The Internal Revenue Service headquarters building on Aug. 27, 2020, in Washington, D.C. Credit - Chip Somodevilla/Getty Images
Every year, taxpayers—mostly wealthy Americans—fail to pay $600 billion in taxes they owe. This so-called tax gap is equal to the federal income taxes paid by the lower 90% of all taxpayers. Ignoring this huge loss is neither fair nor financially sustainable.
Congress is now considering a practical plan to raise billions by collecting at least a part of this tax gap.
The key to the plan is better information. The Biden Administration wants banks to send taxpayers and the IRS an updated form that will contain only two additional numbers: total deposits and total withdrawals for accounts that have a certain amount of money flowing in or out. That’s it. Two numbers. No details on individual deposits or withdrawals. The Administration initially proposed a $600 threshold, but congressional Democrats are considering raising the disclosure level to $10,000.
Expanding the types of income that are reported to the IRS by banks and other third parties will put all taxpayers on the same footing.
Regular wage-earners—those who receive a W-2 from their employer every year—pay at least 95% of the taxes they owe because the employee and the IRS both know how much the person earned. Similarly, retired individuals who receive social security or interest on their savings receive a 1099 report showing how much they received. On the other hand, a large and growing group of taxpayers don’t receive any of these reports. These are primarily wealthy people who receive their income through business partnerships or other entities on which there is little or no reporting to the IRS. According to IRS studies, these taxpayers only pay on average 50% of the taxes they owe.
Will more audits solve this grave disparity in reporting of income? No. The IRS needs information to know which returns to audit. That information will allow the IRS to focus resources on those taxpayers who are most likely not paying what they owe and to avoid unnecessary audits on everybody else. Good information is the key to auditing correctly.
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But even the simple disclosure proposed by the Administration has critics howling—and distorting. Banks and their advocacy groups claim it will be an invasion of privacy and a huge financial burden on financial institutions. They even say it will put their banking customers in an awkward position. But these arguments are based on false notions.
On privacy, banks are already required to send a 1099 to their customers and the IRS on any account that earns just $10 of interest or more. In fact, taxpayers and the IRS already receive 3.5 billion information reports every year. Adding two numbers—total deposits and withdrawals— to one report is a modest change that will benefit everyone who is paying the taxes they owe. The improved information means that the IRS will be less likely to audit honest taxpayers and more likely to audit those who are not paying what they owe.
On costs, the banking and technology experts I have conferred with agree that this new reporting requirement is a minor change to banks’ computer programs. And banks already have the underlying customer deposit and withdrawal information they use to generate the 135 million 1099s people receive annually for interest earned. Taxpayers don’t have to do anything. Common sense tells us that a bank that allows you to do your banking on a mobile device can send a report once a year with two summary numbers—without breaking the bank.
In Washington, a gaffe happens when someone inadvertently tells an awkward truth. In their criticism of the Biden Administration plan, the bank lobbyists committed quite a gaffe. The American Bankers Association said this proposal would put them in an “untenable” position and “damage…the bank-customer relationship.” What they are really saying is that they will be blamed when some of their customers will have to pay tax on income that they have been failing to report for years.
The Administration’s plan to fill the hole in reporting of income is long-overdue and central to ensuring higher income earners pay the taxes they owe. This is a once-in-a-generation opportunity to foster tax fairness. Let’s collect taxes from people who don’t pay what they owe before we raise taxes on everyone else.