Tax Protestors and Penalties: Ensuring Perceived Fairness and Mitigating Systemic Costs

"For voluntary self-assessment to be both meaningful and productive of revenues, the citizens must not only have confidence in the fairness of the tax laws, but also in the uniform and vigorous enforcement of these laws."1 I. INTRODUCTION Each year hundreds of thousands of taxpayers use abusive schemes to avoid paying some or all of their federal income taxes.2 Tax avoidance schemes include abusive tax shelters, fraudulent transactions, and approaches based on an erroneous belief that the federal tax system either is illegitimate or is inapplicable to certain taxpayers. Those who believe that the tax system is illegal or inapplicable are commonly referred to as tax protestors. The following excerpt is typical of the written statements that tax protestors include frequently with their tax returns and court filings: [THE TAXPAYER], UPON PRESENTMENT BY INTERNAL REVENUE, RETURNED AND REFUSED FOR CAUSE UCC 3-501 SAID PRESENTMENTS WITHOUT DISHONOR. IN ADDITION, [THE TAXPAYER!, IS NOT A "U.S. CITIZEN" NEITHER IS HE A 'RESIDENT NOR INHABITANT' OF THE U.S. AND HAS NO INCOME EFFECTIVELY CONNECTED WITH THE UNITED STATES THAT [THE TAXPAYERl DID NOT KNOWINGLY OR VOLUNTARILY ENTER INTO ANY AGREEMENT OR CONTRACT TO BE LIABLE FOR THE NATIONAL DEBT, OR 'ELECTED' TO BE TREATED AS A RESIDENT OF THE UNITED STATES UNDER 26 CFR PART 5h; 26 USC, SECTION 6013(g) & (h) BY THE SIGNING OF FORM 1040 OR OTHER RELATED U.S. FORMS. [THE TAXPAYER] IS NOT A PARTY TO ANY TRANSACTION WITH THE U.S. LET THE U.S. PRODUCE THE ORIGINAL SIGNED CONTRACT [SEC.] 871 4(b) FURTHER PETITIONER SAYETH NOT.3 Fortunately, most people in the United States pay their taxes when and in the amount required. Between eighty and eighty-five percent of all taxes owed are timely paid.4 Most Americans believe that tax compliance is an important element of patriotism and personal integrity.5 Compliance is important because when individuals and businesses fail to pay their taxes when due, compliant taxpayers must bear more than their fair share of the costs of government services. Moreover, businesses and sole proprietors that avoid or evade their tax obligations may be more competitive than their tax compliant counterparts because tax avoiders have lower costs. Successful tax avoidance by some can undermine the confidence that compliant taxpayers have that the tax system fairly distributes its burden among all those who benefit from government services. Maintaining a high rate of compliance, however, requires that noncompliance have consequences.6 Unless there are significant consequences to tax noncompliance, compliant taxpayers view the tax system as unfair because they are forced to assume more than their share of the tax burden.7 A subset of the. larger group of tax avoiders are tax protestors. Tax protestors use frivolous and illegitimate arguments against the obligatory nature of government assessed taxes to justify their refusal to pay their taxes. Tax protestor schemes are often promoted in seminars, in books, and on the Internet.8 The increased number of tax protestors may be attributable in part to the expansion of the Internet and the ease with which it allows tax protestors to spread their message. Although tax protestors constitute only a small percentage of all taxpayers, they are extremely vocal and are growing in number;9 the number of tax protestor returns filed increased from 7,123 in 1979(10) to 18,226 in 1980(11) and to more than 152,000 in 2001.12 Individuals who are dissatisfied with the government and its policies are more likely to be convinced that the tax system is illegitimate than are individuals who are satisfied with the government and its policies.13 An even greater concern is the possibility that growing numbers of tax protestors will be deleterious to tax compliance. General tax compliance may be adversely affected by a perception or reality that others are successfully avoiding payment of part or all of their tax liability. …