Why Congress Shouldn't Tax 1099s

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Harold Pollack waxes indignant over a Senate proposal to fix the terrible provision that somehow made it into the health care bill, forcing companies to issue 1099s for every goods provider with which they do a non-trivial amount of business.  Harold Pollack thinks it's horrifying that anyone would want to slightly pare back health care provision in order to eliminate the billion or so that the tax will raise every year.

Or should we zero out these funds in order to repeal a small health reform provision that clamps down on rampant tax evasion?

That's the choice Congress is likely to face next week. Some prominent Republicans want it to choose the latter, although you likely won't hear about it--at least, not in those terms.

Instead, you will hear about how Republicans are trying to undo some of the damage health care reform supposedly inflicts upon small business.

Here is the basic issue, as described by the essential folks at the Center for Budget and Policy Priorities and in Sunday's New York Times. In theory, all businesses must file 1099 tax forms with the IRS for any payments of more than $600 that go to unincorporated contractors. But the rules have been loose: Firms did not have to report any payments to corporations. They also did not have to report payments for goods and property, as opposed to services. This made it easy for them to under-report income and, as a result, avoid paying taxes on that income.

The Affordable Care Act tightened existing tax law to address both of these problems, by tightening the rules and forcing businesses to report more of those payments. But this effort to enforce what was, after all, existing law has not gone over well with groups like the National Federation of Independent Business, which has been decrying this "1099 collation calamity."

Truth be told, I have some sympathy for small business people here. On a practical level, paperwork is a genuine hassle, one that demands time and resources. As always, the circumstances of some small firms might merit specific adjustments to the new rules. As always, there is another, unmentioned issue that is more psychic. Taxes seem especially burdensome when they are easy to evade. Somehow, it seems extra unfair when you actually pay the money and you still have to fill out the paperwork.

Still, more than half of sole proprietor business income goes unreported. And the dollars add up. The 1099 provisions in the Affordable Care Act will, according to government projections, raise an estimated $17.1 billion over the next ten years. That's $17.1 billion of money rightfully owed to the United States Treasury that is left unpaid.

As you may already have gathered from the tone of this post, Harold Pollack and I are in substantial disagreement here.  In fact, I think that posts like this highlight the reason that so many small business owners vote Republican--and complain that the current health care law is the work of out-of-touch elitists who have never held a real job.

I think that health care wonkery is, in fact, a real job, and a very important one.  But so is running a small business, and the amount of hassle that this new law imposes on taxpayers is all out of proportion to the benefit derived.  Even the IRS in-house watchdog thinks so.  And it's not just going to produce a lot of administrative hassle for the businesses, but for the IRS itself, which will suddenly be inundated by new tax reporting.


For starters, no one is suggesting that this law will do much of anything to close America's "tax gap" (the gap between what the IRS thinks taxpayers should pay, and what they actually do).  The tax gap is almost $300 billion; the new law would reduce that by perhaps a half a percent.  While it's true that the IRS believes that over half of sole-proprietor income is underreported, Pollack seems to think that this means that over half of sole-proprietor income is undeclared--i.e. that businesses are deliberately failing to report taxable transactions.

I've no doubt that they are--but not to the tune of half their income.  The gap is composed of a bunch of different factors, only one of which is underreporting.  Everything from overstating the purchase price of an asset (and thereby underreporting capital gains) to taking an improper home office tax deduction, to taking some complicated deduction for which you aren't actually eligible, contributes to the misreporting.  

And it's hardly surprising that this is most prevalent among sole proprietors, who are more likely than other business groups to be doing their own accounting, and preparing their own taxes.  It takes me a full weekend every year to do my taxes, simply because my freelance income makes me a sole proprietor.  Most journalists have accidentally underpaid at least once due to a 1099 gone astray.

That's why the revenue this tax will raise is so pitifully little.  But the burden on businesses is not little.  For all Pollack's nod towards sympathy for small business owners, it seems unlikely he's ever run one.  Paperwork is an annoyance to people like Pollack and me, who make our living with words, paper, and the ability to research arcane points.  It's an overwhelming burden to the typical sole proprietor, who often can't pay experts, and also lacks the expertise to figure out these questions himself.  Hell, I find it difficult to figure out which deductions I'm eligible for, and I write about taxes for a living.

It's not enough to say that this is money "the treasury is rightfully due".  Some percentage of the money your daughter earns babysitting is money "the treasury is rightfully due", but trying to crack down on one of the most rampant fonts of tax evasion in the country--and using child labor, no less!--would require intrusions into peoples' privacy all out of proportion to the benefit gained.  So we don't do it--even though there's really no moral reason that the employers of said teenagers shouldn't have to issue a 1099 to every kid who sits their toddlers, washes their car, or mows their lawn.

Pollack goes on to cite a potential compromise that excludes businesses with under 25 employees--as if we shouldn't care about any compliance burden that hits slightly larger businesses.  It's that sort of attitude that has made corporate income taxes the complex monstrosity that they are today. 


Tax compliance is a big deal in the US--by one estimate, the ratio of compliance costs to compliance revenue for the corporate tax is almost 30%.  According to the Tax Foundation, the total compliance cost of the tax code is $196 billion--or more than 1% of GDP.  The IRS estimates that Americans spend 6.6 billion hours a year filling out tax forms.

That is not an argument against having a tax code, or trying to crack down on evasion.  But it does mean that any new compliance measures should be presumed guilty until proven innocent.  There has to be some benefit that is commensurate with the cost.  And this measure flunks that test.



But if Harold Pollack thinks that these services are valuable enough to warrant closing loopholes, I happen to have a candidate right here:  academic tenure.

After all, as I was repeatedly assured by professors during the debate over whether we should end tenure, tenure is a very valuable form of compensation.  Without it, we'd have to pay professors much more.

If that's true, then professors are engaged in tax arbitrage.  When companies offer other non-cash benefits, such as housing or cars, those benefits are taxed.  Indeed, many of the underreportings that Pollack believes are so shameful revolve around precisely these sorts of non-cash benefits.  Why shouldn't we tax tenure?  It wouldn't be hard to levy a modest surtax of say 5-10% on tenured academics in order to prevent them from using a loophole in the law to deny Treasury its rightful due.  That ought to supply quite a lot of medical services.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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