Friday, March 24, 2023
Weekly SSRN Tax Article Review And Roundup: Saito Reviews Multibillion-Dollar Tax Questions By Alm, Soled & DeLaney
This week, Blaine Saito (Northeastern; Google Scholar) reviews a new work by James Alm (Tulane; Google Scholar), Jay A. Soled (Rutgers; Google Scholar) & Kathleen DeLaney Thomas (North Carolina; Google Scholar), Multibillion-Dollar Tax Questions, 84 Ohio St. L.J. __ (2023).
The tax gap is an enduring problem. We should raise quite a bit more revenue than is collected by the IRS. Efforts to address the tax gap usually focus on greater audits and enforcement as well as new reporting requirements. But these measures are facing increasing political pressure. One need only look to the vilification of the increase in IRS funding, something for which tax policy experts have long advocated, to see this problem. Given these constraints, what then can we do? James Alm, Jay A. Soled, and Kathleen DeLaney Thomas in their piece, Multibillion Dollar Tax Questions, 84 Ohio St. L.J. __ (2023), say that compliance may be improved by asking the right questions in the right way.
The piece opens with where tax compliance is best and where it falls off. Tax compliance is best when the IRS has the right information and the means to verify it. If there is third-party reporting that is easily verifiable and automatically cross-checked, compliance is high. Take away any one of these, and compliance dips a bit. Take away all of these hallmarks, and compliance is far lower.
To increase compliance where it is lacking, the IRS should ask taxpayers questions to gather information of items without third-party reporting or automatic cross-checks. The authors build off of the research in social psychology that finds that acts of commission, i.e., lying on a yes or no question, are more difficult for people to commit than acts of commission, i.e., not disclosing certain information in an attempt to mislead.
The reasons for this commission-omission distinction are based on two cognitive factors. The first is cognitive miserliness. Actively lying as opposed to not requires a lot more effort on the part of the brain, which is something we generally avoid. Second, lying creates cognitive dissonance. When we do something that is inconsistent with our conceptions of ourselves, and generally people want to think of themselves as good and honest citizens, it creates internal tension. We try to resolve the tension between this conception and our actions or inactions through behavior categorization, i.e., rationalization. It is much easier to rationalize acts of omission over an overt act of commission.
The power of the so-called omission bias and how they can be used in tax compliance are the focus of a few studies that the authors cite. For example, in the U.K., merely mentioning in a notice to the taxpayer that not responding to a letter asking them to pay more would be treated as an active response doubled the rate of repayment. Similarly, in the Dominican Republic, when taxpayers received a letter highlighting both the punishments for not reporting information accurately and saying that such a matter was a voluntary choice, compliance also jumped.
Even in the U.S., there are examples of how a commission frame can help. For example, prior to 1986, there was no requirement for identification numbers, like an SSN, for dependents. As part of the Tax Reform Act of 1986, people had to list the SSNs of their dependents they claimed on their return. Almost overnight, dependents “disappeared.” While the IRS was not able to automatically cross-check everything, they did have access to SSNs.
The one place where this commission framing fell short was with the question on Schedule B regarding foreign bank accounts. While there was a commission framing, unlike all of the examples above, there was no easy way for the IRS to verify the information. It was not until scandals involving Swiss Banks and later the passage of FATCA that this changed the dynamic. The power then of these questions falls off when the plausibility of any verification is low.
To that the authors then examine five of the most problematic areas of compliance: cash and cash equivalents, virtual currencies, household employees, foreign bank accounts, and tax shelters. In each of these areas, the authors then create a question or series of questions to help the IRS ascertain whether there is a higher probability that the return has that information and forces the taxpayer to commit an act of commission if they wish to hide that information. Usually, the questions start with a simple yes or no gatekeeper question to help determine whether the taxpayer has a high probability of falling into one of these problematic areas for the tax year. They then ask additional follow-up questions if there is a yes response to the gatekeeper question. One example in the tax shelter area is to ask first whether the taxpayer had recognized losses in an investment or business venture exceeding $500,000 that was not from publicly held stock or securities. The follow-up then asks if yes to the gatekeeper question, what that amount was.
The goal with the questions here is to strike a balance. The authors want to have the IRS collect more information and force a commission frame, but they also want to avoid too much intrusiveness or significant burdens. That is why they created simple yes and no gatekeeper questions, with the taxpayer required to respond to additional questions only with a yes answer to the gatekeeper question. They also note that there may be questions of efficacy. But currently the IRS has almost no information on these matters. The evidence from case studies abroad as well as a few examples here point to some improvement to addressing the tax gap. While not perfect, it is probably better than what we have now.
Overall, this article is fascinating for its examination and synthesis of various experiments and the harnessing of social psychology research to address an important problem. It trains us then to think of the compliance issue as not just a matter of hard incentives, but soft nudges. Questions and carefully crafted forms or preparation software can encourage or discourage compliance. The goal would be then to have all of these mechanisms used in a way that pushes the needle toward greater compliance rather than non-compliance. While each move may be individually small, when put together the effect can be large.
The piece also gest one to think about other issues in the tax system and how they can be designed with various cognitive biases in mind. This piece adds to the literature on matters like tax salience and how to use it or limit it in improving the overall goals in the tax system. More work and conversation should happen then between those involved in social psychological research and the design of our tax system like this article does.
Here’s the rest of this week’s SSRN Tax Roundup:
- Dan Neidle (Tax Policy Associates Ltd), Carried Too Far? A Challenge to the Tax Treatment of Carried Interest in the Private Equity Industry, 2023 British Tax Rev. 23 (2023) (date posted: Mar. 16, 2023).
- Ashley Craig (Michigan) and Joel Slemrod (Michigan), Tax Knowledge and Tax Manipulation: A Unifying Model (date posted: Mar. 17, 2023).
- Joshua D. Blank (UC Irvine) and Leigh Osofsky (UNC Chapel Hill), Automated Legal Guidance at Federal Agencies (May 27, 2022) (report to the Admin. Conf. of the United States) (date posted: Mar. 17, 2023).
- Amanda Mariano (San Diego State) and Luke Watson (Villanova), Investor Reactions to Treasury Regulations: The Case of GILTI (date posted: Mar. 18, 2023).
- Wolfgang Schoen (Max Planck), Some Thoughts on the Relationship between the Destination-Based Cash Flow Tax and VAT (date posted: Mar. 20, 2023).
- Erika Scuderi (WU Vienna), ‘Provisions Primarily of a Fiscal Nature’: Time to Dispel Doubts, 31 E.C. Tax Rev. 273 (2022) (date posted: Mar. 20, 2023).
- Aitor Navarro (Max Planck), An Introduction to Research in Transfer Pricing (date posted: Mar. 20, 2023).
- Tessa Davis (South Carolina), Amy Soled (Rutgers Newark), and Jay A. Soled (Rutgers Newark), Revisiting the Tax Treatment of Alimony, 71 Kan. L. Rev. 379 (2023) (date posted: Mar. 20, 2023).
- Stephen T. Middlebrook (Unirush, LLC), Sarah Jane Hughes (Indiana Bloomington), and Tom Kiener (Unirush, LLC), Tea Leaves and Tarot Cards: Developments in the Laws Affecting Electronic Payments and Financial Services, 78 Bus. Law. 293 (2023) (date posted: Mar. 21, 2023).
- Henry Wurts, Addendum for Original Derivations (date posted: Mar. 22, 2023).
- Darien Shanske (UC Davis) and David Gamage (Indiana Mauer), Why States Should Adopt the New Corporate AMT, 107 State Tax Notes 601 (2023) (date posted: Mar. 22, 2023).
- Emily A. Satterthwaite (Georgetown), Entrepreneurs' Legal Status Choices and the C Corporation Survival Penalty, 16 J. Empirical L. Stud. 542 (2019) (date posted: Mar. 22, 2023).
- Dina Osina (MGIMO Univ.), Limits of the Tax Sovereignty of the State (date posted: Mar. 23, 2023).