IN HIS STATE of the Union address President Reagan made a persuasive case for tax reform to achieve "fairness, simplification and growth." In addition, there is a factor that is of particular concern in my business of tax collecting: if we fail to make our tax code simpler and fairer in the near future, we could jeopardize a great American tradition -- voluntary compliance with the tax laws.
Fundamental tax reform is now not a luxury. It is a stark necessity if we are to preserve that tradition of voluntary compliance. The latest figures we have are for 1981, when Americans failed to pay $90 billion in taxes they owed to the government. The size of this "tax gap" has probably grown in the last four years, and it is part of our deficit problem.
Not all tax avoidance can be described as cheating, because -- unfortunately -- a lot of it is legal. In the last few years there has been a staggering growth in the ways taxpayers have attempted to avoid taxes by investing in so-called shelters. Tax shelters are "exhibit A" when it comes to demonstrating the unfairness of our current tax system. They are also evidence of the lengths to which some taxpayers will go to avoid paying taxes -- a sign, perhaps, of how close we are getting to a society in which dodging taxes becomes not only fashionable, but acceptable.
Some recent data on tax returns of selected partnerships is instructive, since partnerships are a common vehicle used for tax shelters. Between 1963 and 1982 the number of taxpayers who claimed partnership losses on their individual returns increased from 412,000 to about 2.1 million. At the same time there has been a significant erosion in the base of the federal income tax -- that is, the amount of taxable, reported income -- particularly among taxpayers in the higher income groups.
In 1983, partnership losses that were claimed by individual taxpayers sheltered as much as $35 billion dollars of income that would otherwise have been taxed. A sampling of 88 Form 1040 returns gives an illustration of how this works in individual cases.
These taxpayers held interests in certain tax shelters that are not being challenged by the Internal Revenue Service as abusive. The average income of this group was $193,000, and their total income before losses was $17 million. But their taxable income was just $1.9 million, because they deducted losses of $6.4 million from partnerships, and other losses totaling $8.7 million.
Of these 88 returns, 19 with average gross income before losses of more than $240,000 reported total income tax payments of less than $500. Thirty-seven with average gross income before loss of more than $170,000 reported total tax payments of $6,000 or less.
To compare, a typical family of four with income of $45,000 and no tax shelter losses would pay $6,272 in taxes. The current tax system in this country supports this kind of gross unfairness. It reinforces the notion that there are special privileges -- but only for the few that somehow find ways to take advantage of the system.
Last year, the IRS commissioned a detailed study of public attitudes to the tax laws. The firm of Yankelovich, Skelly and White interviewed more than 2,000 people, and confirmed that most taxpayers consider the system unfair.
At least 75 percent of taxpayers believe their taxes are too high for what they get, and about two out of three believe they have to pay more than their fair share. A whopping 80 percent of the taxpayers in this country believe the present system benefits the rich and is unfair to the ordinary working man or woman.
Can we afford any longer a system whose very unfairness and complexity literally invites tax cheating? Can we support a system where special interests get a variety of tax breaks but the great majority of the people are squeezed just a bit harder each year to make up the difference?
The answer is obvious. Our survey of 2,000 taxpayers produced strong evidence of increasing public cynicism about taxes. Half the population thinks that 25 percent or more of all Americans cheat on taxes; a quarter of the population thinks more than half of us cheat. A majority said tax cheating is increasing. Nineteen percent of those we surveyed admitted cheating on their own taxes. What is the reason for this cheating? The answer given most often in our survey was that the existing system is unfair.
In our sample 38 percent of those questioned agreed with this statement: "Since a lot of rich people pay no taxes at all, if someone like me underpays a little, it's no big deal."
The reaction to the Treasury Department's new and admirable tax simplification package was a case study in what's wrong with our current system. One after another, the special interests have come forward to attack the Treasury plan.
Why? Because regardless of a general lowering of the rate structure to the benefit of the many, the few that have benefited in the past want their special tax breaks to continue. Never mind that they would receive the overall benefits of the reforms. The few also want to continue to receive their preferential treatments. But the very existence of all those special privileges is exactly why we need to reform the system -- not later, but now.
For a quarter century we have been using the tax code to provide incentives for social and economic objectives deemed desirable by Congress. As a result we have a system piled high with patchwork complexities resulting from one so-called reform after another. For example, last year's "reform" effort amounted to more than 1,000 pages of legislative language and was designed to "fix" some of the difficulties of the system.
One of the greatest potential benefits of the Treasury Department's new proposals has gotten too little attention: the prospect of abolishing tax returns for most American taxpayers.
This isn't a pipe dream. About 90 percent of the wage earners in Japan don't have to file tax forms. In Britain, too, most wage earners are usually spared the need to file any forms. We could also develop a return- free program if we had a simplified tax code.
Beginning with the 1987 tax year, we could help 14 million people earning less than $50,000 a year pay their taxes without filing any forms. These taxpayers now file our shortest and simplest tax form, the 1040EZ. By 1990, we believe the program could reach as many as two-thirds of all individual taxpayers. We could determine their tax liabilities by processing information given to the IRS by employers, financial institutions, etc.
Think of the benefits this would bring: By 1990, taxpayers could be spared 97 million hours in return preparation and untold amounts in preparer fees. (Today we are the only country in the world where more than 40 percent of the people pay someone else to do their tax returns.) We would save reams of paper, eliminate much record-keeping, and add millions of smiles to Americans' faces.
What's the alternative? Continued reliance on a patchwork tax code built around tax breaks for special purposes and special interests. But we simply cannot rely on tax breaks to drive our economy, to prop up our businesses or to be the deciding factor for personal investment decisions. If tax breaks are going to make the critical difference between whether one industry makes it or does not make it in the marketplace, then something is very wrong with the tax system and undoubtedly with that industry.
Whatever happened to the free-enterprise system? Since when does it require tax subsidies to make each industry function properly? Or must everyone get some sort of tax break? In that case we have chaos. Perhaps we should reserve tax breaks only for those with the more successful lobbyists. That sounds like the present system.
Today we are preoccupied with adjusting personal and corporate lives to fit the tax code. How much tax you pay is not governed any longer by how much money you earn. It reminds me somewhat of a family where one child is clearly the favorite. The child learns early on to expect special treatment, to know that whatever mistakes he or she makes, his or her interests will be protected. Healthy family relationships become impossible, and the reaction over time from less- favored children is deep and abiding resentment.
We have that resentment today. We also have strong public support for fundamental tax reform, as reflected in several recent opinion polls.
Perhaps it seems unusual that the commissioner of Internal Revenue is becoming an advocate for the American taxpayer. Think about that for a moment. We in the business of tax administration see the returns of the rich and the poor, the partnerships, the corporations, the families and the single people. We have seen it all. In the final analysis I am not sure there is any group of people more sensitive to the need for basic change than tax administrators.
Despite protests to the contrary, time is not on our side. The tax system cannot hold on indefinitely while we fumble around with so-called tax reform or, worse yet, continue meaningless debate over details of a system that cries out for reform. Let's work together now for ourselves as well as for future generations of taxpayers.