May 11, 2007

The Federal Tax Gap: Is Max Baucus to Blame?

Wednesday's Wall Street Journal has this interesting tidbit from Brody Mullins, entitled "Senator's Two Slip-Ups Show Difficulty of Closing Tax Gap," which I would respectfully suggest should be subtitled "WSJ's article Shows Lengths to Which Journalists Will Go To Make Tax Stories Interesting."

Baucus, of course, has been one of the leaders in the US Senate who has been banging the drum for closing the federal "tax gap," which is the difference between the amount of federal taxes that are supposed to be collected and the amount that actually gets paid. The IRS released a study last year estimating the tax gap for 2001 at $290 billion. (The numbers behind the numbers: $345 billion in 2001 federal taxes weren't paid on time; late payments of $55 billion shrank the total gap to $290 billion.)

But as Mullins breathlessly informs us, Baucus appears to be part of the problem. It's a two-part story:
1) Baucus owns a house in Washington DC, and was given a homestead exemption by city tax administrators. This was a mistake on their part, because as a resident of Montana Baucus isn't eligible for the DC homestead credit. After giving him the credit for a couple of years, the city figured out they'd made a mistake and gave him 30 days to pay the extra tax he owed over those couple of years. The bill: $5,625. He paid it, but not within the 30 days given by the city. Mullins says it took him "a few weeks" after the 30-day deadline.
2) Baucus owns a home in Helena, Montana, which he bought from his brother in 2002. (It was their childhood home.) The two of them didn't coordinate over who would be responsible for paying the first property tax bill for 2002, and it got paid (in full) "a few weeks late." Baucus incurred a penalty of $60 for this transgression.

The lesson, according to Mullins, is that Democrats are overselling the potential gains from closing the federal tax gap:
[A]s a taxpayer, Mr. Baucus shows it isn't so simple. Part of the gap is caused by people who purposefully avoid paying taxes and presumably could be caught with stepped-up enforcement. But much of the shortfall is thought to result from confusion and honest mistakes...The senator's tax history shows just how difficult it is to narrow the... $290 billion a year [tax gap].
There are, of course, two tiny problems with this story.
1) Baucus's late payments did, in the end, get paid. The $290 billion tax gap estimate that everyone is citing is what just never got paid at all back in 2001. So even if Baucus's error had anything to do with federal taxes, it wouldn't count as part of the $290 billion tax gap. The resolution of these errors demonstrates, in fact, that the system works well enough (in these cases) to ensure that the taxes owed actually get collected.
2) The taxes in question actually are collected by Washington DC and the state of Montana, so even Baucus actually had contributed to a "tax gap" through these mistakes, it wouldn't be the federal tax gap he was adding to. And it wouldn't be the federal government's fault that the mistakes got made.

There is an important kernel of... something behind Mullins' story, which is why it's not entirely worthless. There are plenty of elected officials out there who are using the federal tax gap as the "waste, fraud and abuse" du jour: they don't want to raise taxes on anyone, so they resort to the "tax gap" as their explanation for how all their pet projects will get paid for. We should all be a little bit suspicious of the attitude that all our fiscal problems can be solved by closing down the federal tax gap.

But that's really as far as one can go in praising this story. Mullins' story doesn't give any insight into why, five years later, the IRS remained unable to collect $290 billion in federal taxes, or what exactly needs to be done to ramp up collection efforts. And that's what we all ought to be getting smart about right now.

Related random notes:
The DC tax error really does appear to be the fault of Washington, DC tax administrators, who implemented a rule just in 2002 that restricts the use of homestead exemptions by people who don't vote in DC. A Washington Post story a couple of years back discussed Karl Rove's difficulties with this provision, and made it clear that it wasn't Rove's fault and that a bunch of other folks in Congress had fallen afoul of the rule. Here's an excerpt from a letter the city wrote to Rove at the time:
"OTR failed to rescind the benefit when the law changed. As a result of OTR's error, the property inadvertently received tax deductions for which you no longer qualified," chief assessor Thomas W. Branham wrote Rove. "We regret any inconvenience that this error on the part of OTR may have caused you."
So it's a problem with city tax administration, and one that the city figured out eventually.

Reprehensibly, the Montana Republican Committee has made political fodder of this, with a TV ad you can see on Youtube.


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