Options to Improve Tax Compliance and Reform Tax Expenditures

This report, prepared by the staff of the Joint Committee on Taxation ("Joint Committee staff"), presents various options to improve tax compliance and reform tax expenditures. This report is prepared at the request of Senate Finance Committee Chairman Charles Grassley and Ranking Member Max Baucus. A copy of their letter follows this Introduction and Summary. This report is an independent work-product of the Joint Committee staff and the options included in it have not received prior approval by Senator Grassley, Senator Baucus, or their staffs.

As requested by Senators Grassley and Baucus, the report describes a number of proposals that would reduce the size of the tax gap by curtailing tax shelters, closing unintended loopholes, and addressing other areas of noncompliance in present law. In addition, the report contains proposals that would reform certain tax expenditures. Each proposal includes a description of present law, reasons for change, a description of the proposed change and effective date, and a discussion of the issues raised by the proposal. The proposals are not ranked or presented in any order other than by subject-matter.

The proposals contained in the report attempt to reduce noncompliance in several different ways. Some proposals address the problem by requiring new compliance or reporting initiatives, revising aspects of the law that have proven to be a source of taxpayer noncompliance, or increasing penalties. Other proposals address the problem by simplifying the law or making it more fair.

Among the proposals contained in this report are the following. According to the National Taxpayer Advocate, noncompliance by self-employed persons accounts for the largest share of the known tax gap.' Prior proposals to curb such noncompliance through required withholding by the party making payments to the self-employed person have raised concerns regarding the burden placed upon the party required to withhold. This report contains a proposal to require withholding on such payments only by government entities. Because such payments represent a significant part of the economy, the proposal can be expected to improve compliance to an important extent without burdening private sector payors. The proposal exempts smaller government entities from the withholding requirement.

The report contains a proposal targeted specifically at tax shelter activity. In addition to potentially providing unintended tax relief to the participants of the shelter, such activity enlarges the tax gap by undermining overall respect for the tax system. Prior proposals to restrain such activity by codifying the "economic substance" doctrine have been criticized as either removing too much flexibility from the courts or potentially applying too broadly to many non-tax-shelter transactions. The proposal contained in this report addresses these concerns by requiring a higher level of judicial scrutiny only in the case of specific categories of uncommon transactions which have the characteristics of tax shelters.

1 National Taxpayer Advocate, 2003 Annual Report to Congress, Publication 2104 (Rev. 12-2003), at iv.

Valuation issues, whether in the context of charitable contributions, transfer taxes, or other situations presented by the tax law, are a common source of noncompliance. The report contains several proposals to resolve valuation controversies in a simpler and more administrable

way.

The report includes proposals to curb the mismatched taxation of income and related deductions, a common sheltering technique. In addition, there are proposals addressing the difficult compliance problem raised by mixed-use property, such as property that provides both business and personal benefits.

The report also contains several proposals that would carry out a restructuring of different tax expenditure areas. One example is a proposal that would consolidate three tax benefits relating to education into a single tax credit for education-related expenses. In general, the proposed restructurings attempt to simplify the law or permit the Congressional purpose to be achieved in a more fair or efficient manner.

Finally, the report contains a number of smaller proposals designed to improve compliance, close loopholes, reform or repeal tax expenditures, end specific tax shelters, and otherwise prevent unintended consequences.

This report contains proposals that touch on virtually every aspect of the tax law. Nevertheless, the report is not intended to be comprehensive. The Joint Committee staff explored and rejected many other ideas as being too difficult to administer or needing further analysis. As requested by Senators Grassley and Baucus, the Joint Committee staff will continue to investigate and analyze possible proposals to increase compliance and reform tax expenditures.

A table at the end of the report contains yearly revenue estimates through fiscal year 2014 of each of the proposals described in the report. With the exception of proposed restructurings of certain tax expenditures and excise taxes, which have been developed to have a revenue neutral effect, each of the proposals is estimated to raise revenue. If the proposed restructurings are viewed as achieving efficiency or other gains, their adoption may provide Congress with the opportunity to revisit the level of benefit provided or tax imposed.

The revenue estimate of each proposal is determined independent of the other proposals, and is based on the 2004 CBO baseline. In general, due to time constraints, the absence of statutory language, and in certain cases, the lack of specificity of certain aspects of some proposals, the estimates should be viewed as general guidance to the Congress regarding the likely revenue impact of the proposal. Some estimates may change significantly as a result of new information, greater specificity of the proposal, and a change to the 2005 CBO baseline. The proposals are generally assumed to be effective upon date of enactment or, in certain cases, at some point after date of enactment; for purposes of these estimates, it is assumed that the date of enactment is October 1, 2005 with no transition relief provided. If any legislation is developed based on one of these proposals, it may be appropriate to revisit the effective date as well as the availability of transition relief.

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