2. Expensing of IDCS favors investment in the oil and gas industry relative to other sectors of the economy. This may cause an inefficient allocation of capital.

Arguments against the proposals

1. Expenditures for research and development are expensed under present law. Exploratory drilling is similar to research due to the high level of risk. This may justify comparable treatment. 2. Most new oil wells are drilled by independent drillers who depend upon this deduction to maintain their cash flow. Drilling activity has declined precipitously over the past 18 months. If the expensing option is removed, the number of wells drilled will be further reduced.

17. Compliance

a. Estimated taxes

Present Law

Under present law, individuals owing income tax who do not make estimated tax payments are generally subject to a penalty. In order to avoid the penalty, individuals must make quarterly estimated tax payments that equal at least the lesser of 100 percent of last year's tax liability or 90 percent of the current year's tax liability. Amounts withheld from wages are considered to be estimated tax payments.

The Tax Reform Act of 1986 increased to 90 percent (from 80 percent) the proportion of the current year's tax liability that taxpayers must make as estimated tax payments in order to avoid the estimated tax penalty. This increase became effective with respect to taxable years beginning after December 31, 1986.

Possible Proposals

1. The increase in the proportion of the current year's tax liability that taxpayers must make as estimated tax payments could be delayed for one year.

2. The safe harbor of 100 percent of the previous year's liability could be made inapplicable to sizeable increases in income.

Pros and Cons

Arguments for the proposals

1. The current year (1987) is the first year that taxpayers are subject to most of the provisions in the Tax Reform Act of 1986. Also, many taxpayers were confused by the initial Form W-4 issued by the IRS. Delaying the increase in the estimated tax threshold could be beneficial to taxpayers uncertain of their ultimate tax liability due to these events.

2. Taxpayers who know that their current year's income has increased substantially over that of the past year should not be allowed to utilize the estimated tax payment structure as a mechanism for tax deferral.

Arguments against the proposals

1. The proposal to delay the increase in the estimated tax threshold does not raise additional revenue new to the Federal Government; it shifts revenue from FY 1987 into FY 1988.

2. Taxpayers need the certainty provided by a mechanical estimated tax safe harbor; altering the 100 percent safe harbor would eliminate certainty from that test.

b. IRS funding

Present Law

Increasing IRS funding in a number of areas could have a direct impact on Federal revenues. For example, increasing the number of employees in Examination and Collection can increase Federal revenues, so long as the increases are not greater than the ability of the IRS to train and absorb the new employees and so long as the point where increased receipts from greater compliance equal the increase in expenditures relating to the new employees has not been reached.

Increasing IRS funding in other areas may have an indirect (and unmeasurable) impact on Federal revenues. For example, improving and expanding taxpayer assistance and upgrading the IRS telephone and mail response system to taxpayers' inquiries could significantly, albeit indirectly, improve overall levels of taxpayer compliance with the income tax laws.

Possible Proposal

1. It would be possible to increase the level of IRS funding in a number of specific areas. The increases could be targeted to improving taxpayer compliance.

Arguments for the proposal

Pros and Cons

1. Increasing taxpayer compliance can increase Federal revenues without increasing tax rates or otherwise altering substantive provisions of the tax law.

Arguments against the proposal

1. Increases in IRS funding may not be within the jurisdiction of the Committee on Ways and Means.

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c. Withholding

Present Law

Under present law, wages and many pension payments are subject to income tax withholding. Most other payments are not generally subject to withholding.

Possible Proposals

1. Withholding could be imposed on income from stocks, bonds, and royalties.

2. Withholding could be imposed on payments to independent contractors, parallel to withholding on wages paid to employees.

Pros and Cons

Arguments for the proposals

1. Withholding increases compliance with the tax laws.

2. The level of tax compliance by independent contractors is one of the lowest rates of all sectors of the economy.

3. There is no tax policy justification for making some forms of income subject to withholding and other forms of income not subject to withholding.

4. It is difficult to distinguish the employment status of many independent contractors from that of employees.

Arguments against the proposals

1. Withholding imposes a substantial administrative burden on those required to do the withholding.

2. Withholding on payments to independent contractors would apply to the gross payments to the independent contractors, and therefore would not necessarily approximate ultimate tax liability, which depends on net income after expenses.