Will Deficit Reduction Equal Fraud Reduction?

December 2010

IN THIS ISSUE

— The Deficit Commission: Closing Loopholes, Reducing Fraud?
— Giving it All Away: Tax Reform and Charitable Giving
— Hard Truths and Harder Choices

GREETINGS!

Welcome to the December 2010 edition of our newsletter! in this issue, we’ll examine the recent proposals of the National Commission on Fiscal Responsibility and Reform to evaluate whether their ideas will reduce fraud as they reform processes.

THE DEFICIT COMMISSION: CLOSING LOOPHOLES, REDUCING FRAUD?

In early December 2010, President Barack Obama’s bipartisan deficit reduction, empaneled less than ten months earlier, delivered a report that proposed a multitude of taxation and process reforms aimed at reducing the federal government’s long-term deficit. But will these reforms do anything to stem tax fraud, among the largest areas of fraud perpetrated by individuals and businesses?

Among the proposals put forth by the commission are the full repeal of the Alternative Minimum Tax, originally designed to tax high net worth earners in the 1970s, but as the law has not been indexed for inflation, many employees and small business owners who are unlikely to be considered “wealthy'” are subject to the tax. This can be a motivator for individuals and businesses to under-report income and, as the Congress has been “fixing’ the bill on an annual basis rather than properly adjusting it for inflation, the demise of the AMT might modestly decrease fraud over time.

GIVING IT ALL AWAY: TAX REFORM AND CHARITABLE GIVING

In the current environment, high income individuals use charitable donations, often directly to their own charitable foundations, to reduce their taxable income. The commission’s proposal would radically simplify this system, thus limiting its effectiveness as a taxable income reduction tool. The commission would replace itemized deductions with a deduction of 12 percent of charitable contributions available to all taxpayers, even those who don’t itemize deductions. This would not only add an element of progressivity to charitable tax rules — a low-wage earner donating $50 during the holidays would receive the same percentage deduction as a billionaire philanthropist — but would de-incentivize charitable giving fraud, which we have encountered on numerous occasions as wealthy individuals find new ways to “game” the tax code via charities that often donate a small fraction of their receipts to charitable purposes. One side effect of this change, were it enacted, could be a near-term decline in philanthropic giving, an area which has suffered significantly in the current recession.

HARD TRUTHS AND HARDER CHOICES

The commission also took aim at a number of other tax deductions where fraud is prevalent, such as the mortgage interest deduction for a non-primary residence. While this particular recommendation would stem the instance of fraud — the motivation to obtain a second home one might not be able to reasonably afford could decrease if the deduction was eliminated — the proposal does nothing to better deter fraud. But the process reforms laid out by the commission, while unlikely to be enacted in the near term, may indeed “level the playing field,” as the authors suggest, in a manner that would decrease loopholes that are currently motivators for a variety of tax frauds.