Mind the Gap

Those of you who have traveled to London, England will likely recognize this phrase as a passenger safety warning on the London Underground. However, in the context of US federal income taxation, this phrase has an entirely different meaning.

The US Treasury / IRS keep track of the "Tax Gap", which is a calculation of the difference between the taxes owed and the taxes paid in a timely manner. According to the IRS, this gap was approximately $350 billion in 2001.

Per the IRS website, "The tax gap can be divided into three components: nonfiling, underreporting and underpayment. Nonfiling occurs when taxpayers who are required to file a return do not do so on time. Underreporting of tax occurs when taxpayers either understate their income or overstate their deductions, exemptions and credits on timely filed returns. Underpayment occurs when taxpayers file their return but fail to remit the amount due by the payment due date."

Many of the head scratching proposals, relating to taxes, are an attempt to close this gap. One of the most recent proposals, expanded 1099 reporting, is an attempt to close this gap. Though this isn't meant to close it in the way that many think it is. This proposal isn't meant to capture unreported income of Wal-Mart or Office Depot, entities which would receive 1099s that they previously didn't. This proposal is meant to reduce the amount of "overstated deductions", particularly small business expenses.

There have been some attempts to repeal this requirement and it may not end up going into effect. I hope that it doesn't, but this is an area that will continue to receive scrutiny from the service as it believes that correcting overstated deductions, especially those related to small business, will go a long way toward shrinking the Tax Gap.

Deficit Panal Draft

On Wednesday (November 10th), the "bipartisan" Deficit Reduction Commission released (Wall Street Journal) a preliminary draft of the proposals being considered for inclusion in its final report due on December 1st.  All things considered it may well be a good first step to reducing the federal budget deficit and helping to simplify our overly complex tax code.  We'll see what actually gets included in the final report (having to be approved by 14 members of the 18 member commission).

The draft is being attacked for either overly restricting the ability of the federal government to spend our money (by the left) or not going far enough in reducing the size of government (by the right).  The plan certainly has flaws, but we would be foolish not to expect those in what is going to be a compromise.

Here is what I think is good about the draft proposal:

• Elimination of the AMT
• Lowering of corporate tax rates
• Simplifying the individual tax rate brackets
• Increasing the age at which you get full Social Security (It's not like they proposed raising it immediately and the fact of the matter is that Social Security wasn't designed to provide retirement benefits for decades as it is currently doing for many of its recipients.)
• Reducing some itemized deductions for a much higher standard deduction.
• NO  VALUE ADDED TAX!!!! (My biggest fear with regard to this commission was that it was going to suggest a value added tax as a supplement to the current income tax system, that it wasn't mentioned at all is a huge plus.)

What I don't like:

• Taxing capital gains at ordinary rates
• Means testing social security benefits (You put money into the system and you shouldn't be penalized because you "don't need it".  That wasn't the "agreement" when you started putting money into the system and it shouldn't be able to be changed now.)
• Ensuring permanent deficits (If spending and revenue are capped at the same amount (21% of GDP), you can be assured that the amount to be spent will always reach the cap, but there will be plenty of times when the revenue won't reach the cap.  This ensures that the federal debt will never be paid down.)

Overall, I think the proposal is a good starting point.  It will be interesting to see what actually gets seriously considered by the President and Congress.

Now What?

In January2011, the US House of Representatives will change to republican control. Between now and then, there is going to be a tremendous focus on what will happen in the “Lame Duck” session of congress.


We can hope that some of the items (AMT Patch and tax extenders) that were not addressed before the election will be dealt with. I’m concerned that there isn’t going to be much of an appetite on the part of the departing congresspersons to deal with this. Here is an article from Dean Zerbe (Alliant Group/Forbes.com) where he gives his thoughts and what might happen.

Going forward, I’m concerned that the administration will stand in the way of getting any meaningful extension of the “Bush” tax cuts and that we may be in for a realization of the largest tax hike in history. The administration hasn’t shown a willingness to compromise in many (any?) areas and has already indicated that they will be likely to make liberal use of the veto.