Obama tax panel on treasure hunt

President Obama has now added tax reform to his to-do list.

The administration said this week it will form a task force to propose ways to simplify the tax code, reduce evasion, close loopholes and make changes in corporate breaks.

One overarching end-goal: Raise revenue.

Obama isn't setting a revenue target but is placing two constraints on the task force's efforts: Members may not propose tax increases for 2009 and 2010; and beyond 2010, they may not propose tax increases on families making less than $250,000.

A major focus for the task force will be to reduce the estimated $300 billion-a-year tax gap -- the difference between what individual and corporate taxpayers owe and what they actually pay.

"Three hundred billion a year or more is a lot of money, and we are interested in being as aggressive as possible in trying to reduce that number," White House budget director Peter Orszag said.
Closing the gap

Reducing the tax gap is far easier said than done.

"Managing to make headway to reduce that gap often means difficult reforms," said James Poterba, president of the National Bureau of Economic Research and a member of President Bush's tax reform panel created in 2005.

The biggest reason for the gap is underreporting of income. There's a high rate of compliance when it comes to income reported by third parties, such as employers reporting workers' incomes on W-2s.

But the compliance is much lower in cases when there's no third-party reporting, such as with small business owners who do mostly cash transactions. The cash economy may account for over $100 billion of the annual tax gap, according to testimony from Nina Olson, the National Taxpayer Advocate.

The IRS is already working to improve compliance. For instance, starting in 2011, brokerages will be required to report taxpayers' cost basis when they sell a publicly traded security. That will make it easier for the IRS to verify capital gains income.

Boosting third-party reporting in areas where it is lacking means more work and expense for someone and almost certainly "will bump into [resistance] from those required to do the reporting," Poterba said.

Of course, the gap isn't all due to intentional tax avoidance. Some of it comes from honest mistakes by filers confused by a tax code that is almost universally acknowledged to be maddeningly complex.

Simplifying the code may actually help narrow the tax gap since currently "people don't perceive the tax code to be fair and that encourages non-compliance," said Len Burman, co-director of the Tax Policy Center.

The perception is that the code now allows too many people to escape paying their fair share. And where there are popular tax breaks to be had, they often come with Twister-like eligibility requirements that can qualify or disqualify tax filers seemingly arbitrarily. And where different credits or deductions target similar groups -- such as retirement savers or low-income workers with kids -- the rules for each are different.

The task force will be charged with suggesting ways to streamline those types of credits.

But what the task force may find is that behind every Byzantine requirement is a rationale and a group that lobbied for it.

"What looks like simplification to one person looks like a tax increase to another," Poterba said.

So, how much of the $300 billion-a-year tax gap can be recouped realistically?

Poterba says he's not sure. "There's not one magic bullet," he said, noting that it takes serious time and effort to change individual provisions in ways that make sense in the broader scheme of things.
Targeted changes more likely than overhaul

The members of the task force will come from the Presidential Economic Recovery Board, which is headed by former Federal Reserve Chairman Paul Volcker. It will present its proposals to Obama on Dec. 4.

Given the president's mandates and the many urgent priorities facing lawmakers, the task force's recommendations are likely to be less far-reaching than those of President Bush's tax reform panel. The Bush panel proposed ways to change and simplify not only individual tax measures but also considered alternative structures for the tax system.

"To get fundamental tax reform you really need the political stars to line up in just the right way. ... It also requires concentrated attention from the political process. It requires a fair amount of heavy lifting," Poterba said.

Those stars were not aligned when Poterba's panel put forth their proposals in November 2005. Nothing came of their report and Bush made little or no mention of it after the day it was presented. But tax experts praised the group's efforts, and Burman thinks there are a lot of ideas in their work that could serve as good starting-off points for Obama's task force.

Even if the Obama task force recommends only targeted changes to the tax code, the administration will still need to get the House and Senate on board in many cases.

It hasn't gotten off to the most auspicious start. The announcement of the task force appears to have come as a surprise to leading lawmakers, according to Congress Daily.

The top Senate Democratic tax writer indicated that the panel could be constructive, but he would prefer they offer a broad set of principles rather than specific tax changes.

"We'll certainly look at it, but we're the Congress, we'll do what we think makes sense," Senate Finance Chairman Max Baucus, D-Mont., told reporters.

"Springing a tax reform panel without talking to [leading tax writers on the Hill] is not politically astute," said Anne Matthias, director of research at Concept Capital. "But it doesn't mean [the panel's work] won't end up being important."