 billion number came from the administration’s proposal and included implementing and administering the expanded information reporting on financial institution flows, a variation on former IRS Commissioner Rossotti’s idea. Congress deleted that but the $80 billion number in the administration’s proposal did not change. See this CRS FAQ on the idea for background info. I don’t know how much implementing and administering it was scored to cost and IRS probably could implement it under its administrative authority. But I would be shocked if the Service tried to do that after Congress explicitly rejected it. That would court a Congressional slap down.
• Ramping up taxpayer service. Koskinen felt that taxpayer service could be quickly ramped up – i.e., hiring more people to answer the phone (an abysmal 11% of calls were answered during the 2021 filing season). I had wondered about how feasible it is to do that given the labor market, training requirements, and so for. But I assume that is something a former commissioner who does not have a partisan agenda should know and be candid about.
• Tax complexity. He validated my instincts that tax complexity is not the problem and that simplifying the tax code (although a very good thing to do: see here for a summary of why) would not right the ship. He pointed out that IRS successfully administered the monthly payment of child credits, a clear achievement. That’s a little off because it’s not an auditing complexity but rather an administration complexity. Nevertheless, it took a lot of resources and expertise to pull off. In my opinion, the points made by a variety of people about complexity being the core problem (see e.g. Clive Crook) are largely a smoke screen and likely intended to make opposition to the funding increase appear less unreasonable, a deflection. (Crook’s picking on the complex retirement rules, something I whole heartedly agree with as a policy matter, seems odd. I haven’t heard that noncompliant retirement plans are a big source of the tax gap. Stuffing of founder stock or other unconventional assets in IRAs is a compliance problem but I doubt it contributes much to the tax gap estimate. I would guess that the mindboggling complexity/ambiguity of subchapter K would be a better target. The IRS barely audits partnership returns, probably for a variety reasons, one of which is likely their complexity and ambiguity.) Even magically assuming the simplest tax code, failure to report income for which there is no information reporting or overclaiming business deductions (allowable under the simplest of tax income tax systems) will always be compliance problems. If Crook had picked on the TCJA (QBI, interest disallowance, etc.) I would be much less skeptical that his hands are clean and he’s not trying to suck up to the GOP opponents of funding increases. This problem can only be fixed by refunding the IRS to normal levels. Major simplification would be complementary icing on the cake and good for other reasons as well.
• Lack of funding continuity. In making clear the management problems with stop-and-start funding, Koskinen pointed out that one year during the Trump administration the agency’s administration and modernization budget was cut by 50%. I had not heard that before.

FATCA compliance

Reading the recent Senate Finance Committee Report on the “shell bank” loophole in FATCA – the Obama era federal law intended to reduce evasion by hiding income in foreign bank accounts – revealed this nugget about how lack of funding has reduced FATCA’s effectiveness that I had missed (not regularly reading TIGTA reports):

According to a recent TIGTA report, as a result of significant IRS budget cuts following the enactment of FATCA, the IRS “has not come close” to building out its original FATCA compliance roadmap and has instead taken “limited or no action” on a majority of planned activities. This has led to significant underreporting of foreign bank accounts by U.S. taxpayers and billions in lost revenue. For example, IRS data identified more than 330,000 U.S. taxpayers from 2016 to 2019 that failed to file required forms to report foreign bank accounts with a balance more than $50,000.70 The IRS has failed to act on this information, leaving at least $3.3 billion in uncollected revenue on the table.

The Shell Bank Loophole, p. 17 (undated) [footnotes omitted].

The report focuses on the $2 billion tax evasion case against Robert Brockman who died last month (WSJ paywall). Outright failure to report income will not stop no matter how simple the tax code is.

Appalling

If you want to laugh and/or cry (I couldn’t decide) here’s a link to Senator Rick Scott’s letter advising people not to apply for IRS jobs because when the Republicans take over Congress and cut IRS funding you’ll get fired. It reads like it was produced by some politico comms who are Babylon Wannabees but aren’t funny, a sort of Animal House writers’ room that controls a US Senator’s media releases. Example quote:

The IRS is making it very clear that you not only need to be ready to audit and investigate your fellow hardworking Americans, your neighbors and friends, you need to be ready and, to use the IRS’s words, willing, to kill them.

Scott letter (August 16, 2022)

Hyperbolically “defunding the police” in favor of “an IRS super-police force” is its conclusion. Explanation: IRS CID agents, a tiny subset of its workforce, can carry firearms and therefore use deadly force, a fact that was stated in the original IRS job posting. That gave Scott’s comms license, I guess. I had one instance in my legal career to deal with two CID agents, seeking info on a legislator. They were not packing heat, unless their guns were in their attache cases or strapped under their pant legs.

Does Senator Scott think stunts like this convince people to vote Republican? Who is he trying to appeal to anyway? Scott is a professed conservative who presumptively should respect institutions and norms. Tax collection is a core government function and ensuring most people pay close to what they legally owe is a matter of fairness and respect for the rule of law. I get that some frat boy comms likely thought this was funny. But a 20% cut in the IRS’s budget and cutting audits of the top 1% by upwards of 75%, which is what was done, is a recipe for encouraging noncompliance.

Aside: Unlike flying undocumented immigrants to Martha’s Vineyard or busing them to NYC and DC, it’s pure rhetoric and at least does not make flesh and blood human beings into Theatre of the Political Absurd stage props. Politics has moved beyond what a normal guy like me can understand. I don’t think I’m just another old man yelling at the neighbor kids to get off my grass; this just seems stupid and mean (w/ regard to the immigrants).

This TPC blogpost is an antidote to some of the misinformation that is being put out about the IRS funding FWIW. Or see this opinion (Sense and Nonsense About the IRS’s Funding Increase From Congress) at Bloomberg by former commissioner Rossotti.

Update 10/6/22

Punchbowl News yesterday had an update on GOP campaign spending in competitive midterm congressional races targeting Dems’ support for the IRS funding, including those involving nonincumbents (??). It reports $12 million in spending since August 1 on 24,000 airings. That doesn’t seem like that much given typical campaign spending these days, but I am naif when it comes to campaign spending. The ads, of course, come with the usual doses of misinformation – e.g., that 87,000 agents will be hired to target the middle class. Political business as usual.

I was out of state for much of the last two months (vacation and family medical emergency) and wasn’t paying as much attention as usual to ongoing developments. The following are quick reactions to a few random developments over that period – nothing of consequence and nothing that I have given careful thought to (dangerous, I know).

Student loan debt forgiveness

President Biden issued an executive order forgiving up to $20,000 in student loan debt for lower income borrowers, fulfilling a campaign promise. I’m not going to weigh on the underlying policy. I have mixed feelings – how America pays for higher education is in need of a permanent fix; this isn’t it, but good arguments can be made for and against an ad hoc partial student loan jubilee to address past problems. (Full disclosure: all three of my children graduated from college while incurring no student loan debt but I do not begrudge government help for those whose financial circumstances required them to do so and are now saddled with more debt than a reasonable ability to pay it. 1(B) of this post and Susan Dynarski’s NYT op-ed provide some useful context, I think.)  But there is a Minnesota tax angle.

As I blogged about ad nauseum in the context of PPP loans, the general rule is that loan forgiveness generates taxable income. Absent a special statutory provision, student loan forgiveness would be taxable. Congress in the American Rescue Plan Act (ARPA) addressed that by exempting the income. This TPC blog post by John Buhl has the details.

The Minnesota angle:

• Higher conformity price tag. The 2022 session meltdown and failure to enact a tax bill means Minnesota has not conformed its income tax to the ARPA loan forgiveness provision. That means the Biden executive order (assuming it survives likely court challenges (NYT paywall)) raised the cost of a Minnesota conformity bill by a material amount. Of course, the state likely will have a large surplus after the November forecast, so paying for a larger conformity price tag should not be a problem except the usual competition for scarce budget resources is always fierce no matter how big the surplus.
• Political fallout? Republicans nationally have opposed the Biden order (e.g., see this Axios story on ads), mainly arguing it is unfair to those who paid their loans back or didn’t incur debt at all. Given the nationalization of partisan issues, I assume Minnesota Republicans will fall in line if they haven’t already. That raises an interesting political question as to whether that opposition will carry through to opposing the favorable Minnesota tax treatment – if they don’t think the forgiveness is a good idea, then exempting the income also should be a bad idea? Of course, Republican DNA finds it hard to not like any kind of tax cut, so who knows? Stay tuned to the 2023 session.

As an aside, it is useful to point out that the student loan debt forgiveness does not involve the extra twist that PPP loan forgiveness did – there is no double benefit. PPP loans were required to be used to pay tax deductible expenses (payroll etc.) and the issue was whether those payments should be allowed to reduce tax on other income (business profits) in addition to not taxing the forgiveness itself. (Congress and the legislature said yes.) The student loan forgiveness is just a straightforward exemption of the income, like the expanded rules for home mortgage debt write-downs after the Great Recession.

Update – lawsuit filed using state taxation to assert standing. In a weird twist, Indiana’s taxation of the forgiveness is being used as the basis for asserting standing in a lawsuit challenging the forgiveness executive order. Federal law does not recognize taxpayer standing to challenge illegal spending (unlike Minnesota law). As a result, a plaintiff must be found whose personal interests (not as a taxapayer) are adversely affected, The plaintiff in the lawsuit claims he is because the forgiveness will trigger a $1,000 Indiana tax bill on his $20,000 in forgiveness. WaPo story. To finesse the fact $20,000 is greater than $1,000 (i.e., is he net to the good which doesn’t seem adverse to me) he says he would qualify forgiveness of his debt anyway under the Public Service Loan Forgiveness program and (I presume although the story does not say) Indiana (like Minnesota) exempts that forgiveness from taxation.

Clever argument if the loan forgiveness is not voluntary (i.e., you don’t need to apply and cannot opt out). That strikes me as implausible. The story quotes a White House spokes person that he could opt out. But Larry Tribe, the Harvard law professor and author of a standard treatise on con law, is quoted in the article as saying the argument is “not beyond the realm of possibility.” Seems highly implausible to me but standing is a malleable and inscrutable concept that seems to regularly morph. My guess is the suit wll be dismissed.

Corporate AMT

The Inflation Reduction Act (IRA) is now law. One of its major revenue raisers is a reenactment of a corporate alternative minimum tax based on book (i.e., accounting) income, about $20 billion/year (JCT estimate). This is a rerun of an idea from the 1980s that did not last long and is down the list of what I would have done (the global minimum tax or raising the corporate rate were better corporate tax revenue raisers).

But the silver lining is that it will give Minnesota a path out of its linkage to the pre-TCJA federal corporate AMT. The feds have not used that tax for five years now. Legislators must have viewed repealing the old minimum tax as an unacceptable benefit to profitable C corps or they couldn’t agree on how to deal with the lost revenue.  But administering and complying with a complex tax based on obsolete federal law grows increasingly untenable with each passing year. Enacting a Minnesota minimum tax based on IRA’s new minimum tax would be preferrable if only from a compliance and administration standpoint. Since Minnesota has not conformed on bonus depreciation (the major preference that will be nicked by the new federal AMT), it’s unclear whether conformity would mainly be a matter of appearance. Careful analysis of corporate returns will be needed. If conformity with the book income AMT is largely a fig leaf to permit deep sixing the old AMT, so be it.

IRA’s funding of the IRS will provide a revenue bonus to the state that should grow over time, although probably very little for several years given how long it takes to ramp up enforcement. CBO’s estimates of the revenues keep shrinking (down $23 b). The reasons are that Congress withdrew the hiring and compensation flexibility for new hires (no idea why) and the stupid Biden tax pledge that Yellen promises to stick by. Ugh.

On a related issue, GOP opposition to the IRA appears to be totally focused on demonizing the IRS funding. See Howard Gleckman’s TPC blog post characterizing the nature of the political debate. The over-the-top and outright false characterizations that elected officials get away with is appalling (former chairs of the Senate Finance Committee should be held to higher standards of conduct; I expect it from Ted Cruz). Much of the funding just restores IRS enforcement to 2010 levels; I think the increase over the real 2010 levels may only be 5% by 2030 (can’t find where I saw that now). Double ugh.

July revenues – nothing to see here

The MMB report on July revenues, in a change from relentlessly above forecast monthly collections, shows that they are about on target (up a modest $64 million). Sales tax up and everything else flat.

The only point perhaps worth noting is that evidence of unwinding of overpayments by owners of pass through entities (PTEs) is still MIA. That probably doesn’t mean much but who knows. The hypothesis is that many owners of PTEs double paid – first by making individual income tax declarations for the income during 2021 and, then, when the 2021 legislature created the PTE entity option (allowing unlimited deduction of the state taxes paid for federal purposes) by paying the PTE entity tax as well. MMB has said the amount may be $1 billion. That will unwind when the PTE owners file their 2021 individual returns and claim the credit for the PTE entity tax. Most of that money would typically show up in September and October because of the due date for extension returns (October 15^th). But given the amounts at stake, some earlier filings could be expected, especially with short term interest rates rising. But a host of other factors involved with individual income tax collections could be masking the effects.  August, September, and October collections will tell the real story (probably muddled by other factors if history is any guide).

Childcare facilities as exempt schools

The Minnesota Supreme Court has held that a childcare (er, early childhood education) facility qualified for a property tax exemption under the constitutional and related statutory provisions exempting “academies, colleges, universities, [and] all seminaries of learning[.]” This reversed a tax court ruling that denied the exemption.

Back when I was working, I tried to stay away from property tax issues as much as possible (too often unsuccessfully) and do not consider myself an expert on them. So, I won’t weigh in on the merits of the decision although I have read it a couple times. I will make a few random observations, though.

This same plaintiff was unsuccessful in an attempt at a property tax exemption claiming to be as an institution of purely public charity about 15 years ago. That case spurred a legislative effort to clarify the statutory rules for qualification as an institution of purely public charity. A main pressure point was the requirement for meaningful support from donations or contributions, rather than service revenue (fees paid by parents or the government). The legislative changes diluted that requirement. That is irrelevant under the exemption for schools. In fact, I don’t think they even need to be nonprofits. At least, it’s not an explicit requirement in the statutory or constitutional language and the Supreme Court has said as much in dicta (“The profit or nonprofit character of the institution is immaterial to a determination of whether or not an institution is a “seminary of learning.” Graphic Arts Educational Foundation, Inc. v. State).

The plaintiff, congruent with the basis of its claims, in the meantime changed its name from “childcare” to “early education” center. Contrary to Shakespeare, an early education center may smell more like a school than a childcare center.

I am sure that the authors of the constitutional language and attendees at the constitutional convention (the relevant language dates to the original constitution) did not think that they were exempting entities that largely cared for children under the age of 5. They likely were thinking more along the lines of traditional teaching of the 3 R’s. Of course, if you’re not an originalist (I’m not), that probably isn’t that important. The actual distinction – what characterizes the collection of entities enumerated in constitutional language and how does that align with what is done in pre-K settings – should matter, though. Both the Supreme and Tax Courts agreed (but not the county) that the nature of its program was educational. The dispute was over whether it was sufficiently “general” and “could readily assimilate” into the public schools, the other two prongs of the test, whatever they may mean.

I suspect the case will cause more childcare centers to seek exemption as schools. That will be a headache for assessors, who will likely require apportionment of the portions of the facilities that are devoted to infant and toddler (earlier than age 3, maybe) care. Goodhue County failed to do that until the case was on appeal (too late). In the larger scheme of things, I doubt this will be much of a hit to the property tax base. But that is a pure guess.

The exemption for schools is not one that the constitution authorizes the legislature to clarify or modify (unlike that for institutions of purely public charity). So, it is unclear how much the legislature, rather than litigation, can clarify this.

Empirical economic research has concluded that early childhood education yields material positive social benefits. Retired federal reserve economist Art Rolnick has been making this case for years now in a variety of Minnesota forums (here, e.g.). So, devoting more public resources to the effort can be easily justified. But I am skeptical that using the property tax under rules devised and enforced by judges is an optimal way to do that.

In a miracle of sorts, the phoenix-like revival of a much-slimmed down Build Back Better bill, now called IRA, has passed Congress (NYT paywall), and will provide a ten-year infusion of $80 billion to the IRS. IRA refers to Inflation Reduction Act (confusingly since IRA = Individual Retirement Accounts for most of us). I doubt it will materially reduce inflation in the near term (that’s CBO’s view as well), so the name is probably misleading. (The big direct attack on inflation – Medicare authority to negotiate drug prices – is delayed until 2026 and then phases in slowly.) Inflation reduction appear to be what got Joe Manchin onboard, although the real policy motivation of Dems lies elsewhere (ACA changes, negotiating prescription drug prices, climate change, yada yada). But so be it; whatever it takes.

Increased funding should help IRS to:

• Modernize its antiquated tax processing system and customer service. Implementing big IT system changes is never easy – for government or in the private sector – so the service improvements are neither likely to be quick nor sure. But they are sorely needed.
• Improve enforcement. This is the prime motivation, to yield revenues. Improvements here will also be a slow process because it takes years to hire and train revenue agents, implement new IT systems to improve compliance, etc. And the legislation does not include tools, like expanded information reporting. As I have repeatedly emphasized, better IRS enforcement and compliance will redound to the benefit of the states, since compliance with state taxes is closely linked to compliance with federal taxes. In many instances, plugging leaks in the federal tax will automatically plug leaks in state taxes.

IT modernization is needed

This WaPo op-ed (paywall) by Catherine Rampell lays out in excruciating detail how the IRS processes paper income tax returns and why modernization is crucial. It’s worth looking at for the pictures alone. I knew that the process was archaic and locked in the mid-20^th century but did not really have an idea of how much so. I knew that the IT systems were old (e.g., some routines still use COBOL and some hardware uses Windows XP) and that data are typed in by IRS employees. But I had no idea how manually intensive the process was, including cutting open 3 sides of large envelops with a “nibbler,” candling envelops to make sure items are not left in them, marking returns up with red pens, hand renumbering lines when prior year returns are submitted, etc. It’s no wonder that processing a paper return often takes six months or more:

A single lap through this facility’s Pipeline is about a quarter-mile. The IRS warns on its website that the whole process can take six months or more. And that’s if no errors are detected.

Why does the IRS need $80 billion? Just look at its cafeteria (Washington Post, 8/9/22)

All this reveals just how crazy it was for Congress in the CARES Act to require thousands of amended returns that need to be filed on paper to claim NOL carrybacks. Supposedly that was to get money quickly to businesses with pandemic-caused losses and cash flow problems. It simply gummed up paper processing for everyone else without getting money to the businesses in a timely manner.

Predictable response from the right

The fiscal reason for the increased IRS funding is obvious: per Larry Summers and others, to raise revenue by restoring pre-2010 IRS enforcement resources, the point at which GOP Congresses put the agency on starvation wages while it was increasingly saddled with more responsibilities under the ACA, TCJA, etc.

It was no surprise that right wing commentators and politicians’ response was to decry the funding increase as hiring and unleashing 87,000 tax auditors (the administration’s estimate of the total number of hires, including IT and customer service employees who will ultimately be added by the legislation) on poor unsuspecting middle-income folks. A sample of two from WaPo, which are more measured and accurate than the nut jobs on cable shows, points out the political risks:

• Hugh Hewitt, Democrats paint a target on their backs with IRS cash infusion (8/9/2022).
• Marc Thiessen, The Inflation Reduction Act? Try the IRS Enforcement Act instead (8/12/22).

Janet Holtzblatt at TPC has a measured take on it and good advice for the IRS and administration (unlikely to be taken, of course): If the IRS Gets $80 Billion, Will Its Agents Come Gunning for You? She points out that the administration has not handled the PR aspects of this very well and there are some legitimate questions to be answered, despite the desperate need for the funding. Jacob Bogage, Democrats’ $80 billion wager: A bigger IRS will be a better IRS (WaPo, 8/6/22) also provides good context.

Will Dems suffer at the 2022 midterms as result of increased IRS funding? Hard to know since I haven’t seen polling on it and the election is still months away. But given how easy the rhetoric is to hurl, it won’t help them and might be the straw that breaks the camel’s back in some close races. They are likely to lose one or both houses of Congres anyway, so passing up the opportunity for partisan political reasons would have been foolish. In any case, they would have had to come up with alternative funding, which may have created even greater political liabilities or could not have cleared the Manchin/Sinema hurdles.

Addendum on Cato’s Take

A blog post at Cato (Chris Edwards, Senate Bill: IRS Funding Hypocrisy, 8/5/22) makes the point – legitimate as far as it goes – that the IRA’s increased tax compliance funding is hypocritical because its expansion of various energy credits for EVs and so forth increases complexity and noncompliance opportunities. It has a graphic to illustrate how this works. The closing paragraph makes the more general and much more questionable point:

Senate bill supporters don’t seem worried about growing tax‐​code complexity. They assume the bill makes sense because the $80 billion of IRS funding is supposed to raise $204 billion in government revenues. But that ignores the added costs and loss of civil liberties imposed on individuals and businesses. More aggressive IRS enforcement will mean more paperwork, more lawyer fees, more time wasted on tax planning, more anguish and uncertainty, less privacy, and less personal financial security. Government will win, but society will lose.

Chris Edwards, Senate Bill: IRS Funding Hypocrisy

My take:

• Having just read a book on the Panama Papers, the idea that the tax gap is heavily a function of illegal use of tax expenditures is, at best, a stretch and more likely a flat-out distortion. Even the simplest tax (because of the necessary allowance of business expenses, including capital cost recovery) is necessarily complex, putting aside outright evasion (much of the reason for offshore entities). As an aside, I wonder where he stands on the differential rates for capital gain income, a feature that drives some of the most challenging complexity with debatable policy justifications for it. Verifying whether one purchased a qualifying EV is probably child’s play, by contrast.
• My preference would be to stop littering the tax code with tax incentive carrots and to rely more on Pigouvian taxes, such as a carbon tax, to reduce carbon emissions. Because of its heavier reliance on market-like mechanisms, a Pigouvian tax would be more cost effective and efficient (in the economics terms). However, the Dems’ reliance on tax incentive carrots is understandable as political matter – the consistent drumbeat of anti-tax rhetoric on the Right (by the likes of Grover Norquist and probably Chris Edwards) is what drives, in my opinion, the use of tax credits and incentives. It’s the natural result and what they should expect because of the direction in which they have driven the political debate. It’s an illusion, of course. Handing out tax credits means revenues will be collected through implicitly higher rates on others.
• There is a small group that cheats on their taxes. Crimping enforcement efforts, as has been done, simply emboldens them and increases their numbers as prospects for getting caught drops. Complexity has, at most, a minor role in this.
• Suggesting that expanded tax compliance funding (as a general matter after what the GOP-controlled Congress has done to IRS resources) is a challenge to civil liberties is the definition of over the-top-rhetoric coming from a putative Think Tank. Good grief, get a grip.