“Taxes are the price we pay for a civilized society.” This oft-repeated quotation is carved over the entrance of the national headquarters of the Internal Revenue Service in Washington, D.C. It is attributed, correctly, to U.S. Supreme Court Justice Oliver Wendell Holmes. When Justice Holmes penned those words, it is likely he wasn’t intending to create a profundity that would be repeated ad nauseum over the years. They appear in his dissent to an opinion addressing an issue with which the Supreme Court wrestled again just a few years ago, in NFIB (National Federation of Independent Business) vs. Sebelius: whether a government imposition is a tax or a penalty.
Just a few lines after his famous quotation, Holmes wrote that he could see no ground for denying a government’s “right to use its power to tax unless it can be shown that it has conferred no benefit of a kind that would justify the tax. . .”
So, what is the benefit U.S. taxpayers receive on account of paying federal income taxes?
Cardi B asked that question when she saw her tax bill earlier this year. The young rapper from New York apparently earned a lot of money last year and, like all new earners, was shocked when she learned that 40 percent of her income had been taken from her in taxes. She complained bitterly (to put it mildly) that she has no idea where her taxes are going. None of the things she thought her taxes should pay for were being done: the streets of New York were dirty, rats were on the trains, prisoners were not given adequate clothing.
When you give to a charity for children, she said (in the expletive-laden rant she posted online), they send you regular photos to let you know how the child you sponsored is doing. She demanded to know how her tax dollars were being spent. She demanded receipts. Let’s leave aside for the moment that her immediate complaints relate to things state and local taxes, not federal taxes, are devoted. Her questions are good ones: what is government doing with all the tax dollars we send it?
Alexandria Ocasio-Cortez is the Democrat candidate to represent New York’s 14th congressional district. Long-time incumbent Democrat Joe Crowley was so confident in his re-election he hardly bothered to campaign. Instead of showing up himself, he sent surrogates to debate her. In a district with 235,745 people eligible to vote in the Democrat primary, Ocasio-Cortez garnered only 15,897 votes. But that was more than the 11,761 who showed up for Crowley.
The headlines shout that she won with more than 57 percent of the vote. Yes, she did. Fifty-seven percent of the votes that were cast. Whether she won, or Crowley forfeited, the result is the same. The young socialist is now given platforms daily on which to promote her free everything for everyone policies. Not to worry, government will pay. The government would have plenty of money to pay for free education and health care and everything else, she says, if it would just stop spending so much on national defense.
So, what should government pay for? To what ends should taxes be devoted? Where do our tax dollars go now?
Unfortunately, answering these questions would only give us a partial answer to what we should want to know. If the federal government spent only what it took in, what a wonderful world it would be. We need to ask an additional question. In addition to “what does the government spend and on what,” we need to ask “where does it get it?” But borrowing is a topic that, to do it justice, we must set aside for another time.
This essay contains quite a few numbers, not because you need to know or remember them, but because you read about numbers like this all the time, in settings that do not provide context or points of comparison. You’ll find those things here, using the latest available numbers, some of which are more recent than others.
Constitutional Guidelines
Section 8 of the United States Constitution reads, in relevant part: “The Congress shall have the Power To lay and collect Taxes, Duties, Imposts, and Excises, to pay the Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States.” The 16th Amendment added and altered: “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”
There you have it: Congress has the authority to impose taxes to pay the nation’s debts and to provide for its defense and general welfare. Pretty simple and straightforward. Budget experts categorize federal expenditures as either mandatory or discretionary. Oddly, ones you might think are mandatory—like those for national defense—are categorized, in our upside-down world, as discretionary. And ones you might think are discretionary—like financial assistance to the needy, which can be accomplished more effectively through religious or community or local government organizations closer to home—are categorized as mandatory.
In early 2009, then-Rep. Barney Frank argued for a significant reduction in defense spending: “. . . [I]f we do not make reductions approximating 25 percent of the military budget starting fairly soon, it will be impossible to continue to fund an adequate level of domestic activity. . .”
That was nearly ten years ago. According to the most recent data available from the U.S. Census Bureau, in 2016, nearly 36 percent of all people in the United States, and more than 52 percent of people under the age of 18 in the country, lived in households receiving some sort of means-tested federal government assistance.
In 1922, Massachusetts citizen Harriett Frothingham challenged the government’s first program in what we now call the welfare state. Congress had established a bureau, and appropriated funds for it, to reduce maternal and infant mortality and protect the health of mothers and infants. Mrs. Frothingham probably bore no ill will towards mothers or infants, but nonetheless challenged the law—the Maternity Act—as exceeding Congress’s authority.
Congress was authorized by the Constitution (as amended by 16th Amendment) to tax her income, but there were limits on how it could spend the revenue so collected. Unfortunately, rather than address the question, the Supreme Court dodged it completely, ruling that Mrs. Frothingham did not have standing to challenge the law. The Commonwealth of Massachusetts had also challenged the law, on the basis that with it, the federal government was usurping Massachusetts’ authority. The Supreme Court ruled against it as well, finding that Massachusetts could opt out of the program. Mrs. Frothingham, sadly, could not. Nor can we.
The Ins and Outs
For 2017, federal receipts were about $3.3 trillion and spending was about $3.9 trillion, for a deficit of about $665 billion. Those numbers, however, do not tell the complete story of the U.S government’s financial situation or fiscal performance. They do not reflect, for example, the tax gap—i.e., the difference between the taxes the government should be collecting and the amount it does collect. When last estimated, for 2010, this came to about $406 billion a year. The number had been experiencing substantial annual increases at that point, and is likely much larger now. The tax gap, in turn, does not reflect the money the IRS gives away that it should not—improper payments, in government jargon. And the IRS estimate of its improper payments is also vastly understated. More on those items in a moment.
Federal revenue and spending numbers also do not include the cost of tax expenditures, which, for 2017, totaled about $1.6 trillion. And they do not include the cost of government regulation, which is estimated to have cost the economy $1.9 trillion in 2015, and more each year since then. The Trump administration is working hard to reduce government red tape, but for many reasons, it will take quite a while.
Tax Expenditures
You can look at tax expenditures as taxes Congress has decided, for policy reasons, not to impose. Or you can look at them as lawmakers avoiding their Constitutional obligation to appropriate taxpayer funds they wish to spend, like tax breaks for “green energy.” Because lawmakers believe that promoting homeownership is good for society, for example, the government annually forgoes billions in tax revenues it would collect but for the federal income tax deduction for home mortgage interest. For 2017, this deduction reduced federal revenues by $65 billion. The charitable contribution deduction reduced 2017 federal revenues by about $47.7 billion. The exclusion for employer-paid health insurance for employees reduced federal revenues by about $214 billion.
But you probably wouldn’t agree with some of the items Congress classifies as “tax expenditures.” Among them is an item called “net imputed rental income.” Believe it or not, tax and budget economists consider it to be a matter of legislative grace that you are not taxed on the rental income you forgo by living in your home instead of renting it out. This tax “break”—not having to pay tax on rental income you have decided not to receive—cost the federal government about $121 billion in 2017. There are only a few items like this, though. For the most part, the calculation of tax expenditures is a ballpark number you can rely on.
Improper Payments
All federal programs are susceptible to making improper payments. They can result from any number of factors, ranging from simple errors by the agency or the recipient, to negligence or gross incompetence by agencies, to criminal fraud amounting to theft of the funds taxpayers worked hard to earn and paid into the federal Treasury under penalty of law. As you can imagine, this is not a new phenomenon. But it wasn’t until 2002 that Congress began requiring federal agencies to identify vulnerable programs and report to Congress an estimate of the improper payments they had made under them. Before the Act went into effect, agencies reported an estimated $20 billion in improper payments for fiscal year 2001. For fiscal year 2004, the first year the Act was in effect, the number rose to $45 billion, but was acknowledged to be incomplete, as it did not include all risk-susceptible programs. Government agencies estimate they made about $141 billion in improper payments for 2017. Since reporting began in 2003, the estimated total is $1.4 trillion.
But these numbers don’t tell the whole story. It is up to the agency to identify the programs on which it reports, and the amounts it estimates to have been improperly paid. Programs the agency doesn’t consider to be particularly vulnerable or to have an especially high rate or amount of improper payments are not included in the numbers it reports.
One of these is the Additional Child Tax Credit (ACTC) program for which the IRS is responsible. Notwithstanding the urging of the Treasury Inspector General for Tax Administration (TIGTA) to do so, IRS does not classify the ACTC program as one requiring it to estimate and report improper payments. For fiscal year 2017, the IRS improperly handed out $7.4 billion of ACTC, more than 23 percent of the total amount it paid for this program. During this period, it also improperly handed out $16.2 billion in earned income tax credit (EITC), nearly 24 percent of the total it paid.
As Senator Everett Dirksen is reported to have quipped: a billion here, a billion there, pretty soon you’re talking real money.
It has been estimated that the wall President Donald Trump would like to construct on our southern border—for purposes of national security—would cost from $21 billion to $24 billion. People who think “horrors—we can’t afford that!” should consider that IRS not making improper payments on just these two programs—ACTC or EITC—for just one year would cover it.
For years, the IRS has been asking Congress for authority to determine eligibility for these programs before paying out the credits claimed. And for years, the IRS Taxpayer Advocate, whose job it is to help low-income taxpayers not get crushed in the machinery of tax administration, has prevailed upon Congress to not grant IRS that authority, or to only grant a limited version of the tools necessary to avoid paying out on false, fraudulent, or simply erroneous claims.
The Taxpayer Advocate’s Office does terrific work, producing annual reports to Congress that are informative and useful. Much of the responsibility for IRS’s inability to prevent making tens of billions of dollars in improper payments every year, however, can be laid at the Advocate’s feet, and its insistence that the IRS not be permitted to take the steps necessary to determine eligibility for “refundable credits” before paying them. And once paid, with very few exceptions, those dollars are gone. They might as well be feathers in the wind.
IRS is hardly the only federal agency making improper payments. For 2017, Health and Human Services made $90 billion in improper payments. For a peek at the relative size of this amount, consider that the $854 billion spending bill Senate passed in August included a $2.3 billion funding increase for HHS. That’s right, an agency that admits to having made at least $90 billion in improper payments last year gets a $2.3 billion increase in funding this year.
Who Cares?
Lawmakers consider they are doing a wonderful thing when they relieve people of the obligation to file returns and pay taxes. The consequence of continuing to shrink the pool of people paying taxes is to also shrink the portion of the population that cares that government takes an ever-increasing share of earnings and can’t be bothered to be a good steward of those funds.
Candidates for public office should be required to explain how they will demand that the federal government treat taxpayers and the taxes they pay with the respect they deserve. Voters must demand that their elected officials see that the government confers benefits that are within its constitutional authority to provide, and that justify the taxes imposed and collected.
Eileen J. O’Connor practices law in Washington, D.C. and previously served as Assistant Attorney General for the Tax Division of the United States Department of Justice.
