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January 11, 2006 (via the New York Times)
I.R.S. Move Said to Hurt the Poor
By DAVID CAY JOHNSTON
Tax refunds sought by 1.6 million poor Americans over the last five years were frozen and their returns labeled fraudulent, although the vast majority appear to have done nothing wrong, the Internal Revenue Service's taxpayer advocate told Congress yesterday.
A computer program identified the refund requests as suspect and automatically flagged the taxpayers for extra scrutiny for years to come, the advocate said in her annual report to Congress. These taxpayers were not told that the I.R.S. criminal investigation division suspected fraud.
The advocate, Nina Olson, said the I.R.S. devoted vastly more resources to pursuing questionable refunds sought by the poor - which under the highest estimate is $9 billion - than to the $100 billion in taxes not paid each year by people who work for cash and either fail to file tax returns or understate their income.
As for the suspected fraud in refund requests, Ms. Olson said her staff sampled the suspect returns and found that 66 percent were entitled to the amount sought or more. Another 14 percent were due a partial refund. She expressed doubt that many among the remaining 20 percent had committed fraud.
Unless taxpayers press for their refunds, Ms. Olson said, they "are not given an opportunity to substantiate their claims or to show that any overclaims identified were due to honest error rather than fraud."
The I.R.S. criminal division defended its program as a successful effort to protect against refund fraud, saying it "has stopped literally billions of dollars of false refunds to criminals." It said the program was intended to be fair to all taxpayers while efficiently using limited law enforcement resources.
Ms. Olson also said in her report that the I.R.S. is answering far fewer telephone calls, spending far less to teach small businesses how to comply with the tax laws and, in general, is cutting back on services to help taxpayers comply with the law. She said cutting taxpayer assistance would probably result in more costly tax collection.
Senator Charles E. Grassley, the Iowa Republican who is chairman of the Senate Finance Committee, said, "We've seen a significant increase in refund abuse in recent years."
"However," he said, "I'm concerned by the advocate's findings that thousands and thousands of taxpayers are having their refunds frozen by the criminal investigation division, yet the taxpayers often do not know their refund has been frozen and can't effectively challenge the I.R.S.'s actions."
Ms. Olson said the criminal investigators' efforts, known within the I.R.S. as the Questionable Refund Program, were unfair and might be illegal.
"At a minimum, this procedure constitutes an extraordinary violation of fundamental taxpayer rights and fairness," Ms. Olson wrote, adding that it "may also constitute a violation of due process of law."
Her staff's sample of frozen returns found that the average reported income was about $13,000 and the refund due was about $3,500.
About three-quarters of those affected were employed parents who applied for the earned-income tax credit, under which all income and Social Security taxes can be returned and, in some cases, a payment made.
The credit is a kind of negative income tax, first advocated by Milton Friedman, the Nobel-winning economist, and championed by President Ronald Reagan as the government's best program to encourage the poor to improve their circumstances through work.
Ms. Olson's report noted that in recent years, Congress has given the I.R.S. more than $875 million to investigate suspected fraud in the $32 billion tax credit program. Ms. Olson has repeatedly said that Congressional estimates of rampant fraud appear to have little or no basis in fact.
She said that in cases where frozen refunds were later issued, the delay was typically more than eight months, which she said was a hardship on the poor taxpayers who had filed proper tax returns.
The criminal investigators defended the program, writing to Ms. Olson that they had blocked $2.1 billion in questionable refunds.
Ms. Olson said that statement was misleading because just two refunds, from a scheme run by prison inmates, accounted for $1.8 billion of the total. These refunds, she said, almost certainly would have been stopped anyway because tax experts at the Congressional Joint Committee on Taxation must review all refunds of $2 million or more.
She said the balance of the criminal division's refund fraud estimate appeared to be significantly inflated.
The criminal investigators also criticized the advocate's finding that 80 percent of taxpayers whose refunds were frozen were entitled to all or part of the money. They said that "innocent taxpayers" were the most likely to press for refunds.
Ms. Olson, in replying to the investigators, noted that they put suspect returns into three categories, the most serious labeled "conclusively" shown to be fraudulent. Ms. Olson's staff studied a sample of these returns and found that 46 percent of refund requests were proper, an estimate that the criminal investigators now agree is accurate.
Congress created the taxpayer advocate as part of a 1998 law intended to give individual taxpayers greater protections from perceived abuses by overzealous tax collectors and auditors.
Ms. Olson, who ran a tax clinic for the poor before her appointment in 2001 as taxpayer advocate, told Congress that the biggest need was a simplification of the tax system.
"Our tax code has grown so complex," she wrote, that "it creates opportunities for taxpayers to make inadvertent mistakes as well as to game the system."
The Tax Foundation, a nonpartisan research group that favors lower taxes, said in a separate report on Tuesday that complying with the tax code cost individuals, businesses and others $265 billion last year.
Ms. Olson cited the growing number of returns considered questionable in her 2003 report to Congress, but it drew little attention because she did not raise any of the fairness, effectiveness and efficiency questions that are in her latest report.
Professor Leslie M. Book of Villanova University, who runs a tax clinic for the poor and has studied how well the poor comply with the tax laws, said the computer program was a blunt and unfair tool for fighting fraud.
"Surely there are taxpayers who are ineligible claiming the credit," Professor Book said.
"But freezing refunds without giving taxpayers due process is an extremely dangerous way to administer the earned-income tax credit," he said. "These taxpayers often need more rather than less protection because they are not sophisticated, are afraid of government involvement."
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