Last week, Republicans in the U.S. House of Representatives passed a $14.3 billion aid package to Israel, paired with a corresponding cut in the increased funding for the IRS included in the Inflation Control Act passed last year. The bill was almost unanimously opposed by Democrats, who lashed out at the new speaker and Republicans for holding aid to Israel hostage to providing tax cuts to the wealthy.
The bill, which will be dead on arrival at the U.S. Senate, was mostly partisan theatrics, with Republicans attempting to placate their base that is pro-Israel but hates more funding for the IRS. Democrats, however, played along with the theatrics when they could have begun a serious conversation about our national debt. After all, it did just exceed $33 trillion and now equates to 123% of our gross domestic product. While that is down slightly from stratospheric levels at the height of the pandemic, these are levels we have not seen since WWII.
So, I am completely okay with members of Congress insisting that any new spending be offset by cutting spending somewhere else. However, I do not agree with the Republicans’ proposal to reduce IRS enforcement which almost certainly make the deficit worse. I pay my taxes and I suspect that the vast majority of you do as well. When someone is not paying their taxes that means that you and I must pay more.
Many economists estimate that as much as 10% of our economy is conducted underground and is never taxed. Much of this is in the illicit drug and human trafficking trades. But there is also a large independent contractor community that largely does not pay the same income and payroll taxes that you and I do. At a GDP of about $28 trillion, if the 10% estimates are accurate, that is $2.8 trillion escaping taxation. The federal government collects about 20% for every dollar of GDP, so taxing the $2.8 trillion in the underground economy could yield as much as $500-600 billion annually. By the way, that would be enough to cut our current annual deficit in half.
But beyond those completely avoiding taxation in the shadows, there is plenty of other fudging that goes on in the preparation of tax returns. For many years, I practiced commercial litigation. In a number of cases, I had the opportunity to review tax returns of prominent and successful individuals as part of the discovery process. I saw all kinds of schemes to reduce their tax bills that would not stand up in an audit. I saw one case where a couple owned a vacation home in a family limited partnership and wrote off the expenses as if it was a business. I saw another where the owners of a private company wrote off all of the expenses of their corporate jet, yet the logs showed that it was routinely used for purely personal trips.
Those in the underground economy and those fudging their tax returns do so, and almost always get away with it, because the IRS is overwhelmed and only audits a tiny fraction, about .04% of returns filed. I am perfectly fine with Congress setting limits on the kinds of returns that can be audited – say only those over $500,000 and those failing to report their income altogether. But to just say we are going to starve the IRS of resources so they cannot enforce our tax laws is self-defeating and grossly unfair to those of us who do pay our taxes.
And it’s not like there aren’t plenty of other places to cut or loopholes to plug -- loopholes which ultimately have the same effect as spending. For example, the carried interest loophole, which allows private equity investors to treat an interest they receive for putting to together a deal as a capital gain instead of regular income, costs the federal government as much as $18 billion annually – enough to fund the aid to Israel by itself.
Of course, the cost of the aid to Israel, even if you throw in the aid to Ukraine and some money for the southern border (all of which enjoy widespread, bi-partisan support), are a rounding error on our national debt and deficits going forward. The Congressional Budget Office’s current baseline projections are that the federal government will run up another $15 trillion in debt this decade, mostly driven by the rising costs of Social Security, Medicare, and Medicaid. The entire package proposed by Biden for Israel, Ukraine, and the border is only about 7% of the deficit this year and .05% of the deficit projected for this decade.
Until we start talking about the fact that Social Security, Medicare, and Medicaid are not sustainable in their current forms, any discussion about the national debt and deficits is mostly partisan noise. But you must start somewhere. So, let’s hear it, Democrats. What is your alternative proposed offset to provide this aid to Israel and Ukraine and to strengthen our southern border?
