Senator Daschle, Secretary Geithner and the Tax Gap

More than anyone else, Senators Baucus and Grassley, the Chairman and ranking member of the Senate Finance Committee, have led the effort to reduce the size of the tax gap. Just two years ago they grilled then Treasury Secretary Paulson on the issue in front of the Senate Finance Committee. They also held up the confirmation of Eric Solomon for Assistant Secretary for Tax Policy demanding that the Treasury Department prepare a plan to reduce the tax gap with measurable benchmarks. To their credit, they have been steadfast in their views on this issue.

It is a bit ironic that they now find themselves in the position of being asked to approve nominees for President Obama’s cabinet who have had significant tax issues with the IRS. First it was the nominee for Treasury Secretary, Timothy Geithner. Now it is former Senate Majority Leader Tom Daschle, the nominee for Secretary of Health and Human Services. Both, in one way or another, underreported or failed to report income on their tax returns.

Interestingly, underreporting of income is the leading explanation of the roughly $300 net tax gap. A lot of this underreporting takes the form of small business owners not reporting all of their income, which reduces the income and payroll taxes that they pay. But, as we have seen with these nominations, underreporting takes many forms.

Today, the U.S. has a tax system with a compliance rate of roughly 85 percent. It has been at this level, more or less, for the past several decades. Senator Baucus called on the Bush Treasury to come up with a plan to raise the compliance rate to 90 percent with the idea that this would raise some $100 billion each year and these additional revenues would help alleviate the deficit and allow the Congress to address a host of problems the nation faces. One response by Treasury was that substantially raising the rate of compliance would require a fundamental change in the relationship between the taxing authority (i.e., the IRS) and taxpayers. Raising the rate of compliance would entail additional complexity and a more aggressive onerous IRS.

As one tenet of sound tax policy, the Tax Foundation believes that “the tax system should be as simple as possible, and should minimize gratuitous complexity. The cost of tax compliance is a real cost to society, and complex taxes create perverse incentives to shelter and disguise legitimately earned income.”

It is interesting and a bit ironic that both nominees blamed their problems either explicitly or implicitly on the complexity of the tax code. What does that say for the plans of Senator Baucus and Grassley to more aggressively go after the tax gap?