While the big stories this week are Kevin McCarthy’s extraordinary downfall as House Speaker, Rudy Guliani’s tax problems, and the ongoing legal circus surrounding former President Trump…
Here’s the strange combination of stories coming out recently about the IRS that we’re paying attention to.
- Charles Littlejohn – former contractor for the Internal Revenue Service – was charged Friday with leaking tax information to news outlets (like ProPublica) about thousands of the country’s wealthiest people.
- According to a recent memo released by Senator Ron Wyden of Oregon, the current chair of the Senate Committee on Finance, shows nearly 1,000 taxpayers who make over $1 million annually didn’t file taxes multiple times from 2015 to 2020
For regular readers of Private Capital Insider, you already know our core tenant of wealth building…
The easiest way to improve returns is to reduce fee drag… and the largest fees we all pay are usually taxes.
That’s why NOT paying taxes may be one of the single best wealth building “cheat codes” there is.
To be clear, I have no problems with people (and corporations) paying the minimum amount they LEGALLY owe…
But I do have a problem with people simply not paying their fair share (or any share at all).
This gap between taxes legally owed and collected is known as the Tax Gap. The gross tax gap in the U.S. accounts for at least $428 billion in lost revenue each year, according to the latest estimate by the Internal Revenue Service, suggesting a voluntary taxpayer compliance rate of 85%.
Why does this tax gap exist?
That’s what we’re talking about in today’s weekend edition of the Private Capital Insider.
-Equifund Publishing
The American Tax Problem
For students of history, you’ll likely recall that the United States was founded by people who hated paying taxes to a faraway government.
Even though President Franklin Roosevelt once said, “Taxes are dues, we pay for the privileges of membership in an organized society”…
It seems that even in today’s divided political climate, the one thing most of us can agree on is that we still hate paying taxes, with the majority of us thinking we pay more than our fair share.
However, as our $32 trillion national debt continues to skyrocket – nearly $100,000 for every single person in America – we’re left in an awkward position of huge (and growing) unfunded liabilities, with no reasonable way to pay for them.
While one simple solution to the problem would be to simply slash government spending, reduce the size of government, and otherwise hold these bureaucrats accountable…
The Biden administration has instead decided the correct answer is to raise corporate taxes.
Already, complying with the existing tax code is incredibly costly:
In 2022, Americans wasted 6.55 billion hours – or an estimated $364 billion in lost productivity and out of pocket expenses – complying with federal tax filing requirements.
And when you add in the more than 13,000 State, County, and City jurisdictions, the monthly compliance burden companies face only skyrockets from there.
To complicate that overwhelming figure, there are typically thousands of sales tax rate updates every year, as rates in each of these jurisdictions change, or new taxes are adopted, and older ones expire.
With President Biden seeking to give the Internal Revenue Service (IRS) nearly $46 billion for IRS enforcement – not to mention, his proposed $4.7 TRILLION tax hike – the problem is likely going to get worse in the years to come, as the tax code only gets longer and more complex.
And as federal collections shrink, this directly impacts the tax burden, pushed down to state and local governments, to make up the shortfall.
Not the mega multinational corporations who can afford to implement complex tax strategies, and who pay almost nothing in taxes…
Nearly two out of every three of the 755 largest corporations in the country – those with over $20 billion in assets – were not audited in 2020. As recently as 2012, nearly all such returns (93%) were being examined by the IRS, generating up to $10 billion dollars in unreported taxes. This number dropped by more than half, to just $4.1 billion during FY 2020.
The dollar significance is even greater if the focus expands to corporations reporting over $250 million in assets. Audits of these large corporations in FY 2012 turned up $24.4 billion in unreported taxes, compared to $5.4 billion in FY 2020.
And certainly not the wealthiest Americans…
In FY 2012, audits of millionaires turned up $4.8 billion in unreported taxes. Now with less than a third the number of audits, the government uncovered only $1.2 billion in unreported taxes in FY 2020.
With 98% of millionaires escaping any scrutiny, fewer audits, in all likelihood, mean many millionaires escape paying billions of dollars owed to the U.S. Treasury.
Instead, it will likely come out of the pockets of everyday Americans – and small business owners – who will be left holding the bag and picking up the tab.
“It’s a middle finger to the American public,” says Florida’s governor, Ron DeSantis.
Small business will be the first to suffer, Joe Hinchman, executive vice-president at the National Taxpayers Union Foundation, told the New York Post.
“The IRS will have to target small and medium businesses because they won’t fight back,” he said. “We’ve seen this play out before… the IRS says, ‘We’re going after the rich’ but when you’re trying to raise that much money, the rich can only get you so far.”
Businesses and the tax bodies themselves know that effective tax administration is a vital part of revenue departments’ ability to collect what is owed.
And by far, the easiest people to enforce tax compliance onto are wage earners.
There is a direct relationship between the information the IRS has at its disposal to verify that a taxpayer has properly paid his/her tax liabilities, and his/her voluntary compliance rate.
For ordinary wage and salary income, compliance with income tax liabilities is nearly perfect (one percent noncompliance rate).
In stark contrast, for opaque income sources that accrue disproportionately to higher earners—like partnership income, proprietorship income, and rental income—noncompliance can reach 55%!
The tax gap also has meaningful implications for fiscal policy.
These unpaid taxes mean policymakers must choose between rising deficits, lower spending on important priorities, or further tax increase to compensate for lost revenue—which will only be borne by compliant taxpayers.
That’s why it’s crucial to focus on enforcing the existing tax code across all taxpayers, in order to ensure everyone pays their fair share (and not a penny more).
And that’s why having strong audit functions – whether it be for individuals and corporations paying their taxes, or how the federal government spends our tax dollars – is critical to a “fair and just” society.
Audits are a necessary evil to ensure that taxes are collected by those who owe them. In fiscal year 2021 alone, the IRS closed 738,959 tax returns examinations, resulting in nearly $26.8bn in recommended additional tax.
Without audits, who’s going to make up for that shortfall? It will overwhelmingly be borne by filers with simpler returns.
Said another way, just like virtually everything else in the game of money, the system is rigged in favor of Insiders and Elites.
And even though I don’t have a solution for solving the broader American Tax Problem…
It’s very clear to me that if you don’t understand how taxes work – and how to leverage the tax code the way Insiders and Elites do to build wealth – you will likely wind up on the Outside, forced to pay whatever the government tells you.
But good luck navigating the sprawling and complex tax code; according to Public Law 117-154, dated June 23, 2022, the U.S. Tax Code stood at 6,871 pages.
When you include the federal tax regulations and official tax guidance, that number jumps to ~75,000 pages.
And if that doesn’t blow you away, consider that today, a single tax code can require upwards of 174 pages.
In fact, it’s estimated that over the past decade, the U.S. tax code has been amended over 4,000 times.
But it’s not just the sprawling federal tax code you have to worry about. There are 13,000 additional state, county, and local tax jurisdictions on top of this.
Growing State, County, and City Tax Compliance Burdens
The Tax Foundation reported that in 2022, the federal corporate tax was levied at a 21% rate. In addition, 44 states and the District of Columbia (D.C.) also levied tax on corporate income, with top marginal rates that ranged from 2.5% in North Carolina, to 11.5% in New Jersey.
Additionally, 15 states levied graduated corporate income tax rates, while the remaining 29 states and D.C. levied a flat rate on corporate income.
But, it’s not quite that simple…
Four states, Nevada, Ohio, Texas, and Washington, subject corporations to gross receipts taxes, instead of corporate income taxes.
As well, Delaware, Oregon, and Tennessee impose a tax on corporate income, and a separate levy on gross receipts, while Pennsylvania, Virginia, and West Virginia levy gross receipts taxes at the local, but not state level.
All said and done (after much analysis, computing and re-computing), New Jersey held first position as having had the highest combined state and federal corporate tax rate – 30.1%.
While six states – Ohio, Nevada, South Dakota, Texas, Washington, and Wyoming – faced no state corporate income tax…
The state with the highest combined state and federal corporate tax rate is New Jersey at 30.1%.
Source:TaxFoundation.org
On July 1, 2023, at least 32 notable tax policy changes took effect across 18 states, including sales tax rate reductions in New Mexico and South Dakota, a repeal of the corporate franchise (capital stock) tax in Oklahoma, the implementation of a payroll tax in Washington, and the implementation of taxes on newly legalized sales of cannabis products in Maryland and Minnesota.
Separately, across 11 states, at least 22 notable tax policy changes have been enacted or phased in this year, and are retroactively effective as of January 1, 2023, including income tax reductions in Arkansas, Michigan, North Dakota, Utah, and West Virginia. Further, a few more states had significant tax policy changes take effect after January 1, 2023, but before July 1, 2023.
This year, 1 in 5 states reduced income tax rates or allowed automatic tax cuts to take effect, decisions that continue a three-year trend of big, mostly regressive tax cuts that will carry a heavy cost for state revenues, families, and communities both now and over time.
Together, the recent tax-cutting spree will cost states tens of billions of dollars in lost revenue over the next several years. That will mean real harm to state revenues, services, and economies now and down the road.
Overall, the cuts will also provide a windfall to wealthy people and corporations, further weakening our democracy by tilting the scales of power even more toward those who already have it.
However, like many things related to taxes, the devil is hidden deep within the details – specifically, taxing authorities’ favorite way to raise revenue without drawing attention, indirect taxes.
- Direct taxes are levied on taxpayers’ income and profits, and are collected by government revenue departments. Some of the most common examples of direct taxes include income tax, corporate tax, capital gains tax, and property tax.
Direct taxes tend to be considered progressive, as those with higher incomes typically pay a higher tax.
- Indirect taxes are levied on goods and services, and are collected by an intermediary (e.g., marketplaces, manufacturers, platform owners, vendors) from the end consumer. Some of the most common examples of indirect taxes include goods and services tax, value-added tax, sales tax, excise tax, and customs duty.
Indirect taxes tend to be considered regressive, as the cost is passed through to consumers through the goods and services they purchase.
But it’s not just complying with the ever-changing city, county, state, and federal taxes here in the U.S.…
We are on the precipice of a new Global Minimum Tax Regime
Governments around the world are increasingly looking to indirect taxes and transaction taxes in order to raise revenues, and otherwise find simpler ways of imposing levies on business activities that are too hard to implement with direct taxes.
Transformative changes to the way companies are being required to provide tax information to revenue authorities (such as electronic filing and real-time reporting) is also creating an imperative to modernize operations at a faster pace.
Nine in 10 (92%) respondents say that shifting revenue authority demands on digital tax administration will have a moderate or high impact on tax operations and resources over the next five years—and several heads of tax say the trend is moving faster than expected.
Most notably, this is happening via the yet-to-be-implemented “BEPS 2.0” framework.
Base Erosion and Profit Shifting (“BEPS”) is an OECD/G20 initiative to close the gaps in international tax rules that allow multinational companies to legally, yet artificially, reduce the tax base in a specific country (Base Erosion) and/or shift profits to low or no-tax jurisdictions (Profit Shifting).
On 11 July 2023, 138 members of the OECD/G20 Inclusive Framework on BEPS agreed an Outcome Statement recognising the significant progress made and allowing countries and jurisdictions to move forward with historic, major reform of the international tax system.
The global tax deal would change where large multinational companies pay taxes (known as Pillar One), and create a global minimum tax (known as Pillar Two). It’s the latter making headlines.
Pillar Two would ensure that large multinational corporations pay an effective tax rate of at least 15%—an attempt to stop companies from moving their profits to tax havens (i.e., low-tax or no-tax jurisdictions).
According to EY, Almost half (45%) of tax and finance executives say Pillar Two will increase the likelihood of new tax audits and disputes, while only 11% say it will result in a decrease.
So far, Congress has chosen not to implement changes in line with the global tax deal. Though the Biden Administration supports the agreement, Congress left those changes out of the 2022 Inflation Reduction Act.
According to best estimates, the U.S. Treasury is likely to lose revenue whether it adopts Pillar Two or not (if all other countries adopt the rules).
Even if the U.S. complies, it is likely to lose $56.5 billion over 10 years. And if it doesn’t, that figure more than doubles to $122 billion.
But here’s the thing politicians don’t seem to understand about tax revenues…
The best way to avoid losing tax revenue is to ensure the U.S. continues to be a place where businesses want to invest and grow.
Here’s the counterintuitive thing about raising corporate taxes in a globalized world…
A seminal study by economists at the OECD ranked the major taxes in terms of their harm to economic growth; corporate income taxes were found to be the most harmful for growth, followed, in order, by personal income taxes, consumption taxes, and property taxes.
Corporate income taxes were determined to be most harmful for growth because capital is the most mobile factor in the economy and, thus, the most sensitive to high tax rates.
Estimates vary, but most studies indicate labor bears 50-100% of the corporate income tax.
This is because labor is less mobile than capital in response to a corporate tax change, so when the corporate tax rate increases and investment flows elsewhere, workers are left holding the bag.
This means the burden of the higher corporate tax falls not only on the business, but also on its consumers and employees through higher prices and lower wages.
And even though the “eat the rich” narrative sounds emotionally appealing…
Tax policy is one of the most complex – but important – things in any country that most people have no interest in learning how works.
Final Thoughts: Tax policy sound easy to fix, but is hard in reality
Why do we have taxes? The simple answer is that, until someone comes up with a better idea, taxation is the only practical means of raising the revenue to finance government spending on the goods and services that most of us demand.
However, setting up an efficient and fair tax system is far from simple…
And the government’s desire to influence consumer behavior creates a series of problems and perverse incentives.
Ideally, the tax policy should raise revenue without excessive government borrowing, and should do so without discouraging economic activity.
