Taxes Matter 13: Maine’s Sales Tax, Tax Zappers and the Laffer Curve, Oh My!

Old Cash Register 2
Creative Commons License photo credit: OhMyGouda in Florida

I just posted this on The Maine Heritage Policy Center’s blog (Maine Freedom Forum), but I also wanted to share this with Wealth Alchemy’s audience because so many of you will likely be seeing this debate coming soon to your own state.

Also, we all need to realize that the retail sales tax is one of the worst taxes out there and is simply on its last legs–all states should be working to eliminate it. The better alternative would be to enact a Business Enterprise Tax as New Hampshire has done which is also one reason why New Hampshire has one of the lowest business tax burdens in the country. Read on . . .

Today the Kennebec Journal has a story about the rise of sales tax zapper computer programs that enable businesses to under-report their taxable sales and lower their sales tax bill. Of course, the article casts Maine’s state government as the victim of unscrupulous business owners:

But some lawmakers are concerned the state may be losing significant revenue from the latest computer technology, called “zappers” because they alter sales records in a more subtle way that still yields a lot of cash for the seller.

“It’s clearly subversive and against our process of treating people fairly, equitably and everyone paying their fair share of the tax burden,” said Rep. Garry Knight, R-Livermore Falls, co-chairman of the Legislature’s Taxation Committee. “I would suggest that zappers be outlawed in this state.”

He said his panel has not looked at the expanding use of technology to cheat on tax laws, but he said if it is happening in other states, Maine should assume some is happening here.

With a zapper program, a $6 burger-and-fries combo at a restaurant, for example, could be altered by the software to reflect a $4 burger sale. In Maine, that would mean 14 cents going to the restaurant owner that should be paid in taxes. In other states, that has added up to a lot of lost revenue.

A retailer can have the program change the sales price of an item. For example, a $20 shirt is reported as selling for $18. In Maine, that’s a loss of a dime; but all of those nickels, dimes and pennies add up.

A retailer can have the program change the sales price of an item. For example, a $20 shirt is reported as selling for $18. In Maine, that’s a loss of a dime; but all of those nickels, dimes and pennies add up.

“Tax evasion is something that we always should take seriously,” said Rep. Seth Berry, D-Bowdoinham, the lead Democrat on the Taxation Committee. “Zappers are something that Maine Revenue Services is not able to track. It is a very difficult enforcement problem.”

He said Maine should watch what other states are doing and consider adopting policies and laws that seem to work the best. He agreed Maine may want to outlaw the computer programs, although he is not sure how effective that may be.

As usual, policymakers are simply treating this as a tax compliance issue when, in reality, this zapper issue is a symptom of a much larger problem–Maine’s sales tax is suffocating the state’s retailers. A few month’s ago I released a study which showed that Maine is annually losing an estimated $2.2 billion in retail sales to New Hampshire thanks to tax-fueled cross-border shopping by Mainers. Lowering the sales tax would encourage more Mainers to stay home to do their shopping. As a result, Maine’s retailers would not be struggling quite as much as they are now and having to resort to desperate measures such as sales tax avoidance.

In fact, the analysis suggests that Maine sales rate of 5 percent is very likely on the back-side of the Laffer curve. In other words, a lower sales tax rate would generate more economic growth and higher tax collections from other taxes, such as income taxes, the remaining sales tax, property taxes, etc., that it would offset the lower sales tax collections stemming from the tax rate reduction. It’s the closest thing to a “free lunch” that one can get in tax policy. Yet, policymakers have just left the sandwich on the table.

No, the real victims here are Maine’s businesses who have historically been treated by policymakers as a “money pinata.” Now, on top of the sorry economy, Maine businesses, especially smaller businesses, will have to live in fear that the next knock on their door will be an agent from the Maine Revenue Service as they attempt to crack down on these sales tax zappers. This will be an added tax compliance cost for all businesses which is especially onerous and demeaning to the overwhelming majority who play-by-the-rules.

Landlords Get Caught in 1099 Dragnet

In my previous blog post, “Prepare for 900% Increase in 1099 Workload,” I estimated that the expanded requirements for filing a 1099 (on everything over $600 in value) could increase tax compliance as high as the estimated increase in revenue of $17 billion.  So the economy would suffer a net loss of $34 billion ($17 billion in new tax revenue and $17 billion in higher tax compliance costs).

Now Commerce Clearing House is reporting that the 1099 dragnet is widening and up next are landlords:

Congress in 2010 expanded the information return reporting requirements contained in Code Sec. 6041. Generally, Code Sec. 6041 requires payments of $600 or more to a single recipient in the course of a trade or business to be reported by the payor to the IRS and the payee, usually on Form 1099-MISC. There are exceptions to the general reporting requirements but these exceptions begin to disappear in 2011.

One of these disappearing exceptions to the reporting requirements involves landlords. The Small Business Jobs Act of 2010 (2010 Jobs Act) (P.L. 111-240) amended the definition of trade or business to include renting real property. Before 2011, most landlords were not subject to the reporting requirements because renting real property was not considered to be a trade or business. Under the new version of Code Sec. 6041, real property rental is now considered a trade or business but only for purposes of the reporting requirements.

Of course, as with many government regulations, there will also be unintended consequences.  In this case, the 1099 requirements could make landlords vulnerable to identity theft:

Since landlords have not, until now, been “engaged in a trade or business,” the reporting requirements create a problem. According to the instructions for Form 1099, sole proprietors and others, like landlords, who are not otherwise required to have an employer identification number (EIN) should use their Social Security number (SSN) for reporting purposes. Moreover, the instructions state that the filer’s name and TIN should be consisted with the name and TIN used on the filer’s other returns. This opens up the opportunity for identity theft.

So I wonder whose going to be scooped up next in the  1099 dragnet as more of these exceptions disappear?

Prepare for 900% Increase in 1099 Workload

I received an email from Commerce Clearing House (CCH), a major tax information firm for tax professionals, with this shocking headline–“Prepare for 900% in 1099 Workload.” What does this mean?  According to CCH:

Today most corporations are required to perform 1099 reporting for less than 10 percent of their supplier population, according to industry estimates. That will jump to an estimated 90 percent under new tax legislation that takes effect in 2012. Legislation could make corporations do nine times as much 1099 reporting.

Under the law, businesses will be required to report purchases of items like office equipment, food and bottled water, gasoline, lumber and plumbing supplies if payments to any vendor in the course of a year aggregate to at least $600. In many cases, companies will also have to report payments for things like travel, telephone and Internet service.

And why are they doing this to businesses? Shockingly, its all about the money.

The new reporting requirement, included in the Patient Protection and Affordable Care Act, aims to close an estimated $300 billion tax gap between what individuals and businesses owe compared to what they actually pay. Congress expects the 1099 measure to raise $17 billion in taxes and fees, offsetting part of the cost of health care reform.

OK, I’m having a really hard time justifying this draconian change in the tax laws to raise a measly $17 billion.  Folks in D.C. call such amounts “Fairy Dust.”  The article does not state which type of 1099 they are referring to, but my guess is that it is the 1099-MISC.  According to this document (pdf) from the IRS’s Statistics of Income Division, there were 85,524,982 1099-MISC forms filed in 2009.  Multiply that by nine times you get 769,724,838 forms.

Now, how much do you guess it costs to fill out the form, make copies, send one to the vendor and file one for your records?  I have no idea, but lets conservatively use a nice round number of $10.  That means the costs of compliance with this draconian measure will come to $7.7 billion–nearly 50 percent of the expected revenue increase!  Assume $20 and the tax compliance costs would nearly equal the expected revenue!

If you think that’s bad, let’s hope they don’t expand the requirements for filing a 1099-B (Proceeds for Broker and Barter Exchange Transactions) which had over 800 million filings in 2009.  Do the math on that one.

But wait there’s more.  It seems there is one loophole around this draconian measure:

So far, the IRS has said only that companies who pay bills with credit or debit cards will dodge the 1099 bullet, because the reporting burden will fall on the credit card companies, Roth says. But using credit cards in an attempt to avoid additional reporting burdens is not a good solution. Many vendors or suppliers may not want to allow it because of the extra cost to them of 2 to 3 percent per transaction, and some purchases will exceed the dollar limit for company credit cards.

Say what?!  So even avoiding the cost of filing the 1099 is going to cost businesses 2 to 3 percent per transactions and, if they hold a balance, interest.  Whoever thought of this idea needs to be taken behind the woodshed . . . better yet, make them file the first couple of million 1099s as community-service.

Isn’t already bad enough that American’s are already shouldering a $1.75 trillion burden complying with federal regulations.