Give IRS the Keys to the Internet?

The IRS likes to talk about how it’s primarily concerned with improving taxpayer services, particularly this time of year. But don’t be fooled. Earlier this year, the Bush Administration proposed to require “brokers” to report online sales of tangible personal property to the IRS.

This is really another giant surveillance program, like the trial balloon the administration has previously floated to require internet service providers to retain customer data to combat crimes committed against children (as I’ve discussed here and here). In both cases, the government is trying to harness the unique capacity of the Internet to identify and document conduct in ways that were never feasible nor possible before — in this case ordinary commercial transactions that just happen to be conducted online. According to press coverage, the proposal is specifically aimed at online auctions (see this and this).

One problem with these seemingly well-intentioned proposals for leveraging Internet capabilities to reduce crime is the proverbial slippery slope. The Internet can be used to collect, store and cross-reference potentially limitless information about each one of us — our day-to-day activities, our associations, our spending habits, even our thoughts. If for example the government wanted to control Medicare and Medicaid costs by identifying who smokes, who drinks, and who doesn’t follow the government’s dietary, exercise or safe-sex guidelines, it will increasingly become possible for the government to do that. Is the only criteria going to be whether the government could save money from imposing surveillance mandates on the private sector (which would operate indiscriminately against the innocent and the guilty alike) versus spending more for law enforcement (which must respect basic civil liberties) or other government programs? There might be little cause for worry if innocence were it’s “own shield” (but it isn’t), or if the government could be trusted to safeguard personal information (but it can’t). Not only do government agents falsely accuse people, but they lose their laptops every day.

The latest idea, innocuously entitled “Expand Broker Information Reporting,” is described on page 65 of a publication entitled “General Explanations of the Administration’s Fiscal Year 2008 Revenue Proposals,” and is one of five proposals for tighter information reporting. Another would require the organizations who process credit and debit card payments for merchants (“merchant acquiring banks”) to report to the IRS the gross reimbursement payments made to merchants.

Brokers like eBay and Amazon would be required to collect social security numbers and file IRS “information returns” identifying gross proceeds from the sale of tangible personal property. The proposal has a de minimis exception (“would apply only with respect to a customer for whom the broker has handled 100 or more separate transactions generating at least $5,000 in gross proceeds in a year”) but, honestly, this is designed to divide potential opposition and will get ratcheted back as compliance costs decline for the brokers or for any number of other reasons.

The proposal assumes online buyers and sellers require the assistance of U.S. middlemen like eBay and Amazon. But any seller who wants to sidestep this information reporting requirement could easily use an off-shore middleman or set up their own shop on the web. As they say, our tax system ultimately relies on voluntary compliance. Just how big of a problem are we talking about here? I was surprised to learn, from a recent Government Accountability Office report, most taxpayers not subject to information reporting pay their taxes anyway.

Past IRS data have shown that independent contractors report 97 percent of the income that appears on information returns, while contractors that do not receive these returns report only 83 percent of income.

Senate Finance Ranking Member Chuck Grassley (R-IA) agrees that most taxpayers pay their taxes and further points out that “a significant amount of noncompliance is unintentional.” Grassley wisely points out that, “ in our zeal to get at the tax gap we cannot wreck the lives of the honest taxpayers. We can’t be like a fellow who tears down his house to get at a mouse.”

The proposal received criticism in the GAO report, which notes that “the dollar amounts expected to be raised are quite small.” I conclude this is a reason not to do it at all, although some might not see it that way. A bureaucrat might propose to solve this problem by requiring that more commercial activity be conducted online, since it is easier to track that way.

Anyway, Senate Finance Chairman Max Baucus (D-MT) has also criticized the proposal for not raising enough money, and suggested that the administration ought to be emphasizing traditional audits.

The IRS says that it gets a four-to-one return on investment in tax enforcement. For every $1 it spends, it gets $4 back in additional taxes collected. So, it would make sense for the administration to propose an IRS budget that would take advantage of that four-to-one return. But they have not. And the tax gulf just keeps growing.

But the administration has good reason to proceed cautiously in stepping up the IRS’s enforcement activities, which has been tried before and has led to serious abuses. Remember the Taxpayer’s Bill of Rights?

Another approach, as highlighted by GAO, would be to simplify the tax code.

Simplifying the tax code or fundamental tax reform has the potential to reduce the tax gap by billions of dollars. IRS has estimated that errors in claiming tax credits and deductions for tax year 2001 contributed $32 billion to the tax gap.

Simplification sounds like a good thing in the abstract, but usually the term is employed as a euphemism for sucking billions of dollars out of the private sector to fund bigger government.

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