Failing to pass an alternative minimum tax patch during the lame-duck session of Congress would be a "real recipe for disaster" resulting in delayed processing of tax returns and economic harm, a former IRS official said November 14.
Clarissa Potter, a former IRS deputy chief counsel (technical) and former acting chief counsel who is now with AIG Inc., said that because the IRS has programmed its computers under the assumption that the AMT patch and related tax credit ordering rules would be enacted before the filing season begins in January, failure to pass those provisions would force the IRS to reprogram its computers and delay the processing of tax returns until the end of March "at the earliest." Potter spoke in Coronado, Calif., at the New York University School of Continuing and Professional Studies annual Institute on Federal Taxation.
Acting IRS Commissioner Steven Miller in a November 13 letter to House Ways and Means Committee ranking minority member Sander M. Levin, D-Mich., described the effects of a failure to extend the AMT patch, which expired at the end of 2011. Without the patch, 28 million more people would be subject to the AMT, and 60 million taxpayers would be unable to file their returns or receive refunds until at least late March, he wrote. (For the letter, see Doc 2012-23365or 2012 TNT 220-35.)
But Potter said Miller understated "how very bad it could be if this actually happens." For example, Potter said, the delayed refunds brought on by the return processing delay would have a significant economic effect. "Sixty million people every year file a return claiming a refund. That's about $170 billion in refunds the IRS pays out every year," she said. "It's a huge driver of the economy in the first quarter of every year, because the people who get those refunds spend them." Therefore, she said, any delay in return processing "will translate into huge economic problems."
The expired AMT patch is just one element of the so-called fiscal cliff, the combination of tax increases and spending cuts scheduled to take place at the end of the year. But Potter said she views the patch as "one of the very strong pressures for actually getting something done" in the lame-duck session of Congress.
Potter and her fellow panelists agreed that while no long-term solution to the fiscal cliff and the nation's deficits could be reached by the end of the year, lawmakers must do something. (For related coverage, see Doc 2012-23526.)
"Short of allowing the Bush tax cuts to expire across the board, anything that's done in the lame-duck session or early next year to kick the can down the road is not really going to raise enough revenue to have a big impact on deficit reduction. It's going to be more symbolic," said Abraham N.M. Shashy Jr., a former IRS chief counsel now with King & Spalding.
Still, Potter said anything done in the short term will have to raise some revenue. She predicted that instead of allowing the top income tax rates to return to their pre-2001 levels, policymakers could agree to set them at lower rates of, for example, 35 and 37 percent.
Any significant tax increase will likely come from a limitation on deductions, Potter said. She noted that President Obama has proposed limiting to 28 percent the value of itemized deductions for high-income individuals, while others have proposed setting a hard dollar cap on deductions. Potter said a hard cap would be simpler to implement than a percentage limitation and added that because Obama's proposal applies to both deductions and exclusions, it would be even more complicated.
Tax Reform Prospects
One audience member argued that even going off the fiscal cliff would still not be a permanent solution to the problems of the nation's deficits and debt. Tax and entitlement reform would still be necessary, he said.
Shashy said that historic federal revenue levels, which have averaged about 18 or 19 percent of GDP for more than 50 years, suggest that taxpayers adjust their behavior in response to taxes and that there is a limit to the level of taxation that they're willing to accept. However, he said, the enactment of a VAT or national sales tax "might be a game changer," allowing revenues to rise above 20 percent of GDP.
Shashy added that while economists agree that a VAT or national sales tax would do much to solve U.S. economic problems in the long run, political opposition means that "it doesn't seem to be in the cards these days."
"And I think that's the problem is we look at a lot of solutions that aren't in the cards," responded Potter. "And the question is, how bad does it have to get before things start getting in the cards?"
Potter was more optimistic about the prospects for corporate tax reform resulting in a lower corporate rate. "It may not be a 28 percent rate, but I do think that in the relatively near term we'll see a lower corporate tax rate," she said.
Both the Obama administration and House Ways and Means Committee Chair Dave Camp, R-Mich., have offered corporate tax reform proposals. While both plans would lower the corporate tax rate and broaden the base, neither plan details those base-broadening measures. (For prior coverage, see Doc 2012-3698 or 2012 TNT 36-1.)
Potter acknowledged that any revenue-neutral corporate tax reform proposal would result in both winners and losers. She said that a corporate rate reduction could be paid for by reducing accelerated depreciation and limiting interest deductions, and she predicted that the corporate sector wouldn't pay for all of the reduced rate but that the noncorporate business sector would "pick up some of the tab."
Closing the Tax Gap
Another way to raise revenue would be to go after the tax gap, but according to Potter, there is little will to follow through with proposals to close the gap. "The fact is that closing the tax gap comes at a very high cost, which nobody seems to be willing to pay," she said.
The most recent IRS estimates on the tax gap, released in January, suggest that about $450 billion in taxes owed goes uncollected each year. (For the estimates, see Doc 2012-357or 2012 TNT 5-51. For prior coverage, see Doc 2012-348 or 2012 TNT 5-6.)
Potter, who said she worked on tax gap efforts when she was with the IRS, pointed out that a law to impose a 3 percent withholding tax on government contracts was repealed because of political opposition to it. A provision imposing enhanced Form 1099 information reporting requirements for businesses, enacted as part of the healthcare reform law, was also repealed, she noted. (For prior coverage of 3 percent withholding repeal, see Doc 2011-24109 or 2011 TNT 222-2. For prior coverage of enhanced 1099 reporting repeal, see Doc 2011-8165 or 2011 TNT 73-2 .)
The panelists also had harsh words for the Foreign Account Tax Compliance Act, which Potter grouped with other tax gap proposals. They agreed that the costs borne by companies to comply with the law far outweigh the revenue benefits to the federal government -- a problem that Potter said is common to tax gap provisions.
"Tax proposals are estimated by how much revenue they raise. There's really just no good way to do it for enforcement compliance provisions. They never raise very much revenue, even if they look really good," Potter said.
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