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POLICY INSIGHT
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Biden Financial Reporting Requirement an Integral Part of Plan to Address Tax Gap

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Senior Director of Federal Tax Policy

An integral component of the Biden Administration’s comprehensive plan to rebuild the depleted IRS and reduce the nation’s large tax gap is a set of financial reporting rules that would help the IRS identify unreported income and reduce the likelihood that wealthy households and businesses underreport their income in the first place.

The new rules would require financial institutions to report two new pieces of information — how much money flows into and out of bank accounts held by individuals and companies — on the form they already use to report interest income in these accounts.

There’s bipartisan momentum for the President’s overall plan to bolster the IRS and improve tax administration. The recent bipartisan infrastructure deal includes $40 billion in mandatory IRS funding — the first half of the plan’s funding component. If this funding is included in an infrastructure deal, then Congress should include the second half of the plan’s funding component in a recovery package, as well as this critically important information reporting requirement.

The information reporting proposal itself has drawn bipartisan support. Former Bush Treasury Secretary Henry Paulson recently joined a group of former Treasury Secretaries in endorsing it, writing that:

We are convinced that better information-reporting requirements can be designed that will permit significant increases in revenue collection without imposing any burden at all on taxpayers and imposing no significant increase in regulatory burdens across the economy. Relying on financial institutions to relay some basic information about account holders is a sensible way forward.

Also, a group of former IRS commissioners who served under both Republican and Democratic Presidents recently underscored the importance of better information reporting:

This information could assist taxpayers in filing accurate returns and help the IRS better focus collection efforts. Research shows that when the IRS has access to third-party reporting, compliance rates top 95 percent. Without third-party information reporting, compliance rates are below 50 percent. Reliable information is critical to an effective and fair tax system.

New reporting requirements often draw initial knee-jerk opposition but are widely accepted as sensible once they’re ingrained in the reporting regime. A good example is the requirement that mutual funds and financial institutions report the “cost basis,” or original purchase price, of financial assets, such as stocks and bonds. This requirement, proposed by the Bush Administration in 2007 and enacted in 2008, imposed a relatively heavy burden on the financial industry. It required these firms to track individual asset purchases and holding periods, dividends reinvested, and so on, including on a range of complex securities. But while various sub-sectors of the industry raised significant concerns at the time, the industry largely adopted a constructive posture as Congress developed the rule. The rule ultimately was enacted with bipartisan support. Today, it is a standard feature of financial reporting.

The Biden proposal is far less complex. Financial institutions would be required to provide the IRS with gross inflows and outflows of a given account. Congress should pass the Biden proposal in full.

Congress should resist any urge to narrow the requirement to a targeted group of account holders. If, for example, the requirement only applied to accounts whose gross inflow or outflow exceeded a specified threshold, people could easily spread their money around to more accounts to avoid the requirement, severely undermining its effectiveness and revenue-raising potential.

In another example, if the requirement only applied to account holders with incomes over a specified threshold, this would impose a higher burden on financial institutions to sort out which accounts they were required to report on. This also would raise serious privacy concerns, as financial institutions don’t have information about account holders’ total income; Congress would have to give the IRS permission to provide it. That, in turn would undermine a key privacy protection of the Administration’s proposal, under which information would flow from financial institutions to the IRS but not the reverse.

While any new reporting requirement will take some time (which the Administration and Congress should provide) for institutions to adjust their systems, the Biden proposal is straightforward. As Treasury Secretary Janet Yellen recently told the Senate Finance Committee:

We’re simply asking to add two boxes to [the IRS 1099-INT] form, one that would be the aggregate inflows into the account over the course of the year, and the second would be the aggregate outflows from the accounts. So it’s not detailed information. It’s for accounts where there’s already a provision of information from financial institutions directly to the IRS. And we’re proposing two additional bits of data that are easily accessible, and involve essentially no additional burden on financial institutions.

Moreover, the expected payoff in additional revenue from the Biden reporting requirement — $460 billion over ten years — is an order of magnitude greater than the 2008 requirement, which was projected at the time to generate $6.7 billion over ten years.

Given the proposal’s relative simplicity and large potential benefits, it deserves the support of both lawmakers and the financial industry.