Mr. President, yesterday I introduced legislation, entitled the Simplification Through Additional Reporting Tax, START, Act of 2006, that will require brokerage houses and mutual fund companies to track and report cost basis information to…
Mr. President, yesterday I introduced legislation, entitled the Simplification Through Additional Reporting Tax, START, Act of 2006, that will require brokerage houses and mutual fund companies to track and report cost basis information to their customers and the IRS. The legislation is cosponsored by Senators Obama, Carper, Kerry, and Levin and is based upon a recommendation made by the National Taxpayer Advocate, the organization created as part of the 1998 IRS Restructuring and Reform Act whose explicit purpose is to make recommendations to Congress to simplify the tax code.
Over 130 million Americans are now struggling with the difficult job of filling out their taxes and 32 million taxpayers will likely have to report a capital gain or loss. For taxpayers all across the country that are angry and frustrated with the tax code, the START Act will hopefully provide some measure of relief and, at the same time, help close what is called the ``Tax Gap.''
The Federal Government now fails to collect close to $350 billion in taxes that are legally owed. This is called the tax gap, an amount that exceeds last year's $318 billion deficit, or this year's projected deficit of $336 billion. The National Taxpayer Advocate has observed that if we eliminated the tax gap, we could cut taxes for every American by $2,000. This would only be true, of course, if we ran a surplus. Because we are running a deficit, and will likely be doing so for the foreseeable future, the tax gap is really a $2,000 tax increase on our children and grandchildren, with interest building every year. This is a moral failure that needs to be addressed.
Unfortunately, while there has been a lot of discussion about this issue in the halls of Congress and within the administration, there has been little action. In the last two years, there have been six congressional hearings on this issue. The Internal Revenue Service Commissioner Mark Everson has said that this issue is a top priority and that over a period of time the government could collect between $50 and $100 billion of the tax gap ``without changing the dynamic between the IRS and the [American] people.'' However, in their latest budget, the Bush Administration has introduced proposals that only attempt to close $259 million of the tax gap in fiscal year 2007, or approximately one-tenth of 1 percent of the tax gap as measured in 2001. This is a failure of leadership. More can be done.
The legislation that I am introducing today does not eliminate the tax gap, but it does address a significant part of the problem. Specifically, the START Act of 2006 addresses the portion of the tax gap related to capital gains. This part of the tax gap results from the underreporting of capital income, and can include income related to the sale of stocks, bonds, real estate, and a myriad of other investments. According to the IRS, the revenue loss from the underreporting of capital income is $11 billion annually. It is important to understand that this figure is based on 2001 data. Since 2001, the amount of revenue collected through capital gains taxes has increased by $190 billion, from $349 billion in 2001 to $539 billion in 2005. If one makes the reasonable assumption that the misreporting percentage has stayed stable during this period, the $11 billion problem in 2001 is now a whopping $17 billion problem in 2005. Over 10 years, assuming no growth in capital gains realizations, this potentially represents $170 billion in revenue that the Federal Government is failing to collect.
The START Act is intended to accomplish three goals: first, reduce the deficit by closing a portion of the tax gap; second, simplify the tax-filing process for the millions of Americans who pay capital gains taxes; and, third, make the tax code fairer.
The first goal of this legislation is to reduce the deficit. We not only have a moral responsibility to our children and grandchildren to begin seriously addressing our growing deficit and debt, we also need to do so to protect our vital trade and national security interests. The total public debt now stands at $8.2 trillion, or $27,728 for each man, woman, and child living in America. This week, the Senate will likely vote again to raise the public debt limit, this time to $9 trillion. By 2011, the debt will have reached $11.8 trillion. In the last three years alone, we will have increased the debt limit by $3 trillion, a 40-percent increase from when President Bush took office in January 2001.
While we are mortgaging our country, it is important to ask to whom do we owe all of this money. Increasingly, the answer is foreigners, and this development represents an economic and security threat to our country. In December 2005, an estimated $2.2 trillion of the publicly held debt was owned by foreign creditors, such as the Chinese and Japanese. It took 42 Presidents 224 years to run up a trillion dollars of debt held by foreigners. This President has more than doubled that amount in just five years. This has weakened our country. Why? Because when the value of the U.S. dollar plunges at the mere suggestion by a Japanese or Chinese central banker that they will sell their holdings in U.S. dollars, it signals that we no longer control our economic destiny. This level of dependency affects our ability to bargain from a position of strength on national security issues with foreign countries. It is worth remembering that there has never been a country that is militarily strong, but financially weak, yet that is the path that we are on today.
Vice President Dick Cheney famously said that ``deficits don't matter.'' Well, they do, as almost all economists will tell you. And the reason they matter is that when we borrow, we prevent both the private sector and the public sector from being able to invest in our country's and our children's future. Our children are now part of a global economy, and are competing against children in Japan, India, and China for the jobs of the future. If we fail to invest in their future because instead we are paying off our debts, we will become the first generation to leave a country that is worse off than the one that we inherited.
While the START Act of 2006 will not balance the budget, it does represent a step in the right direction. The impact of START has not yet been scored by the Joint Tax Committee, so the impact on the deficit is not known. Nevertheless, the capital gains tax gap is now $17 billion per year. My proposal might not close the entire gap, but I expect that it will make a very meaningful down payment on the problem.
The second goal of my legislation is to simplify the tax-filing process and help American taxpayers spend less time filling out their taxes. It is no secret that the Tax Code is overly complex. It now has over 17,000 pages and contains almost four times as many words as the Bible. The IRS now prints over 1,000 publications. Americans now spend 5.8 billion hours and $194 billion every year to complete their tax forms. According to the National Taxpayers Union, the number of taxpayers using paid professionals has soared by approximately 60 percent since 1980 and by nearly 30 percent since 1990. Reflective of this complexity is the fact that one of the leading tax preparation firms, H+R Block, was in the news recently because it could not accurately do its own corporate tax return.
One of the most complex areas of the tax code is Schedule D, the form that taxpayers must fill out when they report their capital gains and losses. For the average taxpayer, simply filling out this one schedule adds 7 hours to the tax return filing process almost a full work day. And, for taxpayers using return preparers to complete this form, it can add significantly to their costs.
Computing a capital gain or loss would seem, on its face, easy enough. You need to know the original purchase price and the final sales amount. Taking the difference between the two should determine the amount of gain or loss. Taxpayers do have the final piece of the puzzle--the sale price, as brokerage houses and mutual funds now report this information, called ``gross proceeds,'' to their customers and the IRS on Form 1099B. But what taxpayers are not told, and what is extremely difficult to calculate, is what is called the ``adjusted cost basis'' in their investment. This is a technical term for the original price of the investment, plus any necessary adjustments.
Taxpayers face enormous challenges in trying to determine the adjusted basis of the securities they have held for many years. The first challenge is simply a matter of recordkeeping. Brokers usually send an investor a certificate of ownership stating the original purchase price of the asset. But stocks or bonds or mutual funds can be held for long periods of time, and many taxpayers lose this information and thus are left without any record of what they paid for the investment. The second challenge is a more serious one and stems from the fact that a taxpayer's capital gain or loss is not always simply the difference between the purchase price and sale price. Taxpayers must often adjust the tax basis they have in their investments due to certain events that take place during their ownership of the security. For example, if a company's stock splits, the tax basis in that stock must be cut in half; alternatively, if there is a reverse stock split, the tax basis in that stock must be doubled. Consider, too, that if you reinvest capital gains or dividends in the same investment, you likewise have to adjust your basis. Determining the adjusted basis can be a very complex undertaking and, under current law, sole responsibility for this calculation falls on the taxpayer.
The START Act would eliminate both of these challenges. By requiring brokerage houses and mutual funds to track and report taxpayer's adjusted basis information, countless hours or days of frustration would be eliminated for the 32 million taxpayers who pay capital gains taxes. More importantly, these taxpayers would have confidence that the amount that they are paying in capital gains taxes is the correct amount. Information returns of this sort will provide taxpayer's with accurate information about their investments that they simply can plug into their tax returns. No more trips into the attic to rifle through old boxes. No more having to sit down and try to calculate the impact of ten stock splits and reorganizations on your shares of IBM or AT+T stock.
In addition to reducing the deficit and making the tax-filing process simpler, the START Act will also make the tax code fairer. Presently, the tax code discriminates against middle-class Americans who earn the overwhelming majority of their income in the form of wages. The reason is that middle-class Americans cannot underpay their taxes because their employers submit wage information reports, called W-2 forms, to the IRS. If a factory worker in Indiana wants to underpay his taxes, the IRS will know about it since his employer sent the amount that he earned in wages to the IRS.
By contrast, taxpayers that rely on capital gains for their income, however, are accountable to only themselves. Under current law, the IRS lacks the ability to monitor the accuracy of taxpayer's calculations since initial purchases are not reported to the IRS. This provides dishonest taxpayers with an opportunity to inflate the tax basis they have in their investments, thereby underpaying their capital gains taxes. Taxpayers that have capital gains income are thus on the honor system to report accurately. While that may work for the Boy Scouts, it doesn't work when it comes to paying taxes. Now many capital gains taxpayers are honest, but some are not. And if the dishonest ones want to do some Enron accounting, there is virtually no way that the IRS can detect it.
The START Act addresses this inequity between wage and capital income earners by putting them on a level playing field. By requiring that adjusted cost basis information be reported to the IRS, every taxpayer that has a capital gain will be treated in the exact same way that every wage earner is treated. If we want everyone to play by the rules, then everyone should be held to the same level of accountability. Moreover, if we want Americans to believe that their tax system is fair, then we need to make sure that they believe that the person next door is actually paying their fair share in
taxes. Third party information returns that allow the IRS to determine if someone is paying their taxes accurately are critical to ensure taxpayers comply with the law and that everyone is paying their fair share in taxes. The IRS uses this type of information return for wages, dividends, and interest income, and in these areas, the amount of non- compliance is negligible. Why should we not hold capital gains income to the same standard?
To accomplish the three goals that I have discussed, my bill requires brokerage houses and mutual funds to track and report their customer's adjusted basis and provide this information to their customers and the IRS. The reporting requirement would only apply prospectively to securities acquired after the effective date. This would prevent companies from having to undertake costly and time-consuming efforts to determine basis information for assets that could be decades old.
The START Act applies to stocks, bonds, and mutual funds. For other types of securities, the bill grants authority to the Treasury Secretary to determine if the reporting requirement should apply more broadly. Financial instruments, such as derivatives, swaps, and options are not covered in the bill, but the Treasury Secretary may decide to include or exclude them when implementing the legislation.
The START Act candidly acknowledges that there will be cases where it will be difficult or impossible for companies to provide accurate basis information. In these cases, such as gifts, bequests, and specialized cases where unique basis adjustment rules come into play like wash sale rules, the legislation grants the Treasury Secretary the authority to require brokerage houses and mutual funds to provide other information that will allow the IRS to understand why basis information is not being provided. For example, in the case of a gift where the adjusted basis is unknown, a brokerage house could in lieu of supplying the adjusted basis figure, simply denote instead a ``G'' on the information return issued to the taxpayer and the IRS.
The START Act also provides authority to the Treasury Secretary to issue regulations that will facilitate the transfer of cost basis information when investors move assets from one brokerage house, or mutual fund, to another. A significant amount of basis information is currently lost when individuals move their financial accounts from firm to firm and the original purchase price information is not transferred to the new broker.
Finally, the START Act requires companies to begin tracking adjusted basis information during the 2008 tax year and taxpayers will receive their first reports by January 31, 2009. This will give companies close to 2 years, more than ample time, to put the processes and systems in place to comply with this new regulation. Moreover, it will give impacted companies close to 3 years before they have to issue their first information report.
Any proposal that imposes a new reporting requirement will have its critics and I am sure this proposal will attract its fair share of attention from some in the securities industry that don't like this idea. I would simply ask these potential critics read the bill before they pass judgment on the idea. I have tried to take a balanced approach and have sought input from a wide-range of experts and affected parties. Specifically, I have tried to balance the need to improve tax compliance with the goal of not placing an undue burden on industry. Specifically, by making the legislation prospective and providing three years of lead time before the industry must issue their first information report, I believe this legislation will present minimal burdens for industry.
In drafting this legislation, I have shared this legislation widely with industry, government officials, academics, and other tax professionals in order to craft the best bill possible. I have received input from the Securities Industry Association of America, the Investment Company Institute, the American Institute of Certified Public Accountants, and the National Association of Enrolled Agents. I have also reached out to small brokerage firms and mutual funds in Indiana to hear their perspective. In addition, the Government Accountability Office, the Internal Revenue Service, and the Joint Tax Committee have been consulted for their expertise on this legislation. During these consultations, I have not heard any explicit criticism of the proposal, but have received many helpful suggestions on ways to make this legislation both balanced and fair to companies and taxpayers. However, I do expect that there could be some philosophical and technical issues that are raised with the bill, so I want to take a moment to highlight those and respond to them immediately.
First, this proposal does not raise capital gains tax rates. For those that are legally paying the right amount in capital gains taxes, they won't pay one penny more in taxes. This proposal only ensures that people pay what they legally owe. And, moreover, what is happening today is that our failure to collect the taxes that are legally owed is effectively imposing a tax increase on our children and grandchildren who will have to pick up the tab for our fiscal failure to merely enforce the laws on the books. For this reason, I would argue that if my bill is enacted it would represent a tax cut for our children and grandchildren who will pay higher taxes if this problem is not addressed.
Some may look at this proposal and dismiss it as antibusiness and just another government regulation. I am sure there were some that had similar concerns when it was first proposed that all U.S. employers should report wages to the IRS. Now, however, we know that this reporting requirement is a cornerstone of ensuring tax compliance. Moreover, the reporting requirement does not elicit any protests from employers because they realize that without it, the U.S Treasury would lose billions in legally owed taxes. As I have said before, the honor system may work for the Boy Scouts, but it is not a great way to collect taxes. Finally, no business would be able to succeed if every year it failed to collect $17 billion per year in sales. In fact, any responsible company would move heaven and earth to address such a problem. U.S. taxpayers deserve the same level of accountability.
Some brokerage houses or mutual funds may argue that companies cannot provide this information because, in some cases, the correct information doesn't exist. This argument does not square with the fact that there are plenty of examples of companies that already provide cost basis information to their clients. If Fidelity or Ameritrade or E*Trade can provide cost basis information to all of their clients, it clearly suggests that the information can be provided.
Some may argue that this proposal will be costly to implement, even if it is a prospective proposal, because they don't have the systems in place to track and report cost basis. I would invite them to go talk to companies that have already decided to offer basis-tracking for their clients, and ask them how much it cost to offer this service. I would also ask them to talk to the software vendors and companies that provide basis tracking services to brokerage house and mutual funds. What they will tell you is that the cost is reasonable. According to a leading company that provides basis tracking services to brokerage firms and mutual fund companies, it typically charges on an annual basis approximately $1 per account. For a company with 10,000 accounts, that is a yearly charge of $10,000, a small figure when you look at the revenues of a brokerage firm of this size.
Some may point out that there are some types of transactions or securities where a brokerage firm or mutual fund cannot reasonably be expected to provide accurate cost basis information. My bill candidly acknowledges this fact. In these cases, brokerage houses and mutual funds will simply be required to provide ``other information'' that will allow their customers and the IRS to understand why adjusted cost basis information could not be provided. This is already standard practice for many companies that provide cost basis information to their customers.
In conclusion, this should be an issue that honorable members from both sides of the aisle can agree needs to be addressed. Democrats and Republicans will fight endlessly about what tax rates should be, but I believe all Members should agree on the principle that
all taxpayers should pay what you owe. We should also all agree that we need to reduce our deficit, simplify the tax-filing process, and promote a fair and equitable tax system. The START Act of 2006 is intended to make progress on all of these goals. I hope it can start a civil conversation about ways to improve our tax system. I look forward to working with all interested parties to craft a workable proposal that provides some needed relief to our overburdened taxpayers.