Beware of Congressional “Pay-Fors”

Posted: Mar 02, 2017 11:19 AM
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History has shown that the defenders of liberty and limited government must remain forever on guard. One reason for this is the tendency of politicians to grab little known or previously defeated ideas off the shelf at the last second to “pay-for” whatever spending scheme they are presently trying to ram through Congress.

A prime example of this occurred in 2010, when then President Obama and the Democratic Congress wanted to spend a bunch of money to “stimulate” the economy—to look like they were doing something, basically—and without debate threw into their legislation the Foreign Account Tax Compliance Act (FATCA). It has turned out to be a massive disruption to the global financial sector, and a threat to individual privacy rights, that only exists because Democrats needed the $1 billion per year in revenue that FATCA was said to raise in order to pretend that their spending spree was actually fiscally responsible.

This is how a great many bad ideas get through Congress. Not as deliberate choices—though many certainly are—but as a revenue raising provision in unrelated legislation which members are not inclined to give much scrutiny or else risk finding an obstacle to their goal of enacting new spending programs.

And as bad ideas go, FATCA is among the worst of the worst.

In order to recover a tiny amount of revenue lost to tax evasion, the law ignores basic privacy and due process rights and treats anyone who invests or banks overseas, including the millions who live abroad, as criminally suspect. Among other things, foreign institutions are required under threat of financial penalty to collect sensitive information about American clients and report it to the IRS. The financial costs on the market of complying with FATCA far exceed the revenue it raises.

The costs on innocent Americans, the vast majority of those being punished under FATCA are also heavy. Much if not most of the revenue it has collected is due to excessive fines for simple and minor oversights from those making good faith efforts to comply with overly burdensome reporting requirements. And because the U.S. has made American clients so costly to deal with, many global institutions are shutting them out. Even the IRS's own taxpayer advocate faults FATCA for continuing to “disadvantage the compliant majority in an effort to prevent potential fraud by a few bad actors.”

The fight to repeal FATCA is on, and there's reason for optimism under the new president and Congress. But it would have been better to avoid the costly error in the first place.

Nor is it just Democrats who make these short-sighted mistakes.

The last time Republicans presented a tax reform plan, they included a provision to require partnerships, personal services companies, and pass-through entities to use what is called accrual accounting rather than the cash method. This would have required the affected businesses to pay taxes on the money they're owed, not the money they're paid.

Under current law, most partnerships—think doctors, lawyers, architects or even farmers—are taxed on income they've received. So, in this example, a doctor sends his or her patient a bill and doesn't owe the government any money until the patient (or his insurance company) pays.

But the last major Republican tax reform plan sought to change that by forcing those same businesses to pay taxes when they send out the invoice, not once the check clears. That's called accrual accounting.

Under this scenario, that same doctor would owe taxes on the patient's visit once he or she sends out the bill, regardless of when the patient actually pays. Potentially paying tax on income a business hasn't collected is an obvious problem. So too are the costs of being forced to change to a different accounting method.

Accrual accounting is not bad in all circumstances, mind you. For larger firms, it can offer a more accurate picture of their financial health. But it shouldn't be forced upon smaller businesses who prefer the less complicated—and thus less costly—cash method of accounting. The forced change would wreak havoc on partnerships affected by this seemingly obscure tweak, forcing them to borrow money, dip into savings or devise their own outlandish accounting gimmicks just to pay taxes.

What's the appeal of this to legislators? Because CBO prices legislation over a 10-year budget window, the people who wrote these earlier tax-reform blueprints effectively shifted money that would be owed to the government in the 11th year to show up in the 10th instead, and thus make it look like the legislation increases federal tax revenue.

The current tax reform process hasn't yet made it to the legislation stage, so we don't know if they'll try this gimmick again. But Republicans are already fighting over how to find enough “pay-fors” to keep their plans “revenue neutral,” and thus eligible for the budget reconciliation process and impervious to filibuster. If the fighting drags on long enough, the danger that they might start blindly grabbing revenue raising ideas off the shelf becomes a serious concern. They should avoid the temptation, as we certainly don't need another FATCA on our hands.

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