THIS IS a story about $2 billion I tried to save taxpayers (I mean you ), how I got chewed up by the bureaucracy and where -- in these inflation-fighting, deficit-cutting days -- this petty cash matter hangs now.
The estimated $2 billion I speak of is squirreled away by those who earn their income from stocks and bonds -- from capital -- rather than labor. The reason they can conveniently do so involves a privileged position in our tax laws, a technological quirk and a powerful lobby.
The privilege is granted by not withholding tax at the source. While Uncle Sam takes his cut up front from salary and wage earners, before they see their paychecks, people who get their money from stocks and bonds get all 100 percent of it. Then, come April 15 of the following year, they add these dollars and cents to the income they report to the Internal Revenue Service and pay the tax due on them -- or at least they are supposed to.
It is here that technology enters. You may have read that the IRS now has powerful computers which match what you tell them about your income -- salary or dividends, wages or interest -- with the information filed by whoever paid you. Indeed, the IRS likes to remind the public (especially in these months of preparing tax returns) of the awesome power of its computers.
Actually, while the IRS computers are as powerful as advertised, it takes manual labor to feed them the relevant information. Reports about dividends and interest paid out by corporations, banks, savings and loan associations and the like reach the IRS mainly in two forms: on electronic tapes and on millions of little slips of paper ("GM paid Auntie Sally $150," "Gulf Oil paid $38 to Uncle Gus," and so on.)
Although this information could easily be fed into the computer, which in turn could check whether stock and bond holders failed to mention these incomes on their returns, the IRS determined that coding the information on these 400 million (give or take a few) pieces of paper would be "too costly."
It would cost about $140 million to code all the slips and to correct the erroneous or misleading social security numbers people supply (six times more than those provided to employers). Hence, most of these slips are unceremoniously shredded.
"We haven't done it, we are not doing it, and we are not about to do it," was IRS Commissioner Donald Alexander's response to the prospect of matching slips with tax returns. He explained that Congress had not awarded IRS the funds needed for this work, and hence IRS was checking only about 10 percent of the paper slips against returns filed by taxpayers.
Nobody knows exactly how much tax revenue is lost in this way; estimates range from $1 billion to $5 billion. The estimates of income "under-reported" by Americans ranged from a low of $1 billion to a high of $16.3 billion in testimony before congressional committees -- which would lead to an estimated tax loss of $380 million at the lowest estimate, $5 billion at the highest. My figure of $2 billion simply represents the middle of this so-far-unverified range.
I tried to get closer to the exact figure by gaining access, under the Freedom of Information Act, to a taxpayer compliance study conducted for IRS by the National Opinion Research Center. But after three months of struggling with the study's data tapes -- of which neither my staff nor I could make any sense -- I gave up. Instead, I called a contact at IRS, who told me that, as of early 1979, the IRS is also interested in these numbers; indeed, it hopes soon to release a figure.
HOW DID I get involved in all this?
I worked a bit in the campaign of one Jimmy Carter, and earned, on a few occasions, the ear of one presidential aide and several of his staff members. I used this entree to suggest (in the days when the tax reform drive was alive and well) that capital owners be granted the same treatment as workers: by withholding tax at the source.
Banks and S&Ls may argue that this would impose extra work on them -- but it is no more than corporations are asked to do for (or to) their employes. To render the task less onerous, perhaps very small amounts should be exempted; say, payments of $25 or less. And, to avoid the hue and cry that widows and orphans will starve while awaiting next April's refund, low-income stock-and-bond owners could file for exemption, as single wage earners getting less than $2,950 can now be exempted from federal tax withholding.
When the drive for tax reform was not going particularly well, I isolated this item and suggested it as worthy in its own right in a July 1977 memo to a member of the White House Domestic Council. He sent it to the Treasury, which contains IRS and sets policy in tax matters. I would hate to quote his response during what was a private conversation; but I will say that I incited no rush to withhold taxes on interest and dividends at the source.Indeed, an unpleasant, almost inaudible, sound came from the bowels of the bureaucracy: "It cannot be done!"
For a while, my reforming zeal was busy elsewhere. Then it occurred to me to call my contact at the IRS again.
"Why can't it be done?" I asked. "What are the difficulties?"
"IRS only administers the law -- it doesn't make it," was the answer.
"But IRS is responsible for securing compliance -- and here is a major source of tax evasion," I pressed.
"We don't know how much it is," was the retort.
I tried a different tack. "Tell me, off the record, what the problem is."
"The banks and S&Ls don't want it; they say they will lose business." (This is not to suggest that the S&Ls had made no contribution to the issue. Aside from actively opposing withholding, the National Savings and Loan League suggested, in testimony before the Senate Finance Committee in 1976, that savers be given a tax credit, to encourage saving.)
"You mean to say," I wondered, "that they are openly in cahoots with tax evaders? After all, mainly people trying to avoid paying tax would remove their accounts if taxes were withheld at the source."
"In cahoots, but not openly," came the reply. "Look at the 1962 hearings."
In 1962, when the House approved such a withholding tax on interest and dividends at the source, the lobby of banks, S&Ls, et al. generated an almost unprecedented mail campaign against it, especially in the name of widows and orphans. The Senate did not pass the bill, and it died. (My IRS contact said that the banks and S&Ls were the most powerful and best organized lobby in the country; but then, he does not deal in gun registration or gas prices.) Then, when the same idea was reintroduced in the Senate as an amendment to the Tax Reform Act of July 1976, it was defeated on the floor.
THE IDEA resurfaced in 1978, in a hearing before a House Government Operations subcommittee. The Treasury's assistant secretary for tax policy, Donald C. Lubick, was asked if the 1962 argument that withholding entails excessive work was less justified in these days of computerization than in 1962. Lubick said that he did not think the objection was valid -- then or now.
The Treasury's representative provided one more reason why the banks, S&Ls, et al. are not eager to support withholding at the source: If tax is withheld on interest, the banks and S&Ls must turn these funds over to the government. If not, interest tends to stay in the accounts, and they can use them for investment.
How does IRS plan to deal with this? By allowing the banks and S&Ls to keep the taxpayers' monies for a while (no period was specified), to remove this objection -- a kind of interest-free loan from the feds. (When Rep. Benjamin Rosenthal suggested that this amounts to trying to buy the participation of the banks and S&Ls, Lubick answered, "No, we are merely extending to them the same privilege enjoyed, until recently, only by commercial banks.")
The forces of reform, although beaten back and otherwise preoccupied, are not quite ready to give up. I recently mailed my 1977 memo to Alfred Kahn, the anti-inflation czar. After all, if we go after workers to keep their wage and salary increases below inflation rates, cut back Social Security benefits, increase Medicare costs for the elderly and thin out pollution regulation, then taking a fairer share of the tax from capital-owning taxpayers seems to be, to put it carefully, at least as good a way to reduce the budget deficit (by increasing revenues) and fight inflation. Kahn promised to look into the matter.
In all seriousness, resolution of this inequity is not up to Kahn or any other government official. To head off a powerful lobby, on the Hill and in the media, countergroups must be mobilized. In the case at hand, as long as labor unions, minority groups and other groups whose members' income is largely from labor do not join with public interest groups (such as Common Cause) which are working for fair laws, there is little hope that income from dividends or interest will be taxed in the same way as that from salary and wages.