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Voluntary tax compliance and the mechanisms to catch the noncompliant are under stress as tax laws have become more complicated and IRS resources have not kept pace. These events in combination have created a genuine crisis in tax administration. The papers in this volume, prepared by economists, lawyers and accountants, evaluate the capacity of authorities to enforce the tax laws in a modern, global economy and examine the implications of failing to do so.
The crisis in tax administration / Henry J. Aaron and Joel Slemrod, editors.
procedure—United States. I. Aaron, Henry J. II. Slemrod, Joel. III. Title.
for Printed Library Materials: ANSI Z39.48-1992.
Can Technology Solve Tax Complexity?
likely to increase than to fall in the years ahead.
national interest that the job of collecting taxes be done fairly and effectively.
these allegations were found to be groundless, the hearings led to a fundamental reorganization of the agency in 1998.
and the Internal Revenue Service.
Carlotta Ribar and Enid Zafran provided proofreading and indexing services.
of topics and a government function that arouses powerful emotions.
payment, that evasion is a crime, and that willful failure to pay taxes is punishable by fines or imprisonment, even if the chances of being caught are remote.
tactics, would suffice to maintain current levels of compliance.
Institution in collaboration with the Office of Tax Policy Research at the University of Michigan commissioned ten original studies on tax administration.
lawyers, economists, accountants, and officials from governments and international organizations.
return data are from IRS (2003, p. 235) and refer to calendar years.
2. Rossotti (2002, p. 15).
3. Rossotti (2002, pp. 12, 20).
theory, but bad in practice” means bad in theory, after all.
problem is that awareness that shelters work undermines voluntary compliance.
income—on labor income as well.
only income generated within the United States is subject to U.S. tax.
effect of other government regulations that particularly burden small businesses.
do so in order to reduce tax complexity. Rather, use of tax software is a byproduct of other characteristics that dispose the user to be computer-literate.
4. IRS (2002, p. 3).
about these and other problems confronting low-income filers. Many difficulties arise from complex and unstable marital and other living arrangements.
the year. The former result suggests that preparers may contribute to evasion.
likely than are unaided filers to use electronic filing, a practice the IRS is encouraging. However, the spread of electronic filing is lagging behind IRS goals.
TAG model but provided more detailed information as well. For example, compliance rates vary depending on the source of income, marital status, and age.
excused from the need to file.
for future resource allocation decisions.
whole tax system and extend to the expenditures that the revenues finance.
room for improvement, that simplified legislation is essential, and that providing adequate funding for the administration is a key to moving ahead.
commissioner_report.pdf ) [July 23, 2003]).
U.S. Internal Revenue Service. 2002. “IRS Sets New Audit Priorities.” Fact Sheet FS2002-12 (September).
———. 2003. Statistics of Income Bulletin (Spring).
Wilson, James Q. 1989. Bureaucracy: What Government Agencies Do and Why They Do It.
5. Wilson (1989, p. 161).
6. Wilson (1989, p. 174).
with very high net worth. This chapter describes the modern tax shelter, discusses some of its effects, and evaluates government efforts to curb shelter use.
shelters. The following definition, while not mechanically applicable, encompasses nearly every transaction commonly described as a tax shelter.
individual taxpayers with as little as $10 million in capital gain to shelter.
party, leaving the shelter purchaser with the back-loaded deductions.
awarded the foreign party may have been 12x.
favorable terms, and that any rules adopted would be prospective in application.
out-of-pocket cost of $500 thousand but receives an $11 million tax deduction.
1. 26 U.S.C. (Internal Revenue Code, hereafter I.R.C.), sec. 101.
of the first seven years of the shelter.
F. Supp. 2d 762 (S.D. Ohio 2001).
2002). The motives for settlement are discussed briefly in Winn-Dixie, infra.
exceeds the cost of raising funds in the no-shelter world.
6. The market for tax shelters is described more fully in Bankman (1999a, p. 1,775).
p. 198; Kies (1999, p. 1,463); Bankman (1999b, p. 1,813).
also Manzon and Plesko (2002).
Perhaps most significantly, shelters threaten to undermine tax compliance.
source would have a dramatic effect on government programs and the economy.
The current tax law is inconsistent in its treatment of investment (and labor).
law thus requires measuring and policing the amount of tax motivation underlying a given transaction—a difficult enterprise, discussed in detail below.
noncorporate investment, debt and equity, and so on.
travel. The costs are certain, while the payoff for even those who favor a cashflow or integrated tax is uncertain.
15 percent of the tax benefit for an average-size shelter is probably reasonable.
a Schedule M for a Fortune 100 company is not easy work.
return for an artificial tax loss of approximately $300 million which would reduce taxes paid (or produce a tax refund) of approximately $140 million. ASA Investerings Partnership v. Commissioner, T.C.
12. Treasury Regulations, sec. 1.6011-4T, sec. 301.6112-1T.
2002 amendments to the temporary regulations greatly increase their impact.
Of particular importance is the elimination of the exceptions to disclosure.
although the IRS has stated that it will not waive certain penalties for nondisclosed shelters, and that nonwaiver may be seen as a penalty in itself.
at the field level aimed at shelter detection, use of the government’s general subpoena power, and most notably a (presumed) one-time-only amnesty provision.
(or discovery of the shelter on audit) may, as a practical matter, serve as disclosure for all taxpayers who purchase a given shelter.
optimistic but perhaps not unrealistic assumption is that the IRS has an 85 percent chance of detecting any given shelter.
What Happens to Detected Shelters? Are Shelters Illegal?
lower for individuals. Certain differences in tax and financial reporting, such as those caused by depreciation, are excluded for purposes of determining whether the $10 million threshold is exceeded.
See, generally, Nijenhuis, Chung, and Kulikov (2002).
profit equal to the rate on a tax-favored investment?
consistent with legislative intent, so the doctrine simply cannot apply here.
a shelter is marketed. The shelter does not cross the line Congress has drawn.
it would have drawn the bright line in a different place.
but that litigation entailed arguments over legislative intent or purpose.
policymakers as Lee Sheppard and some members of the Bush administration.
year to the shelter purchaser.
which must recognize both the early gain and later loss produced by the transaction. In at least one leading shelter case, ASA Investerings Partnership v. Com15. See, for example, Winn-Dixie v. Commissioner.
16. The scope-of-the-transaction issue is not confined to financing transactions. It arises whenever a tax-structured transaction is tied to a transaction motivated by nontax considerations.
profit and to implicitly measure motivation and result against some norm.
economic substance doctrine or are associated with its use.
with the irreducible ambiguity of nonliteral statutory interpretation.
17. ASA Investerings Partnership v. Commissioner, T.C. Memo 1998-305.
revenue from capital, and possibly not from labor either.
interpretation would reveal to be legal tax shelters, which for purposes of exposition I will refer to as loopholes.
company in a transaction that otherwise qualifies as a contribution to capital.
reduce corporate income to near zero.
which we raise no significant money from capital.
in the future. If we wish to adhere to this principle, we must as a practical matter give up taxing capital.
asserted that literal interpretation would reduce the tax on capital to near zero.
Of course the view of the economic substance doctrine and the need for nonliteral methods of interpretation set forth above is (alas!) not that important.
courts and the executive branch.
18. ACM Partnership v. Commissioner, 73 T.C.M. 2189 (1997), aff ’d 157 F.3d 231 (3d Cir.
1998); Winn-Dixie Stores v. Commissioner, 113 T.C. 254 (1999), aff ’d 254 F.3d 1313 (11th Cir.
aff ’d 201 F.3d 305 (D.C. Cir. 2000).
19. Boca Investerings Partnership v. U.S., 167 F. Supp. 2d 298 (D.D.C. 2001); IES Industries, Inc.
Investerings Partnership v. U.S., Opinion 01-5429 (D.C. Cir. 2003), reversing district court opinion.
and did not involve a marketed tax product.
22. See, for example, Boca Investerings v. U.S. (existence of nontax profit motive).
court. Most observers now believe that a taxpayer with a shelter of “average” aggressiveness has a reasonable chance of winning in court.
administration are likely to be more receptive to the literalist arguments of shelter purchasers than the judges they replace.
the government ought to settle cases for their expected value.
24. See, generally, Sheppard (2002).
either because of a new settlement offer or government victories in early litigation. In general the record thus far does not show the government using litigation as a significant weapon; a taxpayer can reasonably expect to settle a shelter case for its expected value.
26. See Bankman (1999a, pp. 1,791–92).
the value of the option embedded in the debt and overstates interest deductions.
on its own and has not supported legislation primarily associated with Democratic representatives.
a shelter offers a positive return so long as it has any chance of winning in court.
characteristics are apt to be attractive purchases.
decline. Enron relied on off-balance-sheet partnerships in part to hide that loss and, absent the scandal surrounding the partnerships, that loss would have greatly reduced the company’s value.
were hard to come by. The exposure of the partnerships—and the deceit inherent in their use—contributed to the collapse of the company.
group of reporters to look into the issue.
course, here as elsewhere, one can criticize the steps taken by our political system as both too mild and too draconian.
market will come back strong.
Prize, in part for his work in this area. Still, not many are taking up the challenge, and most of those who do cannot afford or do not wish to do it full time.
legislator, let alone by a constituent. That is one reason why there are no publicly funded groups that play a role in this battle.
accounting firms to play a disinterested role; they are leading sellers of shelters.
Smaller national and even regional accounting firms have the same conflict.
on the matter for fear of alienating clients.
31. The closest analog is perhaps the Citizens for Tax Justice. That organization has been influential and active across a number of issues. It has not played (and perhaps due to resource constraints could not have played) a major role in the tax shelter debate.
office will have previously served in government as well as in private practice.
Political conviction may in some (perhaps most) cases outweigh prior experience.
installment sales shelter, but that did not stop him, in his stint as assistant secretary of the treasury for tax policy, from vigorously pursuing shelters.
money, because her client has helped deplete the government’s coffers by exploiting an unintended loophole.
could discover and litigate tax shelter cases and receive a share of the proceeds.
penalties, or a retreat from literalist jurisprudence.
you do not have to tell about it, which is what a recently promulgated regulation from Treasury does in the tax shelter field. What is wrong with that picture?
to be doing that. It is an outrage.
incentives are too high, particularly when your risk of being put in a cage is zero.
other ways to get at this problem?
with this liberal attitude toward lawbreakers is to put public disclosure to work.
terms of people’s competitive advantage?
think about making shareholder accounting the same as taxpayer accounting.
healthier, than to get rid of taxes. There was nothing else in the same league.
we do lawyers, and not by accident. The accounting profession is in the forefront of tax shelters, not the legal profession.
his answer. That is the real truth of the matter.
We need to think about the way the regulatory scheme encourages misconduct, allowing firms to both sell tax shelters and then pass on the buyer’s books.
That is a system that, by its very nature, is corrupt.
one for each tax return if the design of the system encourages honest tax returns.
States through tax cheating the same as selling drugs? The same as cheating people in the stock market? The same as cheating people in their employment?
designed to minimize cheating. It should follow the algebra.
this takes place are particularly worth noting.
one of rules with a vague overlay of standards, is desirable.
Knetsch, there are no apparent efficiency losses!
1. Knetsch v. United States, 364 U.S. 361 (1960).
directly and raise revenue that way. We should choose whichever is cheaper.
failure to tax imputed rent).
concerned by this high elasticity, but in this case the transaction is solely a product of the tax system, and its disappearance does not, in and of itself, cause efficiency losses.
went toward unproductive tax sheltering is now raised in taxes.
The second effect is that some individuals will choose to continue sheltering.
example, inject some otherwise undesirable risk into the transaction.
shelters reduces sheltering but makes those that remain worse.
system becomes more complex or more vague, and administrative costs go up.
when there are administrative costs. See Yitzhaki (1979).

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