03 November 2013

Tax Privacy

'United States National Report on Tax Privacy' by Joshua D. Blank in Tax Secrecy and Tax Transparency - The Relevance of Confidentiality in Tax Law (Peter Lang, 2013) describes
the current tax privacy protections that apply to taxpayers in the United States and provides an overview of the policy considerations that have contributed to their enactment. The debate over whether tax privacy promotes individual tax compliance in the United States is as old as the income tax itself. In 1862, when Congress first instituted the income tax to pay for the Civil War, it required the names of taxpayers and their tax liabilities to be to be open to public inspection. Since then, Congress has repealed, enacted, and repealed again similar measures, each time after vigorous discussion of the relationship be-tween tax privacy and individual tax compliance. Today, tax privacy rules prohibit the US federal government from publicly releasing the details of any specific tax-payer’s tax return or audit history unless the taxpayer consents. But debate over this question resurfaces often, especially when the government seeks innovative ways to address the “tax gap,” or the difference between the amount of tax that tax-payers should pay and the amount that they actually pay voluntarily and on time, which was estimated at USD 345 billion annually in 2006.
Defenders of tax privacy have long contended that it encourages individual tax compliance because, without it, taxpayers would limit the information that they disclose to the government. Because the individual tax return contains so much sensitive personal information, defenders of tax privacy suggest that taxpayers might feel vulnerable to embarrassment or harassment if others could view it. As a result, many defenders of tax privacy have speculated that individual taxpayers will comply with the tax system only if they trust that their personal tax information “stops with the government.”
The contemporary tax-compliance literature, however, reveals palpable scepticism toward the taxpayer-trust theory of tax privacy. Many scholars have questioned the hypothesis that, in the absence of tax privacy, individuals would with-hold important personal information from the IRS. Several of these scholars have suggested that tax privacy no longer plays as critical a role in fostering tax compliance as it did in the past. By lifting the curtain of tax privacy, these scholars argue that public access to tax return information would cast “[m]illions of eyes” on tax returns, serving as an “automatic enforcement device.”
For over 150 years, the tax privacy debate has followed familiar patterns. Because neither side has offered a convincing prediction of taxpayers’ reactions to the threat of public disclosure of their tax returns, the question of whether tax privacy promotes individual tax compliance has swung back and forth between these two sides. Both sides have fixated on the question of how a taxpayer would comply with the tax system if she knew other taxpayers could see her personal tax return. Neither side, however, has addressed the converse question: How would seeing other taxpayers’ returns affect whether a taxpayer complies?
This Report probes that unexplored question and, in doing so, offers a new defence of individual tax privacy: that tax privacy enables the government to influ-ence individuals’ perceptions of its tax-enforcement capabilities by publicizing specific examples of its tax-enforcement strengths without exposing specific examples of its tax-enforcement weaknesses. The government publicizes specific examples whenever it reveals the details of any named individual’s tax controversy. Because salient examples may implicate well-known cognitive biases, this strategic publicity function of tax privacy can cause individuals to develop an inflated perception of the government’s ability to detect tax offenses, punish their perpetrators, and compel all but a few outliers to comply. Without the curtain of tax privacy, by contrast, individuals could see specific examples of the government’s tax-enforcement weaknesses that would contradict this perception. After considering this new defence of individual tax privacy in the context of deterrence and reciprocity models of taxpayer behaviour, this Report argues that the strategic publicity function of tax privacy likely encourages individuals to report their taxes properly and that it should be exploited to enhance voluntary compliance.
The remainder of this Report proceeds as follows: Parts 1(b) and (c) provide an overview of the historical development of tax privacy rules in the United States and the current law. Part 2 describes the ways in which the IRS receives data regarding taxpayers’ tax liabilities. Part 3 describes special information-sharing relationships between the IRS and particular institutions and individuals, including banks and lawyers. Part 4 describes the ways in which the IRS shares information with other government agencies at both the federal and state levels. Part 5 describes the ways in which the IRS shares information with the taxing authorities of other countries. Part 6 describes the tax return information that is accessible, and inaccessible, by the public under current law. In presenting this contrast, Part 6 reveals how tax privacy in the United States enables the IRS to publicize its tax enforcement strengths strategically. Part 7 describes private letter rulings and other special agreements between the IRS and specific taxpayers and public access to these arrangements. Finally, Part 8 discusses the consequences of infringement of tax privacy rules and illustrates these rules by applying them to a series of hypothetical situations.
Blank comments that
The IRS does not publish lists of taxpayers and their respective tax liabilities. If a taxpayer is involved in a public civil or criminal trial with the government over tax matters, the public may learn about the taxpayer’s return information. The government currently takes the position that, in these cases, it may publicly disclose in-formation that has become part of a public court record. Further, a taxpayer may enter into a civil settlement agreement with the IRS and, as part of the settlement, sign a waiver of the tax privacy protections described above. And if a taxpayer is delinquent in paying federal income taxes, the government may file a Notice of Federal Tax Lien on the taxpayer’s property, which publicly notifies the taxpayer’s creditors of the government’s claim.
At the state level, taxing authorities frequently publish the names of individual and business taxpayers are delinquent in paying taxes in excess of a specified threshold. Over half of the states in the United States have published the identities of businesses and individuals that have failed to pay outstanding tax liabilities on time. State taxing authorities most commonly use websites to publicize this information, such as Maryland’s “Caught in the Web” and South Carolina’s “Debtor’s Corner.” In most states, the mechanics of tax shaming campaigns are relatively simple. The state taxing authority identifies taxpayers who owe outstanding state tax liability in excess of a threshold amount. After there is no legal dispute as to the amount of outstanding tax liability, the Department of Revenue mails a “Notice of Pending Internet Posting” to these taxpayers warning them that if they do not make payment, their names and amounts of outstanding tax liabilities will be posted on the tax shaming website. State revenue agencies report that taxpayers have responded positively to the threat of public shaming, as they have paid millions of dollars in outstanding taxes in recent years.