[House Hearing, 109 Congress] [From the U.S. Government Publishing Office] HEARING ON IRS LATEST ENFORCEMENT: IS THE BULLS-EYE ON SMALL BUSINESS? ======================================================================= HEARING before the COMMITTEE ON SMALL BUSINESS HOUSE OF REPRESENTATIVES ONE HUNDRED NINTH CONGRESS SECOND SESSION __________ WASHINGTON, DC, APRIL 5, 2006 __________ Serial No. 109-46 __________ Printed for the use of the Committee on Small Business Available via the World Wide Web: http://www.access.gpo.gov/congress/ house ______ U.S. GOVERNMENT PRINTING OFFICE 28-570 WASHINGTON : 2006 _____________________________________________________________________________ For Sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512�091800 Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001 COMMITTEE ON SMALL BUSINESS DONALD A. MANZULLO, Illinois, Chairman ROSCOE BARTLETT, Maryland, Vice NYDIA VELAZQUEZ, New York Chairman JUANITA MILLENDER-McDONALD, SUE KELLY, New York California STEVE CHABOT, Ohio TOM UDALL, New Mexico SAM GRAVES, Missouri DANIEL LIPINSKI, Illinois TODD AKIN, Missouri ENI FALEOMAVAEGA, American Samoa BILL SHUSTER, Pennsylvania DONNA CHRISTENSEN, Virgin Islands MARILYN MUSGRAVE, Colorado DANNY DAVIS, Illinois JEB BRADLEY, New Hampshire ED CASE, Hawaii STEVE KING, Iowa MADELEINE BORDALLO, Guam THADDEUS McCOTTER, Michigan RAUL GRIJALVA, Arizona RIC KELLER, Florida MICHAEL MICHAUD, Maine TED POE, Texas LINDA SANCHEZ, California MICHAEL SODREL, Indiana JOHN BARROW, Georgia JEFF FORTENBERRY, Nebraska MELISSA BEAN, Illinois MICHAEL FITZPATRICK, Pennsylvania GWEN MOORE, Wisconsin LYNN WESTMORELAND, Georgia LOUIE GOHMERT, Texas J. Matthew Szymanski, Chief of Staff Phil Eskeland, Deputy Chief of Staff/Policy Director Michael Day, Minority Staff Director (ii) C O N T E N T S ---------- Witnesses Page Everson, The Honorable Mark W., Commissioner, Internal Revenue Service........................................................ 4 Sullivan, The Honorable Thomas M., Chief Counsel for Advocacy, U.S. Small Business Administration............................. 6 Brown, Mr. Kevin, Commissioner, Small Business/Self-Employed Division, Internal Revenue Service............................. 26 Olson, Ms. Nina, National Taxpayer Advocate, Internal Revenue Service........................................................ 28 Satagaj, Mr. John, President and General Counsel, Small Business Legislative Council............................................ 31 Hall, Mr. Keith, CPA, Partner, Hall and Hughes, PLLC............. 32 Fredrich, Mr. Michael, President, Manitowoc Custom Molding, LLC.. 35 Sawicky, Dr. Matt, Economic Policy Institute..................... 37 Appendix Opening statements: Manzullo, Hon. Donald A...................................... 57 Velazquez, Hon. Nydia........................................ 60 Prepared statements: Everson, The Honorable Mark W., Commissioner, Internal Revenue Service............................................ 62 Sullivan, The Honorable Thomas M., Chief Counsel for Advocacy, U.S. Small Business Administration............... 72 Brown, Mr. Kevin, Commissioner, Small Business/Self-Employed Division, Internal Revenue Service......................... 78 Olson, Ms. Nina, National Taxpayer Advocate, Internal Revenue Service.................................................... 84 Satagaj, Mr. John, President and General Counsel, Small Business Legislative Council............................... 99 Hall, Mr. Keith, CPA, Partner, Hall and Hughes, PLLC......... 104 Fredrich, Mr. Michael, President, Manitowoc Custom Molding, LLC........................................................ 113 Sawicky, Dr. Matt, Economic Policy Institute................. 118 Additional material: Brown, Alvin S., Alvin Brown and Associates, LLC............. 124 Stoner, Floyd E., American Bankers Association............... 146 (iii) HEARING ON IRS LATEST ENFORCEMENT: IS THE BULLS-EYE ON SMALL BUSINESS? ---------- WEDNESDAY, APRIL 5, 2006 House of Representatives Committee on Small Business Washington, DC The Committee met, pursuant to call, at 10:00 a.m., in Room 2360 House Office Building, Hon. Donald Manzullo [Chairman of the Committee] presiding. Present: Representatives Manzullo, Kelly, Akin, Sodrel, Velazquez, Bordallo, Barrow. Chairman Manzullo. Good morning. Before receiving testimony from the panel, I want to remind everybody that we would like to keep the second panel witnesses to their oral testimony to five minutes. In front of you on the table, you will see a box that will let you know when your time is up. When the light is yellow, you have one minute remaining. When five minutes have expired, a red light will appear. Once the red light goes on please wrap up your testimony as soon as you are comfortable. This is the second hearing we have been having on the so called tax gap, which the IRS defines as the difference between what is paid and what should be paid. And everybody agrees that people should be paying taxes legally owed. The purpose of this hearing really is twofold. The first part is whether or not small businesses have been unfairly targeted by the IRS to the exclusion of others that may not be paying their taxes correctly. The second part has to do with what types of remedies are available to the IRS. But I want you to notice that the IRS' efforts are targeted at mom and pop small businesses. I read over the GAO's report on the IRS last night while watching the tremendous game with the University of Maryland. I do not know if I was more excited over that basketball game or over GAO's report on the IRS. This is a report you have to read yourself. It is dated July 2005. Page 11 makes it explicitly clear because the IRS has no way of knowing whether or not corporations pay their taxes correctly, they do not even discuss going after corporations, instead the IRS goes after the little guys, the most vulnerable, the ones without the big lobbying firms in Washington, the ones represented by trade associations and the little guys who always get the crap kicked out of them on Capitol Hill. This GAO report is nothing less than condemning over what the IRS is doing. It should make the IRS hang its head in shame. I want to read from it on page 11. Estimates for some components of the tax gap are based on old data. The data is used by the IRS to determine which persons to pursue to reduce the tax gap. The report explains that ``The IRS has difficulty estimating the tax gap because of different interpretations that complicate determination as to whether or not taxes are paid fairly by corporations. Further the report states that the IRS also ``explained that due to these complexities and the costs and burdens of collecting complete and accurate data for corporation, IRS has not systematically measured large corporate tax compliance through statistically valid studies, even though the officials acknowledged that such studies would be useful in estimating the related tax gap.'' If I were a professor and you turned in the report the IRS is using to go after the small people, you would get nothing less than a F or an F minus. I find it incomprehensible that the IRS is coming out with these new and fiscal schemes going after small businessmen when the data they rely upon is not worthy of a first grader. It's a disgrace that the IRS should rely upon virtually no information. But the word is out. Last year, audits were up 100 percent. If you're a small businessman, they were up 140 percent. The remedies that the IRS is proposing only attach to the little guys, the moms and pops and not to the C corporations. And the incredibility of these proposals means that if a small businessman is the sole shareholder in a C corporation, he's exempt. But, if he can't afford the attorney to go into a C corporation he's not exempt from the wrath of the IRS. I'm really upset about this. And I'm upset about it because of the poor scholarship that's gone into the study, as much respect as I have for Mark Everson and I know that he inherited this. This study was in place even before he came into office. Mark is still using this information for the purpose of going after the most vulnerable. Our job here in the Small Business Committee is to look after people that no one else cares about in this place, the forgotten ones, the 7 billion small business people that always get shuffled, the ones that pay health and accident insurance premiums after 15 percent FICA and FUTA taxes. They're the only business people that have to pay for their insurance with after tax money. And the frustration level of this Chairman is running extremely high at this point because of the number of small business people that are being hit. But in spite of that, we look forward to the testimony of Mark Everson, who I think has done an exemplary job at the IRS. He's got a job that Congress has mandated to go after these people, and he's going after them on the best information that he has and the only methods that he knows. We disagree with the quality of his information and disagree with the remedies he's proposed but agree with the fact that you cannot have a nicer person than somebody like him. And I yield to the minority, Ms. Velazquez. [Chairman Manzullo opening statement may be found in the appendix.] Ms. Velazquez. Thank you, Mr. Chairman. With April 15 right around the corner, taxes are undoubtedly on everyone's mind. Today's hearing will focus on the tax gap; the difference between what the IRS is supposed to collect and what is actually collected. According to the IRS, the tax gap is estimated to be $345 billion per year and growing. As the budget deficit mounts, around $400 billion, the administration is looking for ways to recover lost revenue that was supposed to come flowing in as a result of their fiscal policy. But it has not. Unfortunately, it appears the administration is trying to make up for these shortfalls and balance the budget by unfairly targeting small businesses. Today, we will hear from the IRS about a plan in the President's FY 2007 budget to crack down on small firms by granting the IRS even greater authority for enforcement. This proposal, while having a significant impact on entrepreneurs will only reduce the tax gap by one tenth of 1 percent. This is a large price to pay for a solution that will not even fix the problem. However, any attempt to solely blame the IRS is wrong. What seems to be lost in this discussion is the impact wrong policy choices, specifically tax policy made by congressional Republicans and the administration, have had on this nation's small businesses. While providing minimal relief for entrepreneurs, the bulk of the reform passed has only further complicated the process. It has added thousands of pages to the tax code, which will only exasperate the growing tax gap problem. For proof, one only has to look at the 2004 tax bill. Even the Chairman of the Ways and Means Committee testified that this legislation set back efforts to simplify the tax code. Small businesses are being hit twice; once with the ever- increasing complexities of the tax code and again with the rising possibility of an audit. Given the growing complexity, tax assistance is needed now more than ever for small businesses. Unfortunately, rather than providing assistance, the Administration is closing taxpayer assistance centers. It simply does not make sense for the IRS to shift these resources when the complexity of the tax code is increasing. Congress will be voting on the budget this week and we will see just how much commitment there is to fairness for small businesses. The question at hand is: Will Members support the Administration's budget proposal to further reduce tax compliance assistance efforts and impose strict enforcement efforts? Or will they reject these proposals? While many in the President's party are more than happy to vote for his tax cuts and trump all the supposed good they are doing, when it comes to the consequences, increased compliance costs and a growing tax gap, they are vehemently opposed. Unfortunately, you simply can't have it both ways. As has been the case with tax, energy and health care policy, the Administration continually favors large corporations. It is no surprise that while the tax gap is not only made up of small business taxpayers, this Administration lets the big corporations off the hook and instead focuses on entrepreneurs. At the same time, many small firms have little or no resources to defend themselves. Small businesses are the drivers of this nation's economy, and they deserve every effort possible to decrease the burdens they face. If the goal today is to reduce the costs to small business, Congress should first look to reduce the complexity of the tax code. Most entrepreneurs are doing everything they can to pay the taxes they owe. They should not be blamed for the tax gap. This Administration needs to come to terms with the role their policies have had in furthering the tax gap. They need to admit the problem, then work to reduce the effects rather than point the finger, which is exactly what is happening with this current debate. Thank you, Mr. Chairman. Chairman Manzullo. Thank you. The first panel we here from, Mark Everson, who has served as Commissioner of the IRS since 2003. Next, the Committee will hear from Tom Sullivan who is Chief Counsel of the U.S. Small Business Administration Office of Advocacy. Both have been before this Committee on several occasions. We look forward their testimony. I am going to set this clock at about ten minutes for the first panel. And if you do not use it up, that is fine. But because your testimonies are so complex, I want to give you plenty of time to do that. And Commissioner Everson, thank you for coming and we look forward to your testimony. And I also want to state to the folks here that you will be leaving after your testimony, but the taxpayer advocate plus somebody else from the IRS will be sitting on the second panel. Kevin Brown will be on the second panel, plus I understand you are going to have people from the agency in the audience that will be monitoring all the testimony. We appreciate that. STATEMENT OF MARK W. EVERSON, INTERNAL REVENUE SERVICE Mr. Everson. Thank you. I do not think I will use the whole ten minutes. But we already covered a lot in the opening statements, so I think we will get to plenty in the questions. Good morning Mr. Chairman, Ranking Member Velazquez and the members of the Committee on Small Business. I am pleased to be here again to update you on our efforts to reduce the tax gap. As you know, the tax gap is the difference between the amount of tax taxpayers should pay for a given year and the amount that is actually paid on a timely basis. The tax gap represents in dollar terms the annual amount of noncompliance with our tax laws. We now estimate that for the year 2001, the overall gross tax gap for all types of tax was approximately $345 billion, or a noncompliance rate of 16.3 percent. Our estimate of the net tax gap or what remains after enforcement and other late payments is $290 billion. To reduce the tax gap we seek to improve service to taxpayers, we also enforce the law against those who do not comply. Our working equation at the IRS is service plus enforcement equals compliance. We strive to pursue to a balanced approach for all taxpayers, not just small businesses. For service, our outreach and education programs help small businesses deal with the complexities of the tax code. And we are reducing wherever possible the paperwork and reporting burden small businesses face. Electronic filing, which is growing rapidly across the nation, sharply reduces taxpayer errors on their returns. Our award winning website, IRS.gov, is one of the most widely used websites in the world during tax seasons. On the next panel, you will hear from Kevin Brown, the head of our Small Business/Self Employed Division. Kevin will talk more about our efforts to decrease the amount of time and money taxpayers must spend to meet IRS requirements. We will continue to work to improve services. But as you know, we are also boosting enforcement. The typical small business already has enough challenges without having to deal with a competitor who does not pay his or her fair share in taxes. We need to make sure that all are playing by the same rules. We want a level playing field. No businessman or businesswoman should gain an unfair competitive advantage because he or she decides to underreport income, overstate deductions or fail to properly remit payroll taxes. In recent years we have restored the credibility of our overall enforcement programs. In fiscal year 2005 individual audits were up 20 percent from 2004 to 1.2 million. They're up 97 percent since 2000. High income audits were also up and have increased a 120 percent since 2000. Corporate audits bottomed out in 2003, but by 2005 had recovered by over 50 percent. Collections are more robust. Last year we had 2.7 million levies versus 200,000 in the year 2000. All told, enforcement revenues have increased from $43.1 billion in 2004 to $47.3 billion last year. In the President's fiscal year 2007 request we seek to build on this progress. We are asking for an additional $137 million in enforcement. This increase will allow us to maximize the return on the investment made in enforcement last year when Congress provided $42 million in additional enforcement funding. Our research on the tax gap clearly indicates that where there is third party reporting, there is better compliance. In this regard I would draw to your attention a number of proposals in the President's 2007 budget aimed to address administrative and reporting issues. The most important of these is the proposal to mandate reporting to the IRS of gross receipts by credit card issuers for their business customers. I believe the five legislative proposals that accompanied the Administration's funding request can make a significant contribution to reducing the tax gap. I hope they will enjoy your support. In addition to these specific legislative proposals, I would also note that we plan to study the distinction between independent contractors and employees under current law. Let me make one final point. The extraordinary complexity of our tax system contributes to the tax gap. I continue to be a strong advocate of tax reform and simplification. Thank you. [The Honorable Mark Everson's testimony may be found in the appendix.] Chairman Manzullo. Thank you. Mr. Sullivan? STATEMENT OF THOMAS M. SULLIVAN, U.S. SMALL BUSINESS ADMINISTRATION Mr. Sullivan. Good morning Chairman Manzullo, Congresswoman Velazquez, Congressman Kelly. I am Tom Sullivan, the Chief Counsel for Advocacy at SBA. Congress established my office to independently represent the views of small business before Congress and federal agencies. So the comments expressed here don't necessarily reflect the Administration or the SBA. My written statement was not circulated to OMB for comment. I'd like to submit my written statement for the record and briefly summarize. Chairman Manzullo. All the written statements of the witnesses will be inserted into the record without objection. Mr. Sullivan. Thank you, Mr. Chair. The small business industry groups who come to my office to try to appeal to us to bring their views into other government agencies have expressed concern that IRS is focused on small entities as a primary means of improving tax compliance. News articles illustrate the reasons why these trade groups view IRS' focus to be trained on their members. A March 20th ``Tax Notes Today'' article reported that IRS increased its number of audits primarily through a spike in small business audits. In recent testimony the Commissioner highlighted the return on investment for resources spent on enforcement each dollar, the Commissioner said, spent generated $4 in additional taxes collected. Small business groups who have appealed to my office are insistent that a similar analysis of how the service function of IRS realizes a return on investment would go far to demonstrate the balance of service plus enforcement. Nina Olson, the National Taxpayer Advocate who is on the second panel this morning, has on numerous occasions and recently at a hearing over in the Senate encouraged the IRS to ``recognize the central role taxpayer service plays in achieving compliance and do more to study the optimal ways to deliver taxpayer service and the magnitude of the impact.'' Also you mentioned, Mr. Chairman, in your opening statement the GAO. GAO has encouraged the IRS to conduct research on the reasons for taxpayer noncompliance. And in 1996 GAO made similar recommendations. Small business groups feel that this type of research on the service components of IRS can guide the IRS' education in taxpayer compliance programs. Now let me turn my attention to some of the specific proposals that were mentioned by the Commissioners and will be mentioned in the second panel by the National Taxpayer Advocate. The Treasury proposals and the Taxpayer Advocate's proposals that I will address require third party reporting and withholding. The Administration has proposed information reporting and backup withholding on credit card payments, payment card issuers, which are credit and debit cards. They would report reimbursements made to merchants and withhold taxes in certain circumstances. Second, the Administration has proposed to require information reporting and backup withholding on all non-wage payments made to government contracts. Small business groups who have come to my office have expressed that an unintended consequence of the increased withholding will be its harm to the cash flow of small businesses. In general, cash flow or liquidity is one of the most significant constraints small entities face in managing their business. According to a recent NFIB survey cash flow issues ranked in the top ten of important problems faced by small businesses. Small entities have a more difficult time paying their bills when their cash flow is interrupted. And small businesses must either borrow additional capital or forego early payment discounts to manage cash flow shortfalls. Another unintended consequence of increased withholding is that tax deductible expenses of small entities may unnecessarily be taxed. Payments received by small entities for the services and products they provide include both their expenses and profits. Small business groups are concerned that another unintended consequence does not enter into the equations of withholding because expenses are generally tax deductible while profits are subject to tax. Before Treasury and IRS impose new reporting and withholding requirements, small business believe it is important to determine the impact that small card issuers and small local governments will need to absorb as a consequence of these reporting and withholding strategies. The National Taxpayer Advocate has proposed other reporting and withholding regimes. The third party proposals detailed in my written statement, while presented as voluntary really impose additional administrative burdens on small businesses that contract with self-employed taxpayers. Small businesses currently shoulder exceedingly high tax compliance costs. A study that was recently updated by my office shows that the cost of compliance costs employers with less than 20 employees a total of $1304 per employee. Additionally, requiring the payors of self-employed taxpayers to withhold may distort the line between being an employee and being an independent contractor. Payors of self-employed taxpayers may become vulnerable to employer liability issues in that blurry line of independent contractor versus employee. Those issues include workman's compensation and unemployment tax issues. Research sponsored by my office continues to show that the cost of tax compliance is 67 percent higher in small firms than in large firms. What can the IRS do to limit this disproportionate burden or unlevel playing field? Small businesses believe that IRS can evaluate the service they provide taxpayers so the importance of taxpayer service is not lost as they attempt to improve tax compliance. And certainly this hearing is an opportunity for IRS to consider some alternatives that may minimize the unintended impact of some proposals on small business. Thank you for allowing me to appear this morning. [The Honorable Thomas Sullivan's testimony may be found in the appendix.] Chairman Manzullo. Thank you. Ms. Kelly, why don't you go first? Ms. Kelly. Thank you. I appreciate it. I have a markup in another Committee I have to get to. I am very pleased to have the two of you here. There is no one that knows who really likes to dip in their pocket on April 15th and pay taxes. They would rather keep the money. Quite frankly, as a Republican in this Congress, I would like to have them keep the money. But that being said, when you talk about small business as a small business owner, former small business owner I know that the tax system is very complicated, but I also know that there is an attitudinal problem. Many times when someone comes into your office and says ``I am here from the IRS for an audit,'' the attitude is ah-ha got you. At point in the past in my husband's office there was an auditor who came and said ``I have not found anything, but I have to find something because I have to cover the cost of my salary for being here.'' I know that that is not the first time that I have heard that. I have heard that in testimony in this Committee from other people, other small business owners. Our problem as small business owners is several. The basic problem is clarity. We do not get enough education at the small business level to truly understand the tax codes. So you wind up holding on to every tiny little slip of paper because you do not know what the tax man is going to want when he comes in. It is everything from whether or not your business has donated to charity, paid for an ad in a high school book, all kinds of things that effect us as small business owners. And I would encourage you, Mr. Everson and your group, your staff; Mr. Sullivan, I know you are out trying to help with clarity, but I know that both of you know that we have got to work through chambers of commerce, the NFIB, the groups that are out there to get more education on this tax code to the small business owners. It makes it easier for them. And without their full knowledge of all the little tiny tangential laws that may effect their particular business, then they do not save or have necessarily what is there. Because my husband and I own several different small business we at one point in our lives for a period of about 15 years were audited on every single year by the IRS because the IRS did not know enough about the businesses that we were running to understand what we were filing as our tax code. And I see heads in the audience shaking. Sure, other people have been through that. I am not the only person. Well, what concerns me is that we have some evidence here in this study that Chairman Manzullo was talking about that nothing really has changed over the course of the last ten years. We need to have a change. So I would like an open commitment from you to try to help us teach small businesses better than you have been to approach a clarity with the type of business that people are in. Someone who shoes horses for a living has a totally different business than someone who is making small pieces of equipment for the Intel industry. All these different businesses have different approaches to their business. You have got a one size fits all approach to the filing of things, and that is very difficult and it makes it very complicated. I would like to see you work toward clarity. Can you give me some assurance that you are going to do that? Mr. Everson. Well, you have covered a lot of ground there, and I agree with a great deal of it. We are committed to outreach and education and I think Kevin will get into some more of the details on that. But we have active programs working with the NFIB, which you mentioned, and all the different groups and get involved in their newspapers. And I think that is an area where I would suggest to you that that has been a success story of recent years. Can we do more? Absolutely, we need to do more. Two other points on this. Again, simplification of the Code. As you keep handing us the Jobs Act. The Jobs Act was this thick. We've talked about the proposals. The Chairman and I talked yesterday about one of the things we want to look at is the definition of employee versus independent contractor. This is our training manual to apply the 20 part test on whether somebody is an employee or an independent contractor. We can only educate our people so well with the law that you have given us, if you will. So this is a joint discussion. But, yes, we will continue to focus on the education and the outreach. The last point I would say is I do not agree with the idea that somebody has to find something. Our no change rate on audits that you are talking about runs something like 16 or 17 percent. This research that we have undertaken the Chairman does not have much faith in it but we think it is pretty good, we believe will help us better figure out where we want to look so that we are not in that situation that you are discussing; that somebody is in there saying ``gee, there is nothing here.'' This is something where we believe if we use the research properly, we will be able to risk adjust where we look. Ms. Kelly. Well, just a follow-up on that, Mr. Everson. Are you in fact investigating more small businesses in this nation, is that a fact? Mr. Everson. Yes, that is fact. If the Chair will indulge me for just a minute I would like to show several charts that will sort of frame this issue. Selected coverage rates 2005. Companies with assets of $250 million, 44 percent. That is why we did not bother to do the research. We did the 46,000 audits on individuals, the coverage is so much lower. I would not use any more money on the corporations based on even if I knew that the tax gap was understated by half, because it is a relatively small piece. We are in there all the time auditing the biggest companies. Estate tax, gross estates with over $5 million, 28 percent audit rate. Corporations $10 to $50 million assets, 14 percent audit rate. Individuals with income over a million dollars, that's 5 percent. This is still too low. We are bring this up. What we are talking about here is individual businesses, individuals with the Schedule C, that is at 3 percent audit rate. That is in contrast to the fact that if we go to the tax gap map you will see that the problem. Time filing that's most the individuals, that's about 8 or 9 percent, underpayment. You say you what you owe us but then you just do not pay us, that is another 8 or 9 percent. Eighty percent of it is under reporting. Most of that is in the individual income tax. The biggest piece is in the under reported business income and that has an effect on the self-employment taxes. So it is really a bigger number than the $109 billion that effects the $39 billion? The areas where we don't get much reporting, third party reporting come up to $110 billion of the tax gap. The biggest piece there is Schedule C income, that is $68 billion. That $68 billion has different components. The biggest single piece of that is gross income, that is $39 billion. There are other pieces in here. And I agree. Look, education of what depreciation could be or car and truck expenses, we can do better there. But I don't think that gross income is--that most of this education will do it on this $39 billion. The question here is whether the income is being reported. Why is this important? Because if you look at individual returns, this shows the change in individual returns since 1978. It has gone up 50 percent for all individual returns. We are up at over 135 million now. But Schedule C filers have gone up by 175 percent. This is no surprise to you. You know what has happened; there is a small growth in small businesses. But that issue that I just showed there, that is going to get bigger as time goes on. So the basic rule here, we want to increase the audits, and we are increasing them everywhere, it is not just small businesses. But when we get the legislative proposals this is what you--this breaks out the compliance relatively speaking. Wages, we have 150 million Americans, we are not talking about them here, but there are 150 million American employees. They are used to reporting and withholding, by the way. We are not proposing withholding. We are proposing backup withholding. But the average America, 150 million of us including everybody on this panel, is used to reporting on your wages. There is no cheating on wages, a one percent noncompliance rate. Where you have no reporting. no reporting like the income for the Schedule C filer, the noncompliance rate is over 50 percent. That is the problem. That is the problem. Ms. Kelly. That is possibly, sir, because of confusion. Mr. Everson. I would agree on things like depreciation of car expenses, but not on gross receipts. Not that complicated when somebody pays you, when somebody pays you in cash or with a credit card, it is not that complicated. Ms. Kelly. Mr. Everson, what is your basis for all of this? Have you hypothesized a number? Mr. Everson. No. Forty-six thousand audits were done as a part of the national research program that has been reviewed by GAO and others. What the Chairman was talking about earlier was, with which I agree, he stated accurately what happened. We did not do the research on the C-Corps and the reason we didn't do the research on the C-Corps was because, as I said, we are already auditing those big firms by over 40 percent a year. So that this was a very intensive effort, cost of tens of millions of dollars to do this research. Looked at by GAO and others, a lot of academics participated in it. Ms. Kelly. Let me just say that I notice here the reason I am saying, all these yellow boxes have a little code down here saying ``dependent on older estimates.'' Mr. Everson. Yes. Yes. Ms. Kelly. So I wonder about the metrics you are using on these charts. Mr. Everson. What I would say to you is all of what we have been talking about is over here. I concede freely to you that these are the big corporations right here. Even if this number is doubled because it is off by a factor of 100, what I am suggesting to you is we already have plans in place to attack that. So that where we spend our research effort, our initial-- Chairman Manzullo. With withholding plans in place, your remedies are aimed solely at small businesses. You want to have backup withholding on credit card companies and on independent contractors solely as small businessman, completely excluding the C corporations. I am sorry. Ms. Velazquez? Mr. Everson. I'm sorry, Congresswoman. I am happy to come see you and continue to talk about this. Ms. Velazquez. Mr. Emerson, thank you for your testimony. Everson, I am sorry. Mr. Everson. Actually, I hate to correct the Chairman, but it is Everson. So if you will give me that opportunity. Ms. Velazquez. Everson. Okay. How much did you say that you spent on this study? Commissioner Everson. I think that study cost us something like $100 million. I could be wrong. Is that? This is the head of our research program, Mark Mazur. He says that is about right. Ms. Velazquez. Okay. So you spent all that money to figure out the tax gap? Mr. Everson. Yes. Ms. Velazquez. And did you figure out why people were under reporting? Do you have that data, complete data? Mr. Everson. We do not have that. The problem-- Ms. Velazquez. So is it because they are cheaters or the tax code complexity? What is it? Because let me tell you, if you go to any university and you are going to do a research on a problem and then you make a conclusion without really trying to figure out why these people are not paying or are under reporting so that you can then develop a public policy to tackle the real issue, so why do you think that enforcement is the answer? Mr. Everson. Well, I think that there are a number of studies that have certainly substantiated the impact of the enforcement in terms of both the direct impact if you look at what we have brought in, we have increased the direct monies that have come back to us in the last three or four years, plus the indirect impact that if I am audited and I mention it to my neighbor, they will perhaps file differently. So that is clearly there. The debate that you are talking about is, which I agree, is on trying to quantify the service impact which we have been looking at. It is very difficult to do that. The statisticians who have looked at that have had a great deal of difficulty trying to find that. Now when we did the research, to answer your question, our people tried to determine but were not successful because if we go to you, if we find a problem in your return, if we ask you did you intentionally cheat, what are you going to say? You are going to say no. I mean, that is the normal response. Nobody is going to admit, or very few anyway, that they were intentionally violating the law. So it is very hard to determine with the precision that you or I might want when you do the audit the exact reason. Ms. Velazquez. But your response and your answer is based on a prejudged finding that they are under reporting because they do not want to pay. In no way you are doing any effort to find out whether or not the tax code complexity is the one preventing these people from paying? Mr. Everson. No. I would not agree entirely with that. I have stated-- Ms. Velazquez. But let me ask you so enforcement is the sole answer? Mr. Everson. No, not at all. I think-- Ms. Velazquez. So let me ask you another question. Mr. Everson. Yes. Ms. Velazquez. I just want to hear yes or no. Mr. Everson. Yes. Ms. Velazquez. So enforcement coupled with what? Mr. Everson. With service. As I said at the beginning, we believe in service and enforcement. Ms. Velazquez. Okay. Mr. Everson. You need to do both. And if I can say again what I said in the oral statement, I believe simplification is essential to get after this, particularly for small businesses and people-- Ms. Velazquez. In terms of reducing the taxpayer assistance programs and the reduce of staffing at your office that have been the trend in the last three to five years? Mr. Everson. You made reference to this in your opening statement. Last year the Administration had a proposal to shutter 68 walk-in centers. We have not done that. The '07 request that is pending before the Congress right now maintains services at a steady state. We are not contemplating any reductions in the services in the request, ma'am, that is before the Congress right now. So I think we got the lesson from last year's difficult discussions. Ms. Velazquez. Okay. Mr. Everson. So we are not proposing that again. Ms. Velazquez. Okay. So we will hear a lot about what the IRS is doing towards enforcement. But I want to look at Congress' record on the issue. According to a report published by the Democratic staff of the House Ways and Means Committee there were 900 changes to the tax code in the 108th Congress. The FSC/ETI legislation passed-- Mr. Everson. Yes. Ms. Velazquez. --in 2004 provided for 561 changes and added 250 pages of tax law changes. This does not even include the 2001 and 2002 tax cut that added complexity and thousands of burden of hours on small businesses. How would you assess Congress' record on helping reduce the tax guide? Mr. Everson. Well I take my own self interest seriously and I am not going to take a particular shot at Congress, other than to say that that record that you are talking about adding complexity, it gets us nowhere. What I have said repeatedly is-- Ms. Velazquez. Give me a grade, A, B, C? Mr. Everson. I've got to say that over time Congress fails in the effort to get a simple understandable tax code. Ms. Velazquez. So that is an F? You know, I used to be a college professor and I love-- Mr. Everson. I think we can agree on that. Ms. Velazquez. Mr. Sullivan and then Mr. Everson-- Mr. Everson. Thank you. Ms. Velazquez. --would you agree that the tax codes has in 2001 have increased complexity? Mr. Everson. I would agree that the tax code since 1986 over a period of years of control of Congress by both parties has grown in complexity. This is an inevitable process. And what happens is you have got these cycles where people eventually get feed up with all the complexity and there is a real call for reform. I am an advocate of that reform. Ms. Velazquez. But five years ago we heard a lot about, you know, this is going to be the Congress and this is going to be the Administration's-- Mr. Everson. I am not wading into-- Ms. Velazquez. Of course. Mr. Everson. Let me make one thing clear. I am not wading into a partisan debate on this. I am giving you the simple fact that over decades this code has continued to grow; that's all. Ms. Velazquez. Mr. Sullivan, Advocacy has done numerous reports on the issue of taxes and small businesses. For example, I know that the Office of Advocacy studied the impact of marginal rates on small businesses. That was quite a timely report considering Congress was voting on marginal rates in 2003. Given the huge impact of this $2 trillion in tax cuts, why have you not done any work to study whether these changes have increased complexity for small businesses. Mr. Sullivan. Congresswoman, actually we have done some studies on the overall complexity. We have not narrowed in on whether specific year tax cuts contribute. Ms. Velazquez. Okay. Mr. Sullivan. But I would point the Congresswoman and this Committee to a working paper by an economist in my office, Dr. Saade Radwan that documents what Commissioner Everson was saying, that however well intentioned each different change may be, and this echoes your concerns, Congresswoman Velazquez, the overall complexity actually is harmful to small business. Ms. Velazquez. So are you telling me that are you going to commission a study on this? This is huge for small business. Mr. Sullivan. Well as the Congresswoman pointed out, sometimes our timing of studies does not exactly comport with congressional action. Actually, this is not on purpose, but our studies take anywhere from one year to two years. Ms. Velazquez. I know. It was coincidental 2003. But can I get a-- Mr. Sullivan. But we tried to get that study done as quickly as we could, and we hope that it benefits the debate. What we will try to do is continue to focus in on what parts of the tax code or the over all complexity of the tax code benefit small business. And as far as focusing in on specific year tax changes, I would direct the Committee's attention to a March report by the Department of Treasury that is peer reviewed that documents a number of different pros and cons of recent tax changes. Ms. Velazquez. Thank you, Mr. Sullivan. Mr. Everson, does Small Business Self-Employment Division of the IRS has served a critical role by meeting with members of the small business community to identify concerns. It has also been helpful to small business and tax practitioners who need a system making determinations about tax code questions. I am concerned that there have been efforts by the IRS to shift resources in this division from compliance towards more enforcement. Can you talk about the staffing level at your department? Mr. Everson. Sure. And I'll let Kevin talk about it afterwards in more detail. But what we did in the last year was we had people who were on the enforcement side within this division, SB/SE, and we were doing part time work on outreach. And what we did was we consolidated this to make this a year around full time responsibility. Because what was happening was when you get into this busy season that we are in now, they were being taken off of that outreach. We did not think that was particularly effective. So we have made some changes in the last year or two to try and have a more dedicated full time work force on this. Ms. Velazquez. So, Mr. Everson, we constantly hear how small businesses are paying less taxes under this Administration and they saw enormous benefit from the tax cuts. If that is the case and rates are lower, it seems there will be less incentive to intentionally taxes by under reporting income. However, the IRS is cracking down on small businesses. Do this not seem kind of backward? Do you disagree with the theory that lower tax rates should lower tax avoidance? Mr. Everson. I think that the debate, I do not want to wade into the policy debate because my job is to administer the code, good or bad, as written. Obviously policy decision are taken to provide incentives for economic activity. There are compliance issues, though. Complexity is one, also stability is another. We have not talked about stability. The constant changing of the rules is an issue on top of just how complex they are. If you look at our research, which is for 2001, you are right that each year the revenue stream of the government changes. It changes for rates, it changes for increases in corporate receipts versus individual receipts. So there is a mix effect that takes place over time. But what we would suggest is we're concerned about going after the gap in all the areas, but we do prioritize. If we go back to the bar chart, one of the things that's very clear from the research is is that, again, where there's no reporting like there is for employees, that the gap is largest. So we want to get after that through not just some more audits, but also through some additional reporting. Ms. Velazquez. I would have more questions later, Mr. Chairman. Chairman Manzullo. Thank you. Could you put up that chart, selected IRS coverage rates FY 2005? Sometimes these charts remind me of that guy on Johnny Carson giving the directions to the used car lot. Do you remember that with the freeways, wore the big hat and everything? Mr. Everson. This? Chairman Manzullo. How many corporations are there with assets above 250 million? Do you know the figure for that? Mr. Everson. I don't have the figure. I can certainly get it for you. But the number of the largest corporate audits that we did last year were--I guess this would be all of our companies over 10 million in assets. See, Kevin's group has companies with assets up to 10 million; it has got the C-Corps and the individuals filing the Schedule C. Our large and mid- sized business unit is anything over 10 million assets. We did about 13,000 audits last year. Chairman Manzullo. Well, how many companies are there? Does anybody know? The gentleman just handed you a-- Mr. Everson. Yes. This is the number of audits. It doesn't say with--the number of returns. Okay. I am told it is about 11,000. Chairman Manzullo. For corporations with assets over 250 million? Mr. Everson. Yes. Yes. That is correct. I guess we got 11,000 returns filed in calendar 2004, 11,000 had assets over 250 million. Chairman Manzullo. Not the estate, but the next one, corporations between 10 and 250 million? Mr. Everson. That would be-- Chairman Manzullo. You guys can help your boss out. Don't let him guess here. Mr. Everson. Oh, he's got it right here. Chairman Manzullo. Okay. Mr. Everson. It's all right here. He is just making me add up the numbers. Chairman Manzullo. All right. Mr. Everson. It is about 43,000. Chairman Manzullo. But where are the number of corporations that are under 10 million? Mr. Everson. That is a different category. I think that that audit rate is less than 1 percent. For C-Corps assets of 10 million, it is about seven-tenths of one percent, Mr. Chairman, that audit rate. Chairman Manzullo. Do you know how many there are? Mr. Everson. Oh, a couple million, I guess. Chairman Manzullo. Well-- Mr. Everson. Let's see. Yes. Now let me show you one additional-- Chairman Manzullo. Let me back up. There are 2 million firms that have 10 million-- Mr. Everson. Two million C-Corps. Chairman Manzullo. Two million C-Corps that have under 10 million in assets? Mr. Everson. C-Corps. Let me show you what is happening with the C-Corps, Mr. Chairman, and why this is not as big an area of emphasis. Chairman Manzullo. And the audit rate on that group is about .3 percent. Mr. Everson. Point seven. Chairman Manzullo. Point seven. All right. Go ahead. Mr. Everson. Mr. Chairman, this lays this out. Because you have talked to me before about S-Corps what has happened over the years, again, starting at the same point. 1978 we had about 2 million C-Corps and a half a million of the S-Corps. Look at what has happened here, and this line is crossed now. Far more businesses are operating as S-Corps. The C-Corp number-- Chairman Manzullo. Now let me stop you. What is the audit rate for S-Corps? Mr. Everson. The audit rate for S-Corps, go back to that chart, .3 percent; it is next to nothing. Chairman Manzullo. All right. Mr. Everson. That is why-- Chairman Manzullo. Then how many S-Corps are there? Mr. Everson. Well, it is right here. Chairman Manzullo. Okay. Wait a minute. So it is about three and a half million? Okay. All right. Mr. Everson. So what we are doing, this is an area where we were doing nothing. Nothing at all. I am not saying we missed this, but take a look at this. S-Corps, .3 percent. So one of these we have corresponded is about is your concern that the next stage of the research we are putting here. Now we may conclude that there are not problems with the S-Corps, but with an audit rate like that we just do not know. Chairman Manzullo. Well, that is the whole point. Mr. Everson. That is why we are doing the research. Chairman Manzullo. No. You see, you just do not know and yet you go full ahead pell-mell after the mom and pops? Mr. Everson. Well the S-Corps we're doing the research program with 5,000 returns-- Chairman Manzullo. I mean you spent $100 million. How much more money and more time do you need to do this? And why do you advocate such draconian withholding measures when your research is not done? Mr. Everson. Let me make sure that I clarify the--I would not agree with the characterization of draconian. We are proposing-- Chairman Manzullo. Well, how about plutonian then? Mr. Everson. We are proposing reporting and backup of withholding. If you look at backup withholding which is in place for all Americans now for let's say dividends and interest. Let year we got something like 330 million reports on dividends and interest. Only a little over one in a thousand didn't come in with the proper taxpayer identification number. That is what would trigger potentially the backup withholding. So it is a very de minimis number of people. Chairman Manzullo. Let me finish with this before we get into that, because I want you to explain the withholding on it. Well, how many individual businesses are there that fild Schedule C? Mr. Everson. It is now up to about 16 percent of all the returns. So what would that be? About 18, 20 million? Twenty million let us say. Chairman Manzullo. So you got 20 million people. So there would be substantially a lot more people would be audited-- Mr. Everson. Well, as I indicated, our priority has been to-- Chairman Manzullo. No. Let me finish. Let me finish. A lot more people would be audited. You have a better chance of being audited if you are a small business person in terms of the personnel that the IRS is dispatching for that? Mr. Everson. Well, those are the rates right there. And we have a high rate. A lot of controversy. I get a lot of comments from Madam Velazquez side of the aisle on EITC audit rates, because look at that. That is 2.4 percent and some people think that is too high. That program has a lot of concern because of the high error rate stemming sometimes from fraud, but largely from the complexity of all the definitions. There are a lot of issues in there. We try to run a balanced program, but what we have worked on in the last several years has been particularly in the high income area, take a look at that five percent audit rate and also on the corporate areas where we brought that back up and progressively worked on the shelters. So I would not agree with the characterization that we have focused particularly on small business. I would not agree with that at all. Chairman Manzullo. Well, you said that yourself. Mr. Everson. No. I said we are, we need to do more and we need keep forward. Chairman Manzullo. You are focusing on small business. What you do not understand here, do you know who comprise a lot of C corporations that have under 10 million in assets? These are lawyers, accountants; these are all service organizations. Mr. Everson. Yes. Chairman Manzullo. Service companies. Manufacturing companies and other retailers would have more than 10 million. And there is a whole group of people in there that are under 10 million that you are not even touching as long as they are a C Corporation. Mr. Everson. Well, the thing is, Mr. Chairman, again we measure our effectiveness in part by what I mentioned before, this no change rate. For the small C-Corps the no change rate, that is where we go in and it is Congresswoman's Kelly's issue of we do not find anything. When we have done the C audits on the smallest businesses, that no change rate is something around 40 percent in contrast for individuals that rate is 15 or 16 percent. So-- Chairman Manzullo. Well wait a second. Your audit rate on two million companies with under 10 million in assets is .7 percent? Mr. Everson. Yes. Chairman Manzullo. That is a pretty small number? Mr. Everson. Yes. Chairman Manzullo. But you have already made the assumption based on your study that GAO does not like that you are not going to go after these people. Mr. Everson. I did not say we are not going to go after these people. But what we do is we use the studies to risk adjust and also we use our own results. And as I just indicated, when we look at the C-Corps, the very smallest of them, a no change rate means we do not find anything 40 percent of time. There is in our field experience, if you will, we see relatively more compliance in that entity. Chairman Manzullo. But the only remedies you are proposing are against non-C entities, mom and pops, withholding, is that correct? Mr. Everson. I think that we are working across three fronts, if you will, to do more across the board. And what we are doing first is we are increasing our enforcement activities. We are improving our procedures, which includes a whole series of productivity and other improvements and using research where we have it. And then we are making, as you suggested, some legislative proposals. Chairman Manzullo. Right. Now the legislative proposals, and by the way I found it very interesting that you want to level the playing field. I have never known the IRS that wants to level the playing field between two businesses. I am sure that businesses would rather have less regulations and the IRS trying to make things easier for one and not for the other. I just find that astonishing. But in terms of the withholding, let me walk you through a scenario. Mr. Everson. Yes. Chairman Manzullo. Let us say that I am a restaurant owners, a non-C-Corporation, mom and pop, the way my brother was. And I report a million dollars in gross receipts for tax year 2006. And, hypothetically, through your research IRS estimates that restaurants receive 50 percent of their payments from customers using credit cards and 50 percent in cash. Then the credit card companies send the IRS information which you want from every credit card company for every business except C corporations. They send you information that my restaurant reports $400,000 in credit card charges. No. I'm sorry. Reports $800,000 in credit card charges. The return shows a million dollars gross, you have $800,000 in credit card charges. What would the IRS do? Mr. Everson. Well, I will not give you a specific answer because I am not an expert in that area. But what we do is we have formulas where we work based on history and research and we select our audits based on those formulas. Chairman Manzullo. No, I-- Mr. Everson. No, please, let me finish. Chairman Manzullo. No, just a second. Mr. Everson. I'm trying to say-- Chairman Manzullo. I made it easy for you. Mr. Everson. I can't tell you what we would do. It depends on resources we have. Chairman Manzullo. Well, let us say you decide to audit. So you decide to audit. Mr. Everson. Right. It comes down to what Congresswoman Kelly was asking about before, having a knowledge of the business. The pattern of credit versus cash receipts might be different in a restaurant than it is in a dry cleaner or a small gardening services. Chairman Manzullo. Let me go through it one more. Mr. Everson. Yes. Chairman Manzullo. The return shows a million dollars gross receipt. Mr. Everson. Yes. Chairman Manzullo. This is a restaurant. Mr. Everson. Yes. Chairman Manzullo. Hypothetically, all right, the IRS says 50 percent comes from credit cards and 50 percent comes from cash. And then the credit card companies send you notice that there was $800,000 charged in credit cards which should trigger in somebody's mind that it should be 1.6 million reported as opposed 1 million reported. My question is if the IRS has that information, which is what you want, is that not correct? Mr. Everson. Yes, that is correct. That is what we want. Chairman Manzullo. What would you do with it? Mr. Everson. If someone sticks out, if a business sticks and is different from others-- Chairman Manzullo. And this one would. Mr. Everson. Yes. If it would, it might trigger an audit. Chairman Manzullo. All right. And then what would you do? I mean not talking about the audit. Would you ask the credit card company to withhold? Mr. Everson. No. Chairman Manzullo. You would not? Mr. Everson. No. Because the backup withholding attaches if you as--let us say you are the credit card issuer. Chairman Manzullo. Okay. Mr. Everson. If you forward it to us the wrong number, a number that matched up Everson and you reported that I had a taxpayer identification number, but when we went to match up it didn't match up to what we showed for Everson, that is what would trigger backup withholding. Chairman Manzullo. So in the hypothetical that I gave you that would not trigger any backup withholding? Mr. Everson. No, sir. Not at all. Chairman Manzullo. Okay. So that is why the documents that you put out are-- Mr. Everson. They are unclear. Chairman Manzullo. They are unclear. Mr. Everson. Okay. Chairman Manzullo. So it is only if there is something wrong with the taxpayer identification number? Mr. Everson. That is it. And that is the same way it works on dividends and interest right now, which people are used to doing. Chairman Manzullo. Okay. Let me take you to another scenario. The restaurant owner, not everybody who has a credit card has a TIN number, is that correct? We used to call it an SS-4 when I practiced law. Has a taxpayer identification number or Social Security number? Mr. Everson. Well if you don't have a Social Security number, you have got a bigger problem than that, because you got to file a tax return with us, you got to have a number that identifies you. So you got to have a number. Chairman Manzullo. Okay. Do you need a Social Security number to get a Visa or MasterCard, anybody? Is it normally required? I think it is, would that be correct? Mr. Everson. I think it's a pretty standard piece of information. Chairman Manzullo. Am I correct in assuming that? Mr. Everson. Yes. Chairman Manzullo. Now there are a lot of small businesses that do not get a taxpayer identification number but report their income on a Schedule C through their own Social Security numbers? Mr. Everson. Absolutely. That is correct. Chairman Manzullo. You don't have a problem with that?? Mr. Everson. No. No. We are not suggesting we change that. Chairman Manzullo. Okay. Well then explain to me, Commissioner Everson, where there's a faulty taxpayer identification number, give me the scenario in that restaurant thing if you could? Mr. Everson. Yes. They haven't been square with you as the credit card issuer. They put down my Social Security number because they don't want the IRS to get the right number. And this is no different than, again, dividends and interest. Chairman Manzullo. So this is really actual fraud? Mr. Everson. Yes, or--well, look, what we do is we send out notices. We do not impose backup withholding. Let me be clear here. There can be confusion. A credit card issuer, somebody could have made a mistake just like Merrill Lynch might. We send out notices. Again, let me give you the numbers for last year total returns filed in 2003 for dividends and interest. We got almost 320 million reports. The number where the TINs did not mention up was 334,000. That is a little over one in a thousand. That is what triggers notices and ultimately backup withholding. Chairman Manzullo. But notwithstanding, you still would require every credit card issuer or clearinghouse give the IRS information on how much every single small business in the nation was generating in credit card receipts? Mr. Everson. That is the gist of the proposal, that is it, sir. And-- Chairman Manzullo. No, let me stop you right there. Mr. Everson. Yes. Chairman Manzullo. Do you have any idea what that would cost in terms of regulation? Mr. Everson. We are working with the industry. We have the banking-- Chairman Manzullo. The answer is you do not know? Mr. Everson. We do not know a precise number at this stage. Chairman Manzullo. But notwithstanding the fact that you do not know, you are still asking Congress this year for those legislative proposals? Mr. Everson. We have made a broad proposal. We are going to work with the Congress and we will try to minimize the burden, but you are correct? Chairman Manzullo. All right. Now let me give you a scenario where I got involved and Ms. Velazquez also got involved. When the HOPE Scholarship for the $1500 tax credit for middle and lower income taxpayers was instituted, Secretary Rubin testified before the Senate and he was asked a question: How much would it cost the 7,000 universities, colleges and community colleges and trade schools across the nation to send out a form showing the source of the payment for the tuition? He said the cost would be the cost of the stamp. I got involved as Chairman of the Small Business Committee because actually, believe it or not, we have jurisdiction over colleges that have less than 500 employees. The annual cost was $100 million. And I worked with Chairman Rossotti for five years, changed the law and changed the regulations. And, of course the IRS, because the IRS considers itself exempt from the Regulatory Flexibility Act and continually refuses to do any research or reporting or compliance with that Act as to what it would cost the small business people, IRS was off by $100 million. Now I would say with these fine research fellows that you hire for $100 million a year, before the IRS even comes out with any notion of any change in reporting, I would suggest that you figure out exactly how much it is going to cost and you do that before you even come up with a proposal. And that is where this is deficient because Secretary Rubin was so wrong. In fact, I was fighting the software manufacturers and you were in the middle of that also. Remember that? And it is a good thing that Commissioner Rossotti was a systems person. I mean his background was in computers and analysis. And he recognized the problem right away. And we worked with 7,000 schools across the nation. They could not believe that this burden had been imposed. Now Congress had imposed that burden. And that is what can happen when legislation is proposed and there is no research done on it. Ms. Velazquez? Okay. Well then I have just got one other question to conclude. And that would be I understand fully now the withholding on credit cards would only be triggered in the event that there is some fraud going on. Mr. Everson. Well there could be confusion, sir, and we send notices out. Chairman Manzullo. But there's confusion and it is corrected right away and there's no withholding? Mr. Everson. That would be right. We send out notices. Chairman Manzullo. Let us say that I have got the restaurant and Mr. Sullivan is a plumber. I do not like to use the words plumber around Congress. But let us say he is a plumber and he does work in my restaurant from time-to-time. And then you notice that Mr. Sullivan is not, maybe he has been late in filing the quarterly estimate from time-to-time and you think that perhaps he is not reporting all the income that comes in. Are you proposing any remedy that would have me as the payor withhold or report to you on the money that I owe him as the plumber? Mr. Everson. No, sir. We are not changing those. Our proposals do not run to increased reporting from business. I know you do not believe this, Mr. Chairman, but I tried to be sensitive to your concerns. And what we proposed is the more reporting by the credit card issuers, and here ten of those businesses do 84 percent of the $2.2 trillion in credit card issuances around the country or dollars that come in through credit cards, and also governmental entities do some more reporting, not a business doing it; what you are talking about. That is-- Chairman Manzullo. So under your proposals I, as the restaurant owner would not have to do anything more? Mr. Everson. No, sir. Chairman Manzullo. Is that correct? And you would never ask me to withhold on any payments that I would owe to him? Mr. Everson. No, sir. Chairman Manzullo. And I understand that there is a present law passed by Congress and for which you are not responsible, that says even in that scenario I am supposed to report any independent contractor payments in excess of $600 a year? Mr. Everson. That is correct. Chairman Manzullo. That is the existing law? Mr. Everson. The existing law, I think you are correct in stating-- Chairman Manzullo. And that is not followed. That is not followed? Mr. Everson. I would not say that it is not followed. I think we could do better on that. Chairman Manzullo. The more sophisticated the business, the more that is done? Mr. Everson. Well, yes, that would probably be right. I mean, it gets to some of the issues we were talking about before as to what gets reported. People may if they get the 1099s, they may be reporting the 1099s they get as income, but not the ones they do not get. Chairman Manzullo. So let me make sure this is very clear. Mr. Everson. Yes. Chairman Manzullo. This helps both you and me. The only additional reporting that, yes I guess I will use the word ``only'', that you are requesting would be to have the credit card companies issue to the IRS at the end of the year all the transactions-- Mr. Everson. No, gross receipts. Just one number. Chairman Manzullo. I'm sorry. Gross receipts for unincorporated businesses. Mr. Everson. For all the businesses, yes. That is right. Chairman Manzullo. For incorporated businesses also or just unincorporated businesses? It's just unincorporated. Mr. Everson. I think it's just unincorporated. Yes. Chairman Manzullo. It is just the little guys? Mr. Everson. Well-- Chairman Manzullo. Yes. Mr. Everson. --we have not been that specific, sir. Chairman Manzullo. Well-- Mr. Everson. We said it by general language so you have got an opportunity to weigh in. Do you want to put the companies in there, too. Chairman Manzullo. No, I understand. But it is targeted at small businesses? That is your target-- Mr. Everson. It is targeted where I showed. Chairman Manzullo. I have got your paper here. Mr. Everson. Yes. It showed--I think we have been pretty clear as to where we think we can get the money. Chairman Manzullo. No, I want to clear this up before I let you go here. Mr. Everson. Okay. All right. Chairman Manzullo. It is targeted at sole proprietorships, the 25 million people out there and the partnerships that are not corporations. Mr. Everson. I think that is fair enough. Fair enough. That is where the biggest under reporting is. Chairman Manzullo. Do you think that corporations under report? Mr. Everson. It goes back down that other road. Chairman Manzullo. No, I mean-- Mr. Everson. Yes. Chairman Manzullo. Because if you are doing that much auditing-- Mr. Everson. We are doing the auditing, yes. We set up-- Chairman Manzullo. And you find out that they do not pay the-- Mr. Everson. We set up billions of dollars in additional assets from them. Chairman Manzullo. But you only want to impose the additional reporting on small unincorporated businesses and not on the incorporated business, is that correct? Mr. Everson. Well, we have not been that specific. If you want to add the big C-Corps, you know, Blockbuster Video to it, I do not know. Chairman Manzullo. No, it is here. Mr. Everson. We can certainly put that in there. It is a general proposal. We did not submit language. We have said we want to work with the Congress on the contours of the proposal. Chairman Manzullo. Well-- Mr. Everson. We have got the American Bankers Association coming in this week to talk to people about this. So we clearly want to talk about this. Chairman Manzullo. It says payment cards are a growing form of payment for retail business transactions. And it goes on here. I mean, it is obvious that the additional reporting that you want to have the credit card companies do is only for the little guys because you consider them to be the biggest cheaters. Mr. Everson. ``Biggest cheaters,'' I have not use that word. Chairman Manzullo. But it is true. It is true. Mr. Everson. I have showed you where the biggest piece of the tax gap is. Chairman Manzullo. No, I understand. People cheat, people cheat. Mr. Everson. What we are trying to do here again is level the playing field so that: (1) The Government gets what it is due. And also so that the small businesses playing by the rules does not get disadvantaged. Chairman Manzullo. Let me read your writing here, your proposal. ``It is expected that as under current information reporting regulations certain categories of merchant payees such as corporations will be excluded from the reporting and backup withholding requirements.'' These are your own words. Mr. Everson. If you have a problem with that, we will work with you on that. Chairman Manzullo. You think I am sitting here because I enjoy reading this? Mr. Everson. Okay. Chairman Manzullo. I mean the reason for this hearing is the fact that in your own words the only people that you think of significance who are not paying their income taxes are these little guys. Mr. Everson. I do not think that. I am not suggesting that, sir. But we do not see--I do not think the revenue line is where we see problems with C-Corps. Chairman Manzullo. Well, you know, I think-- Mr. Everson. That is what we are talking about here, is the revenue line. Chairman Manzullo. What is the revenue line? Mr. Everson. Gross receipts. They have more sophisticated accounting systems and I believe you would find that-- Chairman Manzullo. You mean like Enron and those clowns? Mr. Everson. I do not think that-- Chairman Manzullo. How much did those clowns take from the American people? How many corporations out there are the Enrons, the small Enrons? Mr. Everson. Look-- Chairman Manzullo. Ms. Velazquez, do you have any idea? Would you not like to know? Ms. Velazquez. But let me just say that you sound like a Democrat today. Chairman Manzullo. Oh, no, no. We are in there with the little people. Mr. Everson. Mr. Chairman, if you talk to your colleagues at Ways and Means and, Ms. Velazquez, nobody would tell you that we have done anything except work on high income and corporate people. You can look at the KPMG matters, the aggressive shelter work we have done with Son of Boss increasing all this. Chairman Manzullo. Well, no, I-- Mr. Everson. We are not going after just the little guy. Chairman Manzullo. No. I am just saying that in your own words you have already said you are going after the little guys. Mr. Everson. No. On revenues the bigger problem is clearly where we have indicated. Chairman Manzullo. All right. You know this page 117, this is your document. Mr. Everson. Okay. Chairman Manzullo. And I just read from your document. Mr. Everson. Fair enough. Chairman Manzullo. Mr. Sullivan, am I correct that this is targeted at little people? Mr. Sullivan. I think the Chairman and Commissioner Everson are actually expressing the same concern, although a little bit differently. The small businesses that come to my office have said that there is reporting in the proposal and they are terrified that the next step after reporting is withholding. That is what they are terrified about. And I think you will hear more about that from the next panel. Chairman Manzullo. Okay. Mr. Sullivan. Because that is certainly something that the Taxpayer Advocate has talked about. And I think Commissioner Everson has said he is sensitive to those concerns, which I think-- Chairman Manzullo. Okay. Mr. Sullivan. But they are fearful of what comes after reporting. Mr. Everson. I understand that concern and I am making no proposal and do not support the withholding. As you know, I have said to you privately to you in the past. Chairman Manzullo. Yes. Because my question is, and I will let you go on this finally-- Mr. Everson. Okay. Chairman Manzullo. Treasury has different compliance suggestions than the Taxpayer Advocate, is that correct? Mr. Everson. Yes. The Taxpayer Advocate is set up to look at issues of problems of dealing with the service and gives us internally as a part of the IRS to try and help us improve our administrative procedures. Chairman Manzullo. Right. Mr. Everson. But she also makes an annual report to Congress highlighting 20 areas where her office has concluded that there are particular problems navigating the code or enforcement procedures. Chairman Manzullo. But her suggestions for enforcement compliance are separate from yours? Mr. Everson. Absolutely. They are not Administration proposals. Chairman Manzullo. All right. And hers are even more pervasive, and we will have fun with her shortly. Mr. Everson. Let her characterize her own thoughts. Chairman Manzullo. All right. Mr. Everson. I never try to speak for Nina. I have learned that in my three years on the job. Chairman Manzullo. I want to thank both of you for coming. I know we have taken a lot of time, but I wanted to get explicitly clear what the Treasury has proposed in terms of withholding. And I know we have taken a lot of time to do that, but it has been worthwhile to do that. Again, Commissioner Everson, every time we have called you have come to the office, you have been available. You have been very transparent with us. And I really appreciate the efforts that you are doing at the IRS. And, Mr. Sullivan also, we did not ask you a lot of questions but we did not have to. I appreciate the work that you do on behalf of the small businesses. And the first panel is excused. Mr. Everson. If I can say one last thing, Mr. Chairman. Chairman Manzullo. Yes. Mr. Everson. I am happy to be here. I appreciate the vigor with which you and your Committee members represent your interest. And I think this is the way that tax policy ought to be reached. Because it should not be done in the dark of night in some appropriations rider where people are doing things that have impact. This is a full debate. We want to work with the Congress on these issues. Chairman Manzullo. Thank you, Commissioner. I appreciate it very much. Let us get the second panel ready. [Recess.] Chairman Manzullo. I'm surprised you guys stuck around after the first panel. We are going to go from left to right. If you could keep it to five minutes, I would appreciate it. Obviously your full statements will be a part of the record. Our first witness on the second panel is Kevin Brown, who also has been a frequent visitor to the office. And he is the Commissioner of the Small Business/Self-Employed Division at the IRS. We look forward to your testimony. Thank you very much. STATEMENT OF KEVIN BROWN, SMALL BUSINESS/SELF-EMPLOYED DIVISION, INTERNAL REVENUE SERVICE Mr. Brown. Good morning, Chairman Manzullo, and Ranking Member Velazquez, and distinguished members of the Committee. I appreciate the opportunity to talk with you today about the work of the Small Business/Self-Employed Division of the Internal Revenue Service. The SB/SE organization is made up of 28,000 employees who serve about 45 million taxpayers, roughly one-third of the taxpaying population. Our taxpayer base consists of seven million small businesses, including corporations and partnerships with assets of $10 million or less; 33 million self-employed and supplemental income earners; and five million other taxpayers who file employment, excise, estate, gift, fiduciary and international tax returns. As I begin, I want to echo a couple of the themes you have just heard from Commissioner Everson. First, whether we are providing service through education, outreach or burden reduction, or we are seeking out noncompliance through our enforcement efforts, our intent is to help all taxpayers, including small businesses, comply with the tax laws and to ensure that these laws are applied fairly to all. Secondly, it takes a balance between service and enforcement to achieve compliance, and SB/SE strives daily to maintain this balance for its taxpayer community. Today I am going to focus primarily on the service side of the equation by highlighting some of our recent efforts. We know that the vast majority of small business taxpayers rely on their practitioners to handle their tax returns. Given this situation, it is vitally important that we reach out to the practitioner community so that they can, in turn, support their small business clients. We have built a robust outreach and education program to do just that, to touch thousands of stakeholders and through them reach millions of small business taxpayers. The result is more than 15,000 relationships with national and local partners including practitioner organizations, small business and industry associations and federal and state agencies and governments. One of the more well-known services we provide is the Small Business Forums which we co-host with the United States Chamber of Commerce, the National Federation of Independent Business and the Small Business Legislative Council. Through these forums small business organizations receive the latest small business information from the IRS and in turn are able to share their members' concerns and issues with us. Due to the success of the national forums, we are launching local small business forums at the state level this spring. SB/SE also devotes resources to identifying major sources of taxpayer burden and to developing and implementing ways to reduce this burden. Since 2002 our Office of Taxpayer Burden Reduction has been instrumental in reducing taxpayer burden by over 200 million hours. Here are some highlights. In January 2006, we implemented the Annual Forum 944 for employers who have a total annual employment tax liability of $1000 or less. Most of the estimated 950,000 eligible Form 944 filers also will be able to pay annually with their form 944. This year we implemented a new automatic six-month extension period reducing burden by 11 million hours. Simplification of the office in the home deduction for the small business taxpayer is high in our priority list for tax year 2006. We are looking into several ways to address the burden caused by Form 8829, which is completed annually by about 2.4 million Schedule C filers as well as Schedule A filers. I also want to mention our SB/SE Disaster Coordination Office. In the aftermath of the recent hurricanes this office played a key role in the IRS' success in providing on the ground assistance to individuals and businesses in dealing with the myriad of related tax issues. Most recently the IRS has been partnering with the Department of Housing and Urban Development and Mayor Ray Nagin of New Orleans to help make businesses in the hardest hit areas of New Orleans and Louisiana aware of Federal incentive relief that is available to them. In summary, Mr. Chairman, I believe that the SB/SE Division of the IRS is providing much-needed support to the small businesses of America. We have demonstrated our commitment to service through the outreach and education we are providing, the partnerships we have developed and our numerous efforts to reduce taxpayer burden. At the same time, by using our enforcement resources to detect noncompliance, we are helping compliant businesses by eliminating the unfair advantage created when their competitors fail to comply with the tax laws. Thank you, Mr. Chairman. I will be happy to answer any questions you and the other Members of the Committee may have. [Commissioner Brown's testimony may be found in the appendix.] Chairman Manzullo. Thank you. Our next witness is Nina Olson. She is the National Taxpayer Advocate serving as advocate for taxpayers to the IRS and the Congress. We look forward to your testimony. STATEMENT OF NINA OLSON, TAXPAYER ADVOCATE SERVICE Ms. Olson. Thank you. I believe you. Mr. Chairman, Congresswoman Velazquez and Members of the Committee, as you know, my organization, the Taxpayer Advocate Service devotes a substantial portion of its efforts to assisting small businesses and self-employed individuals who experience problems with the IRS. Through February of this fiscal year, small business cases accounted for about 44 percent of Taxpayer Advocate Service case closures, around 90,000 cases a year. And we have been able to provide relief to small business taxpayers in nearly 75 percent of those cases. In addition to our case work, the Taxpayer Advocate Service is actively involved in identifying areas of the tax system that impose burdens on small business taxpayers. When we identify systemic problems we make administrative and legislative recommendations to help mitigate these burdens. I discussed several of the recommendations I have made in my written testimony, including recommendations from my 2004 annual report to reduce burdens on small businesses. I am please that Chairman Manzullo included many of these proposals in the Small Employer Tax Relief Act of 2005 that he introduced last fall. In my annual reports to Congress I have also made administrative and legislative recommendations to reduce the tax gap. The IRS estimates that the net tax gap runs at about 290 billion a year. The IRS expects to receive about 135 million individual income tax returns this year. Therefore, the average individual tax filer is effectively paying a surtax of more than $2100 a year to subsidize noncompliance. As the statutory voice for all taxpayers, I find that to be an unacceptable state of affairs. It is unfair to the millions of taxpayers who pay their taxes in full and it erodes public tax confidence in our tax system. After all, if my neighbor is not paying his taxes, why should I. When you drill down a level the IRS data show that the cash economy is the largest single contributor to the tax gap. And while 99 percent of wage income earned by employees shows up on tax returns, the IRS estimates that only about 43 percent of self-employment income reportable on a Schedule C shows up. The low rate at which taxpayers report cash economy income creates two sets of problems. First, it places honest businesses at a competitive disadvantage. If one taxpayer is paying his taxes but a competitor is not, the honest business person will lose out on sales because the noncompliant competitor can use its tax savings to undercut the price of goods and services. Second, taxpayers operating in the cash economy have greater opportunities to be noncompliant because they know the payments they receive are not being reported to the IRS and therefore will be difficult for the IRS to detect. And as I know from 27 years I spent working with small business taxpayers professionally and as a self-employed person myself for those years, many small businesses operate on tight margins and plow every cent they can save back into their business. They have enormous difficulty saving money and since there is no mechanism to withhold taxes from their income, they often find they have spent their funds by the time tax payments are due. Then the IRS may come calling and these people would often come to me for help. Unfortunately, the most I could do in some of these cases was to help them request collection alternatives and in other cases it was simply too late. The sheer weight of the tax debt caused the business to go under. In light of the concerns I've expressed about the high rate of noncompliance in the cash economy and the extreme pressures small businesses face if they are audited, I have tried to offer proposals that strike a reasonable balance between reducing the high rate of noncompliance in the cash economy and avoiding excessive burdens on small businesses. There is no one size fits all solution and my proposals are just that; proposals that I and others may be able to improve on. But I think they represent a useful starting point. My written statement discusses some of my proposals in greater detail, but I would like to briefly highlight our proposal to amend the Internal Revenue Code to require the IRS to promote making estimated tax payments through its electronic funds transfer payment system and to establish a goal of collecting at least 75 percent of all estimated tax payment dollars through EFTPS by fiscal year 2012. One key feature of EFTPS that many taxpayers may find attractive is the ability to voluntarily schedule more frequent automatic estimated tax payments up to-- Chairman Manzullo. Ms. Olson, could you talk about the most controversial, the backup withholding? Ms. Olson. Certainly. Chairman Manzullo. I think it starts on about page 11, 11 and 12. You can tell that's where our concern is. Ms. Olson. All right. Chairman Manzullo. We appreciate the other information and agree with it, but we want you to address the proposal we disagree with. Ms. Olson. Okay. But I would like to say about that proposal-- Chairman Manzullo. Go ahead. Ms. Olson. That it is the third in a tiered approach. That my goal is to get people to be able to stay out of trouble by being able to make estimated tax payments as easily as they would make automatic debits from their accounts for a car or a mortgage payment. And then I also have a proposal about companies that want to do withholding for their independent contractors, that they could come into the IRS, and this would not be the IRS contacting them, but that they would come into the IRS and say we want to treat our people as independent contractors but they are having a hard time saving and we want to do this voluntary withholding. And they would be considered independent contractors for all purposes such as deducting expenses and everything like that, except for the fact that the payor would be withholding. And I believe that those two proposals will eliminate a large amount of noncompliance and help companies, small businesses stay out of trouble in the first place. But for those individuals, those persons, those entities that are substantially noncompliant and repetitively noncompliant, and I believe that that is something Congress could determine or you could allow the Secretary to determine, but where there is a repetition of nonpayment of taxes year after year, then I propose that the IRS be able to use backup withholding in order to get the attention of those taxpayers and get them to call us. And once they call us, then we can channel them and say, folks, we will release backup withholding if you will schedule a year's worth of estimated taxes a year in advance so we know that you are not getting into trouble again. We will help you resolve your arrears, but we want to put you in a going forward basis with your estimated taxes. And so that is the withholding proposal. I am saying that you have to have a demonstrated history of noncompliance, in your words these might be the cheaters, they are cheating other taxpayers. Chairman Manzullo. And that would--I have got to get this out in your testimony in chief here. And that backup withholding would be on money coming from? Ms. Olson. Payors. Chairman Manzullo. Such as a credit card company? Ms. Olson. Well, I did not propose the credit card company. Chairman Manzullo. Or? Ms. Olson. It would be from, for example, if you were in construction and you were working for a large contractor and you were on the framing crew, then you would have the contractor do the backup withholding. Chairman Manzullo. But that is done now because of withholding for? Ms. Olson. For interest and dividends, that is right. Chairman Manzullo. No, no, no. For worker's compensation insurance to make sure it is-- Ms. Olson. That is correct. Chairman Manzullo. But your proposal would also apply in the hypothetical that I gave the Commissioner about the restaurant owner that would owe money to the plumber if you found that the plumber was substantially noncompliant, is that not correct? Ms. Olson. That might happen in that instance. Now, I would imagine that the IRS would not be taking it down to that level. That they are going to be looking at persons who are repeatedly noncompliant and that it is worth them implementing-- Chairman Manzullo. We always look at the worse possible scenario. Ms. Olson. I agree. I think that that is a legitimate concern. Chairman Manzullo. I interrupted your testimony. Did you get out everything that you had wanted to? Ms. Olson. I think so. Chairman Manzullo. Okay. Thank you. Ms. Olson. Yes. Thank you, sir. [Ms. Olson's testimony may be found in the appendix.] Chairman Manzullo. Our next witness is John Satagaj. And, John, we look forward to your testimony. STATEMENT OF JOHN SATAGAJ, SMALL BUSINESS LEGISLATIVE COUNCIL Mr. Satagaj. Thank you, Mr. Chairman, Ms, Velazquez, Members of the Committee. It is always a pleasure to be here. I think I noted last time I was here it was just a year ago for the same subject, it was a historic moment because I completed Commissioner Brown for the great work he is doing. So I am going to double it up. He is two-for-two, he continues to do a marvelous job. If we clone Commissioner Brown, we would have a much better situation and maybe not as combative and we have to be with the IRS sometimes. So I compliment-- Chairman Manzullo. That was combative. The Commissioner is very smart because there's a Proverb that says that a soft answer turns away wrath. And he succeeded in doing that with his great smile and his personality, and also his candor. Go ahead. Mr. Satagaj. There is always going to be a tax gap; we all know that. And you alluded to the GAO study earlier in your testimony and opening statement. I believe the IRS has been doing tax gap studies since the studies. I think the first one was 1977. The first GAO report was in 1988. It looked at the '77, '82 and '87 tax gap ones And I guarantee if you take that '88 study and put it up against the one you referenced, it would say all of the same things. You know the data is old, we do not know what it is, we are not asking. We have been talking about the same issues about how you analyze the tax gap and how you find it. Nothing has changed between the 1977 tax gap estimate and the one today in terms of understanding what it is really about. And I think you illustrated that very well in your opening statement. The next point I want to make is about the blue book that you referenced, the five proposals and the one I call it the phantom six, the one on the independent contractors. And with all due respect, I think whoever wrote that did a disservice to the President of United States. Because the words are there and I've heard for the two or three weeks or four weeks since that has been out is ``Well, it is a general proposal and we need to figure out what it really means.'' And your conversation with the Commissioner about the corporations and the credit cards illustrates perfectly how little we know about those proposals and the potential impact. Does it cover C corporations? Is it excluding C corporations and S-Corporations? If it is, and I think for a while there I heard the Commissioner say that, then we are looking at all sole proprietors. How many sole proprietors take credit cards? And when you exclude all the brick and mortar that our S- Corporations and C corporations, who are you going after? You have got 25 million of them maybe, but how many of them take the credit cards? And if it was not meant for that universe, why did we propose it? But it illustrates that that proposal, those words means things to us in the small business community and we get upset about them. I was talking to Advocate Olson, Nina, about that sentence, the phantom six. Well, I guarantee every one of us, and I told her this, it was a disservice to her. Because all of us who worked that independent contractor issue read that sentence, the first reaction is, ah ha, the Advocate is getting her proposal through in a different way through that proposal. And you have heard what she has talked about, and it is not that. And so we have a disservice to the President and to all of us if we are not careful how we choose our words. Because it means something to those of us in the small business community, and we did not see that there. So with those points, one last point. The IRS every year puts out a--they give bunk frivolous myths about filing your return. You know, things that you should not do that people claim, like the 16th Amendment is invalid so I do not have to file my return or if I put all zeros, I do not have to pay a tax. There was one that was interesting in there, and I pulled it out because I think it's really relevant to today. Filing a tax return is voluntary. A lot of people say I do not have to do it. And this is the IRS' words. Some people mistake the word voluntary for optional. But filing a tax return is not optional for those who meet the law's minimum gross income requirement. The word ``voluntary'' as used in the IRS publications, court decisions and elsewhere refers to the fact that the U.S. tax system is a voluntary compliance system. Now here is the important sentence in my mind and everything we are talking about here today about whether it is information report, it is backup withholding or it is anything. This is the sentence that we talk about our system. ``This means only that taxpayers themselves determine the correct amount of tax pursuant to law and complete the appropriate returns rather than have the government do this for them as done in other countries.'' This is what America is about. This is what about being a small business is American is about. And we had better be darn careful if we are taking away any one element of that voluntary system. Thank you, Mr. Chairman. [Mr. Satagaj's testimony may be found in the appendix.] Chairman Manzullo. Thank you. I forgot to state that you are testifying on behalf of the Small Business Legislative Counsel. Thank you for your testimony. Next witness is Keith Hall, CPA speaking on behalf of the National Association for the Self-Employed. We look forward to your testimony. STATEMENT OF KEITH HALL, HALL AND HUGHES, PLLC Mr. Hall. Thank you. Chairman Manzullo, Ranking Member Velazquez, I thank you so much for the opportunity to be here today as a small business owner. To a small business guy like me any number that ends in billions is a touch concept to grasp. The tax gap that we are talking about today is one of those touch concepts. Through the National Association for the Self-Employed I visit with thousands of small business people each year. Based on that experience, I hope to shed a little light on some of the proposals and how they effect people like me. I specifically would like to talk about three things. First, and perhaps the most concern for me, is a proposal to initiate required withholding on non-employee payments. The withholding proposals would be based on gross payments as opposed to taxable income. This would require the same amount of cash withholding from all independent contractors regardless of the nature of their business. The business owner with the lowest profit margin would be hurt the worst, since they would be hit with the same amount of cash withholding even though they have less money to work with. Tracy Boulware, who is an NASE member from Houston, told us and I quote, ``I own a small company. I pay my taxes. Sometimes my profit margin is only 3.5 to 5 percent. This type of legislation could put me out of business. It is that simple.'' The small business that has only a 3 to 5 percent profit margin would be devastated and probably could not continue to operate. But that is not the only bad stories that would be out there. I personally have a client in Garland, Texas that has a business cutting grass at retail strip centers. His total gross income for last year was about $240,000, which seems like a lot of money. But he has two full time crew chiefs and employees a number of college students during the summer. So at the end of the day he has about $40,000 of net income and pays about six grand in taxes. But under a withholding rule he would have $12,000 of his money withheld. That translates into about $500 per month less to manage his family and manage his business. When I asked him if he could manage on $500 less a month, he also gave me a quote, but I thought I probably should leave it out here. We talk a lot about creating jobs and we talk about a stronger America, but this guy is actually out there doing it. And because he chooses to put a lot of his money back into the community he is going to be hurt the worst. The key point is that withholding based solely on gross payments would be greatly unfair to many taxpayers and for some it would mean the difference between surviving and not surviving. A second is the credit card reporting. Almost everyone has some type of information that is reported to the IRS either by their employer, by their bank or by their clients. This proposal would expand that type of reporting to credit and debit card transactions. Now capturing information can only have a positive impact, in my opinion, particularly in light of those taxpayers who consciously choose to avoid reporting income. If requiring the credit card companies to report these payments will help identify those that abuse the system, I am all for it. If reporting is used to match credit card receipts to the tax returns similar to the way 1099s are done today, I think it is a great idea. If, on the other hand, the reporting is used to make judgments regarding other items on the item, I think problems could arise. Discussions have included taking the total credit card receipts reported for a particular business and then extrapolating that total to total income, thereby making assumptions on amounts that are not reported. Making assumptions on information that is not reported will, again, paint all small businesses with the same paint brush which can only end up causing more problems then it solves. Perhaps the most critical problem with this proposal is an estimated return on investment. The Treasury estimated that it would save $225 million compared to 335 billion, which is nominal, especially compared to the burden it is going to place on both the IRS and on business taxpayers. The bottom line here is I am in favor of increased reporting, I am just afraid that this proposal will provide a lot more numbers but won't really have a big impact on fixing the tax gap. Lastly is education versus enforcement. Most issues faced by small businesses deal directly with the complexities of the tax code. The IRS' commitment to education over the last five years has made a tremendous difference. Anyone who thinks that the IRS has not been a friendly and more helpful entity has not had a chance to review their website. The commitment to that website changes in the Form 941, 940, the new Form 944; all prove that they have been listening and that they want to help. I am afraid, however, that the commitment to education might be fading. It seems clear that the proposed budget is moving away from education and toward enforcement. Point blank, more education means more compliance. My belief is that $1 in education is worth much more than $1 in enforcement. When I graduated from college, and I will not say how long that was, my goal was to make a lot of money, to conquer the business world and to be the man. But as I have gotten older I recognize that all we really have a chance to do is make a difference. Today you guys are called on to make a difference, not only for me, but for millions of small business owners just like me in evaluating each one of these proposals. It is my wish that the difference you strive to make is based on reducing overall tax code complexity and maintaining a commitment to education. Thanks again for the opportunity to be here, and thanks for making a difference. [Mr. Hall's testimony may be found in the appendix.] Chairman Manzullo. I appreciate that. Our next witness is Michael J. Fredrich. And I am going to touch upon his biography because first of all, I forgive you for graduating from the University of Wisconsin because I went to Marquette. Mr. Fredrich. It was a rough time and I forgive you, too. Chairman Manzullo. That is all right. It says personal, married 31 years to the same woman, no children, 13 dogs, 10 cats, six horses and no mice. And with that introduction-- Mr. Fredrich. That is right. Chairman Manzullo. But BS degree in nuclear engineering, MBA in finance, corporate turnaround specialist. Industries include manufacturing. You know the time I spend in manufacturing. I really do look forward to your testimony. STATEMENT OF MICHAEL FREDRICH, MANITOWOC CUSTOM MOLDING, LLC Mr. Fredrich. Well, thank you, Mr. Chairman. And thank you Ms. Velazquez. Chairman Manzullo. I'm sorry. On behalf of the Small Business and Entrepreneurial Council. Go ahead. Mr. Fredrich. Yes. Thank you. Well, I am happy to be here today. And I read the testimony of Mr. Brown and I would have to say, I would not want your job. I think you are trying to do the right thing and you are dealing with really an impossible situation. I mean our tax code is so complex it crosses people's eyes. I mean, I do not know how many people in here actually do their own taxes, but I mean it is just impossible to do. And I know this is not a debate, but Ms. Olson, I read yours, too. And if you are helping the small business, do not help so much. We do not need that kind of help. I view this proposal as one more straw on our back of small business. We are, you know, a professional tax collector. We collect federal tax, state tax, Social Security tax, Medicare, unemployment tax, state and federal. We file W2s. We do 1099s. And we do not get paid for any of this service. And on top of this now we are going to become immigration police, which is not the topic of this. There was competition mentioned that we want to make everybody pay their taxes so we have a level playing field. I would offer this to anybody that thinks adding more burden on small business creates a level playing field and improves competition. I would say this: You are looking at the wrong competitors. Our competitors are not other small businesses in this country. Our competitors are small businesses and companies around the world. And I offer this as an example. One of our customers, Kohler Engine--we make parts that's Kohler Plumbing, but they also make engines. Most people probably do not know that. They have a group of people that go around and assess your cost structure and they compare you not just to other people in this country, they compare you to other of your competitors in the world. So we have competitors in China and we have competitors in India. And they look at our cost structure and they say well your costs are too high. So here is your choice. You can lower your price or you can lose the business. And that is fact. And they are not the only company that has it, lots of companies have that. So that is the cost reality that we are dealing with. In my testimony I have a thing here called the Anthony factor. Small businesses do not and cannot have a high overhead. We cannot employ more people than we absolutely need to. So in situations like our computer system, we cannot have an IT person on staff so we use Anthony. We pay Anthony the way we pay everybody else. We pay him by check an we issue him a 1099. And the thought of having to start now messing around withholding on Anthony is just silly. I mean, it is just one more straw. And at the increment it does not seam like it is a lot, but it is. I mean, you have to look at the whole thing in its total. Another example. We do not have a direct salesman, we have a guy that we have been trying to leave his current employment where he makes $120,000. He has a salary of $120,000. And we said to him, look it, why do you not start your own company. Be your own boss. We think you would flourish and you could represent our company in selling our products and we would benefit and you would benefit and it would be good for us. So now here is a guy, he is going to leave, walk away from $120,000 salary into a situation here he makes zero on day one. Absolute zero. So now you are going to enact some legislation that is going to require us to withhold 28 percent of what we are going to pay him. Well, he cannot afford that. I mean, he is already walking away from $120,000. So, you know, that is how this kind of thinking, I mean you would think you would want to encourage people to start their own business, and that is how businesses start. I mean, they start with people going out on their own and saying, hey, you know, I can do this for myself. And this legislation or this proposal it really dampens that. One other thing I would like to say. I heard this with regard to audit activity $1 yields $4. That is just bunk. When you make a calculation like that in a free market transaction where you have a willing buyer and a willing seller and the IRS does not come to you and say hey, we would like to do an audit, what do you think. No. They say we are going to do an audit. Okay. So then you have to go and hire your support, your tax accountant, you have to go hire Kevin here and say hey I need representation that pulls you away. And they do not factor those costs in there. They do not factor the focus that is taken away from the business. Can you imagine? We do not run on a big staff. I mean, I am not there today. My partner is there today. But we are there everyday that we can be. And to take our focus away to have an audit where somebody thinks they make $4 for every dollar of audit cost ignores the other half of the equation. What is our cost? I mean, that has to be your true yield on what an audit costs. So I mean they go through this plan of we are going to expand--my time is up. I am sorry. I will summarize quickly. I think you need to be simpler. You need Hagelian logic; less is more. Our tax structure is too, too complicated. That is my testimony. [Mr. Fredrich's testimony may be found in the appendix.] Chairman Manzullo. Now I am convinced that you were at the University of Wisconsin. Hagel is the author of Communism. Mr. Fredrich. The solution. In business if you want to make something better-- Chairman Manzullo. You do not get it. Everybody accuses the University of Washington of being very liberal and said-- Mr. Fredrich. I was in engineering school there. Chairman Manzullo. All right. Sorry about that. Appreciate your testimony. Mr. Fredrich. Thank you. Chairman Manzullo. The next witness is Dr. Max Sawicky, an economist with the Economic Policy Institute, who has worked at the State and U.S. Treasury Department. We look forward to your testimony, Dr. Sawicky. STATEMENT OF MATT SAWICKY, ECONOMIC POLICY INSTITUTE Mr. Sawicky. Thank you. I would like to thank you, Mr. Chairman and Ranking Member for inviting me. If Ms. Olson does not supply enough disagreement, maybe I can fill in the gap. The United States has enjoyed a tax holiday for years now. We are, as you know, spending much more than we are taking in, both in terms of the Federal Government in the U.S. relative to the rest of the world. Very few economists think these imbalances can be sustained indefinitely. And because of that the need for revenue, I think, is going to become inescapable. Tax increases are not fun and I think that fact is going to compel renewed and expanded interest in the tax gap, which is another source of solution. Now, I would take exception to some of my friends. Tax increases, in and of themselves, do not fix this because in the long run we have health care spending increases in both the public and private sector which will need to be paid for one way or another. If they are not paid for by the government, they are paid for by someone else. If they are not paid for, then somebody loses health care. So the problem is much bigger then revenues, but revenues I think are going to be impossible to avoid. And that means the tax gap, among the other things. Now the elephant in the room here which nobody has really touched upon which pertains to a number of the issues that have come up is resources for the IRS. If there is a lack of service and education of taxpayers, that is amenable to remedy with more resources. If there is a lack of research or an unevenness in the focus of research, that is amenable to more resources. If there is a shortfall in technology, which I think is a particular problem with the IRS, that is a crying need. Proposals to flat fund the agency or even reduce funding in real terms after adjusting inflation mean that when we talk about more service, it is going to come from somewhere else. The agency absolutely has to process returns; that is an unavoidable expense. If we do more education, it is going to mean less enforcement with all the problems that have come up. And unlike other issues in the budget, this is not a trade off issue. The research, contrary to my college here, I think is pretty decisive and emphatic that more spending on a variety of measures, not only the ones that have been mentioned here, bring in much more money than they cost. There is very high payoff ratios that have resulted from very elaborate and sophisticated research on this question. So then of course the question remains what is the right focus. And people are concerned here that small business is being singled out. As the Commissioner said, the IRS uses formulas to determine audit. These are confidential; they have to be. I think nobody from the outside is supposed to know what those are. I think the confidence in terms of what the agency is likely to do with better financing, although it cannot be simply given away without any oversight, is that they are going to go where the money is. And that is not particularly to small business, it is to businesses with lot of employees and/or high net income. It is not to very short with very high income. So in terms of small business within that dreaded blue box in the tax gap map there is a lot of differentiation between really small and small compared to Chrysler but not small compared to most Americans. And I think the agency can be relied upon if their mandate is to get the best bang for the buck in terms of revenue to go to where the money is and not to the really small people. In that final vein, one small business category that has not been mentioned here is, let us say a woman taking in sewing making $13,000 a year, somebody mowing lawns. People receiving the earned income tax credit have been the target, the real target of inordinate attention by the IRS I think at the behest of the Congress in a gross misfocus of priorities from the standpoint of revenues as well as justice. And if there is unfairness there, we cannot be surprised if it bleeds over into other places. Two more thoughts. One, I think the advance in the computer technology and the economy, the reduction of the cost of transactions which we already see burgeoning ahead is going to make a lot of these discussions obsolete. It is going to be easier and easier to collect and report information, the process, and without necessarily the need for draconian withholding rules, which I am impressed by some of the testimony in terms of the problems in that vein. But reporting, I think, is much less of an issue, will become decreasingly so in the future. And finally, I cannot disagree with all the commentary about the importance of the simplicity of the tax code and the fact that it has gone radically in the wrong direction really since 1997, I would say. And this complexity for good, bad and different reasons has increased costs all the way around. And everybody in Congress is concerned about this but nobody has roused themselves to really deal with it seriously. And again I come back to the fundamental imbalances in our economy and in the budget which get much worse in the long run, which I believe will compel the political system, Congress and the President, to approach the revenue including the tax gap with high seriousness. And part of that solution will be, I think, significant simplification of the tax code. Thank you very much. [Dr. Sawicky's testimony may be found in the appendix.] Chairman Manzullo. Thank you. You must have been rejoicing last night with that marvelous basketball game. Was that not something? Mr. Sawicky. I have a 6:30 school bus to catch in the morning, so I miss a lot of that late night stuff on TV. Chairman Manzullo. You're alma mater. Mr. Sawicky. My alma mater is--oh, yes. Yes. Right. Chairman Manzullo. Okay. Mr. Sawicky. I read about it in the paper. I missed it. Chairman Manzullo. It's obvious you do not like basketball, so I will go on to something else here. Ms. Olson, on withholding, your proposals do not even touch credit card withholding, is that correct? Ms. Olson. Well, I did not propose the credit card withholding, the Administration-- Chairman Manzullo. That comes from Treasury. Ms. Olson. The Administration proposed it. Chairman Manzullo. So I guess unless you want to talk about, let us go on to-- Ms. Olson. Right. Chairman Manzullo. --what your proposal for withholding is. Could you walk us through a scenario? Ms. Olson. Yes. First, when you and I had talked earlier you asked me to get numbers, so now I have numbers. Chairman Manzullo. Is it not great to come into the office first? Ms. Olson. Yes, it was very helpful. Chairman Manzullo. Good. Ms. Olson. And it crystallized the mind. There are for tax year 2004, which would be last year's filing season and are the most recent data that we have since this year's filing season is not finished, there were balance due returns overall, there were approximately 4 million balance due returns. Individual returns they reported tax dollars, they made some payment and here is the dollars that are owed. Chairman Manzullo. These are individual returns? Ms. Olson. These are individual returns. Chairman Manzullo. Okay. Go ahead. Ms. Olson. So that will include Schedule C. Chairman Manzullo. Okay. Go ahead. Ms. Olson. Of those returns 1.45 million were Schedule C returns. So that is first the universe that we are talking about. Out of the 128, 133 million returns that we get every year, to even begin to look at my withholding proposal, we are talking about 1.45 million returns. That is just the starting point. Now of the dollars that are balance due for 2004. Okay. Let me just say one thing. That Schedule C balance due returns then constituted 35 percent of all balance due returns we got in tax year 2004. Chairman Manzullo. Can I stop you right there? What percentage of the total returns do the Schedule C returns comprise, do you know that? Ms. Olson. Maybe 18 percent my research guy says. Chairman Manzullo. About 18 percent. Go ahead. Ms. Olson. Okay. Chairman Manzullo. Thank you. Ms. Olson. And then when you look at the dollars that are due on these balance due returns, we had about $12 billion on all individual income tax returns due. Okay. A balance due. And I am not talking here about under reported income. I am saying people said this is how much we owed, we were not able to pay. Chairman Manzullo. Right. Okay. Ms. Olson. So on those 4 million returns for all individual taxpayers, it was about $12 billion due. And for Schedule C returns what we had was about $6 billion due. So the Schedule C balance dues were about 50 percent of the dollars, although they were 35 percent of the balance due returns and 18 percent of the overall taxpaying population. So that is not the end of the equation, though, before you get to backup withholding. I mean, some of those people may be one time people, of those 1.4 million taxpayers that were Schedule C that filed a balance due return. They may just have had a bad year, you know, and they are going to contact us and get into an installment agreement. They may never repeat that problem again. So what my universe is to even begin to look at backup withholding are people who have had recurring balance due returns where they are getting so far behind, where they are showing a balance due of $5,000 a year and you have three years in a row and you are getting to $15,000 with penalty and interest accruing and you are never going to dig yourself out of that debt. And that goes back to what I was trying to say in my oral testimony. You never dig yourself out of that debt. And so what we were trying to say there is we have got a repeater, we have got a problem, we have got a trend starting with this taxpayer. And the next thing that is going to happen is that taxpayer is going to go out of business. So what I want to do because all of our notices that have been sent out to that taxpayers are not bringing him in and we are not getting an arrangement. He is not coming in and he is not scheduling his self-employment, his estimated tax payments on a monthly basis is to institute backup withholding, just like we do with the individual with the interest and the divide where people are not responding. Chairman Manzullo. On whom? Ms. Olson. On repeaters who are showing a trend on Schedule C. Chairman Manzullo. No, I am sorry. The people that would have to withhold? Ms. Olson. Okay. If they have 1099s, we would go out to their payors. And I would imagine if you just got a 1099 for $600 or $650 the IRS would not be contacting that person. But if you had someone that it looked like there was one payor, you know you were really working for one person, we would go out to that person and say we want you to withhold. Chairman Manzullo. So that could be a corporation? Ms. Olson. It could be a corporation. Chairman Manzullo. It could be a sole proprietor? Ms. Olson. It could be another sole proprietor, that is right. Chairman Manzullo. So you would be asking a sole proprietor, a small business person, to withhold? Ms. Olson. Yes. Chairman Manzullo. And then to send that money to the IRS? Ms. Olson. Yes. Chairman Manzullo. John Satagaj has something to say about that, is that the segue? Mr. Satagaj. It is hard to believe, I guess is the only words I can use. Chairman Manzullo. I am astonished. I am astonished. This is the Taxpayer Advocate. Mr. Satagaj. Yes. I mean, actually, I do not want to get into too-- Chairman Manzullo. Go ahead. You can argue with her. Mr. Satagaj. I am struggling with the repeat, how many of them are repeaters even. Ms. Olson. Actually, we were supposed to have that number this morning and we did not receive that number. But it would obviously be less than 1.45 million because that is the total balance due that we have. Chairman Manzullo. So then you would be asking businesses that hire this repeater who is an independent contractor to withhold because this independent contractor is not paying his tax, is that correct? Ms. Olson. On a repeated basis, yes. Chairman Manzullo. Okay. So then unless that independent contractor comes in with this magic certificate of compliance-- Ms. Olson. No, we have not gotten to that yet. No. Chairman Manzullo. But in any case, but it is correct-- Ms. Olson. Well, what I would like is that what you would have is that essentially one backup withholding payment would make that taxpayer call the IRS and then part of my proposal is that when the taxpayer calls the IRS, we will release withholding, backup withholding if they will get into this monthly payment plan-- Chairman Manzullo. That is correct. But now what you are saying now is that the creditors of the guy who-- Ms. Olson. Right. I am asking this small business employer, right. Chairman Manzullo. --is continuously--not the employer. It is not employer. It is the payor. Ms. Olson. Right. Okay. The payor. You are right. Chairman Manzullo. The payor, that is correct. Ms. Olson. The payor. That is correct. Chairman Manzullo. You would be asking that person-- Ms. Olson. Yes. Chairman Manzullo. --let us say it is the plumber. Let us say the plumber does, I do not know, 300 jobs a year, whatever it is. So you would be going after all those people-- Ms. Olson. Well, not necessarily. I mean, those are the questions that the IRS has to decide whether you were going to get money from them or not. Chairman Manzullo. The problem is this-- Ms. Olson. Yes. Chairman Manzullo. -- is you make a general recommendation. You are smart enough to say general recommendation, a little bit smarter than Treasury that comes right out and says let us do this. You make this general recommendation, but you have done nothing to show the cost of implementing it in terms of the burden that is on the innocent business, like my brother with the restaurant. I mean, he is supposed to be placed in a position to determine whether or not his plumber is paying his taxes? Ms. Olson. Well, see that is a valid point. But with all of my recommendations, they are recommendations. The IRS now has a small business burden reduction model. And we will feed this proposal in and look at what it should be. Chairman Manzullo. Well, can I help you feed it right now? I think-- Ms. Olson. So I mean I have been listening to the panel. Chairman Manzullo. --it is stupid and it stinks. And may we go on to something else on behalf of all the Frank Manzullo Juniors who went out of business after 41 years. I am sorry. There is no way Frankie ever would have known about a certificate of compliance if you asked him to withhold. He would look at that thing and say well what does this mean? I mean, he has a high school education, actually a business school education, and he is a veteran. And he is a very smart guy. Ms. Olson. Well, many of these-- Chairman Manzullo. But he would have no idea what that means. Chairman Manzullo. He already-- Ms. Olson. Well, many of these small business people have employees in additional to independent contractors. Chairman Manzullo. Of course. I understand that. Ms. Olson. And they are handling withholding in the context, too. Chairman Manzullo. Right. But I mean-- Ms. Olson. So it is the same mechanism. Chairman Manzullo. But look at the different small business groups out there, NFIB members went from the average of three employees to I think it is now about five, and the other groups are somewhere in that particular area. I mean what happens if not only it is his plumber but also the electrician? You know, these small business people hire small business people because it is good for business. That is the culture; it is just the way it is. I mean, there could be a half of dozen people that you would send a notice to, especially if it is an area like Rockford, Illinois that led the nation in unemployment at 25 percent. And now it is still at seven percent where people are struggling to make their payments, taxes are going up and the average wage for the people in the biggest county in my District has gone down because of the loss of manufacturing jobs. And they are struggling. They are hurting. Ms. Olson. I understand this. Chairman Manzullo. So you would be asking the small businesses that are left to do backup withholding-- Ms. Olson. No, I would not, sir. Chairman Manzullo. --in the event that you find these characters that are not fully compliant with the IRS? Ms. Olson. Right. Now so the other point that I want to make is that the IRS in its current levy program, for example, what it has the authority to do under law right-- Chairman Manzullo. Right. Ms. Olson. --now if someone is behind in their taxes and we can tell that someone is working for one individual person or we can see from the 1099s or that they are working for 25 individual people, we can go out to those payors and levy on the payments that they are making on that person right now. Chairman Manzullo. Only if they owe money. Ms. Olson. Well, that is what I am talking about here. Chairman Manzullo. That is correct. Ms. Olson. The IRS has tolerances. We do not go out if there are 25 people and they are paying X amount of dollars and it is below our tolerances, we do not go out to absolutely everybody who shows up on a 1099 when we go out and do our levies. You know, and the same procedures would occur here. We would be making those tolerance decisions. Chairman Manzullo. I mean whenever you have decisions, you are talking about bureaucrats. You talk about bureaucrats, you are talking about forms, you are talking about the forms--you know what my brother would do if you said any future work this plumber does you have to withhold? Do you know what he would do? Mr. Satagaj. New plumber. Chairman Manzullo. New plumber. Ms. Olson. Well, what is he doing in the current situation when we go out and say to him we're going to levy on-- Chairman Manzullo. Well, no, that is the whole point. Then you end up putting this guy out of business. Ms. Olson. That is happening today in the levy context. Chairman Manzullo. Well, no, but it is different in the levy. The levy is where the creditor is actually holding money that is owed. You can't levy on zero. Ms. Olson. You can put it on accounts receivables. And if the plumber is working and there is a payment that is due to him, then we can levy on that. And that is-- Chairman Manzullo. Well you know what he would do as a small businessman? Ms. Olson. --precisely what we are doing now. Chairman Manzullo. He would just go on to get somebody else. Why should the small-- Ms. Olson. But I am saying that that is what is happening here and it is happening today. Chairman Manzullo. No, I understand it. But I mean you have got so much research you have to do and of course the IRS considers itself exempt from the Regulatory Flexibility Act on any regulation. So you come out with these regulations and you have absolutely no way of knowing what the cost will be. Ms. Olson. Well, actually, to that point part of the reason why we have said that these were proposals is because I am making them publicly and I am sitting here willing to discuss them with you. Chairman Manzullo. But that's-- Ms. Olson. And I have stood before 22 small business groups and listened to their concerns, and I have incorporated many of their concerns. Chairman Manzullo. John? Mr. Satagaj. I mean to there is the issue of, you have raised the issue. You are going to get rid of that plumber and go to another one. You have got the fact that you are going to have a lag time here between the years involved and when you are getting out the notices. It presumes they keep going back to the same people all the time for the same business. I mean, there are a lot of presumptions in this to get to the point where you're actually going to be able to match up the person that you want to withhold from the person. Ms. Olson. Yes. Mr. Satagaj. I mean, you got too many-- Chairman Manzullo. All right. Michael, how many subs do you have in any given year in your business, in your plastics industry, subcontractors? Mr. Fredrich. Oh, I would say five to ten. Chairman Manzullo. Okay. What about sub-subs? Of course, you would not be dealing directly with them, would you? Mr. Fredrich. We would not. But-- Chairman Manzullo. How many people do you buy materials from? Mr. Fredrich. The materials are all larger customers, people that we use as subcontractors. For example, we have a guy that comes in and runs a machine that measures the tolerance on parts. And we do not have to do that that often because it is just for new parts that are getting approved by the customer. So, you know, he would come in maybe seven/eight times a year and we pay him as an independent contractor. But I would say this: You know, they are talking about withholding. If you withhold 28 percent of somebody's gross revenue, nobody has a 28 percent profit margin. It is just not there. I mean if you are talking about withholding, maybe you would have to figure out what their profit margin is. Ms. Olson. We did do that. Mr. Fredrich. And then the percentage of tax. But 28 percent is-- Chairman Manzullo. It is a lot of money. Mr. Fredrich. It is off the wall. I mean you put-- Chairman Manzullo. Congresswoman Velazquez? Ms. Velazquez. Thank you. Ms. Olson, what will be a liability issue for the payor Ms. Olson. It would be the same rules under backup withholding today, which is that if you have the obligation to do backup withholding, then you would be liable just like a bank would today. If I could make two points. One is my proposal is not to go to anything but payments that are currently subject to 1099 reporting. Ms. Velazquez. Okay. In your recommendations would you ask the IRS to put more resources into education? Ms. Olson. I have made-- Ms. Velazquez. Personnel? Ms. Olson. --at my number one most serious problem for taxpayers in this past year's annual report the trend in taxpayer service, which includes the outreach and education to taxpayers. And I have criticized some of the changes that have been made in the Small Business Self-Employed Operating Division-- Ms. Velazquez. And do you hear that more staff people have been shifted around-- Ms. Olson. I state that in my testimony. Ms. Velazquez. --and that the resources will be put into outreach and education? Ms. Olson. I am very concerned about that. Ms. Velazquez. So how do you expect then for business to understand when they will be in violation or noncompliance? Ms. Olson. If I am not satisfied that the IRS is adequately staffing this, then I would not be supporting this. I would not be putting forward this proposal. Ms. Velazquez. Right. Ms. Olson. This cannot be separated out from just compliance. I mean enforcement. Mr. Brown. Excuse me. We do take the service component of our mission very seriously. And there has not been a reduction in the number of resources devoted to it. I mean, there has been a recasting of who performs some of those services. And some have migrated to other divisions. But in terms of sheer number of people and sheer number of hours devoted to the service side of the equation, that has been constant. And we take that very seriously. We have tax forums around the country and they are very important in terms of educating taxpayers. Ms. Velazquez. Let me ask: Have you shifted resources from assistance to enforcement? Mr. Brown. We are devoting the same amount of resources to service as we did before. We had an organization called Taxpayer Education and Communication and there was an error-- Ms. Velazquez. But then you are defeating the purpose because if you are going to implement this new proposal and go after all these people now, if you are going to have and devote the same type of resources, that means-- Mr. Brown. You are suggesting we would devote more resources to it? Ms. Velazquez. Correct. Mr. Brown. I agree with you that we need to do more in this department. That we need to devote both more research and become-- Ms. Velazquez. But I understand your funding, your budget will be flat funded. Mr. Brown. Our budget will be adequate for what we need to do here. Obviously-- Ms. Velazquez. That is what I hear from the Administrator of SBA when he comes here and you see the mess that as a nation we have been witness in regarding the victims of Katrina. Why? Because the budget of SBA has been cut by 50 percent in the last years. Mr. Brown. We believe we have the resources necessary to do the work here. Ms. Velazquez. Okay. Thank you. Mr. Satagaj, in your testimony you seem to focus on the problem of complexity as a driver of noncompliance. Unfortunately, the President's Commission Tax Reform Panel that put together a report on simplifying the tax code and nearly all of their recommendations have simply been put aside. Why do you believe that efforts to simplify the tax code have failed and this problem only continues to get worse? Mr. Satagaj. A real question. I do not know that I know the answer to that one, and I am honest to say that. It is frustrating that we have not done it. You allude to that report. Former Commissioner Rossotti sat on that panel and I would say that he has been one of the very effective spokesman for small business and he had some very intriguing proposals in there, and some of them lead to actually the very systems we are talking about here ironically about reporting. Because he talked about checkbooks and he talked about credit card. But the payback to get that was you would have a simpler system. Ms. Velazquez. Sure. Mr. Satagaj. And there is something there to make an incentive for the businesses to be part of that system, whereas these proposals there is no incentive to it. I do not have an answer to why, to be honest with you. Ms. Velazquez. Okay. Well would you agree that if our tax bills focus on simplifying the tax code, that concerns about the tax gap will be reduced? Mr. Satagaj. I think so. I think that certainly is a part of it. There are several things that fall in there, but that is one part. Ms. Velazquez. Mr. Sawicky, would you like to comment. Mr. Sawicky. Sawicky. Ms. Velazquez. Yes. Would you like to comment on my questions to Mr. Satagaj? Mr. Sawicky. Well, a broader simplification if it broadens the tax base makes lower rates possible. And I think the research and common sense is universal that lower rates reduces the incentives to evade taxes and also reduces the incentives to look for legal ways to reduce one's tax payments. So you cannot have too much base broadening from my standpoint. Why do we not get more? Well, I think it is because half the people in this room are involved in activities to get concessions in the tax code for one or another interest. And as the Commissioner I think said, as these things pile up to the breaking point, at some point I think probably with a financial crises resulting from our trade and budget deficits, they will be compelled to do something serious about simplification for the purpose of gaining revenue. The alternative would be problems in financial markets that cause serious damage to the economy. Ms. Velazquez. But in your view both Congress and the Administration bear some responsibility for increasing complexity of the code? Mr. Sawicky. Well, the people that write the code are responsible for the complexity of it. And from my standpoint and including the legislation in '97 as well as what came after, we have had increasing complexity in the tax code. And also that entails all kinds of swiss cheese holes that take parts of the base away from taxes. Ms. Velazquez. Mr. Brown, in terms of the area of enforcement do you believe that by focusing on corporate tax shelters will be a more efficient use of the IRS resources as opposed to the current efforts to go after small businesses? Mr. Brown. I think both are necessary, as the KPMG situation the Commissioner alluded to earlier, many of those taxpayers are involved in a deal called Son of Boss that involved about 1300 individual taxpayers who ended up paying us more than $3.7 billion. And this is not money we hope to collect. This is money that we have received. Ms. Velazquez. So would you say that these larger businesses over $250 million or more are better equipped to deal with an audit in terms of manpower and costs? Would you agree that the relatives costs are much higher for these Schedule C filers? Mr. Brown. Yes. Ms. Velazquez. And with this measure let us talk about the cost to the honest taxpayer who is subject to an audit? Mr. Brown. Well, the credit-- Ms. Velazquez. Does that represent a win/win for our economy? Mr. Brown. Well, I think that is why we really wanted third party reporting. The intent here was to not place the burden directly on the small business. And I realize, of course, that there are some pass-through costs when you are talking about credit card companies having to report this type of information. But that was the genesis of the idea for increased third party reporting as opposed to withholding or going some other way which would put the cost directly on the small business. Ms. Velazquez. But you do not think that that will represent a financial burden on small businesses? Mr. Brown. I do think it will represent somewhat of a financial burden on small businesses, yes I do. Ms. Velazquez. Do you really think so, because you have not done any impact analysis? Mr. Brown. Well, we obviously have to meet with the industry. When you are talking about third party reporting, there are always going to be costs that we might not be able to know, but that is exactly why we are meeting with the industry. Ms. Velazquez. Mr. Brown, the IRS suggests five initiatives to close the tax gap. And according to your figures the cumulative impact of these changes will reduce the tax gap by one-tenth of one percent. Even that, would not the time of the Administration, the IRS, the Treasury and Congress be better spent on taxing simplification rather than trying to go after such a small amount given the huge administrative burdens that they seem to create? Mr. Brown. The proposals we believe do not create huge administrative burdens. I guess I would take issue with that word. Ms. Velazquez. Well, we would start $100 million that you pay for a study. Mr. Brown. I think Senator Baucus asked the Commissioner at a hearing recently the same question and he said is this enough? This does not represent enough in terms of efforts. So I think the point is valid that this is a minor piece. As to tax simplification, I applaud any efforts to simplify the code. It is very difficult for our revenue agents to enforce the laws when even they sometimes are not certain about the laws, let alone the small business they're intending to audit. Ms. Velazquez. So you agree with me that since 1997 the tax code are more complex? Mr. Brown. I have been in this business since 1987 and every year it has gotten more complex. Ms. Velazquez. More so after 1997. Mr. Brown. 1987 is when I got into this business, and it is been much more complex every year. Ms. Velazquez. Thank you, Mr. Chairman. Chairman Manzullo. Thank you. Now, what side of these proposals do you come down on, with Ms. Olson or with the Commissioner? Mr. Brown. Oh, with the Commissioner, obviously. Ms. Olson. The Advocate speaks for herself. Chairman Manzullo. Are you not glad that the Commissioner went first? Mr. Brown. Yes. Chairman Manzullo. Right. Mr. Brown, I guess this was the so called ``blue book''? Mr. Brown. Yes. Chairman Manzullo. On page 117. Do you have it there? Mr. Brown. I do somewhere in this rule book, yes. Chairman Manzullo. Could you flip to it? This is when it talks about increased information reporting on payment card transactions. Do you see that? Mr. Brown. If you will give me a second, I will find that for you. Thank you. Chairman Manzullo. Does that say on top increased information at page 117? Mr. Brown. It sure does. Chairman Manzullo. Okay. Would you go down to where it says ``reasons for change'' And read the last sentence in there where it says ``in addition.'' Now this is only, as the Commissioner said, with regard to people that give somebody else's wrong tax number. Mr. Brown. That is correct. Chairman Manzullo. You want to read it out loud for us? Mr. Brown. Sure. ``In addition, implementing a backup withholding system for payment card reimbursements to businesses would lead to material improvements in the compliance rates of these taxpayers without imposing a significant burden on card issuers.'' Chairman Manzullo. Who came up with the last portion of that sentence? Mr. Brown. This was a combined effort between the Treasury Department, the IRS and other parts of the Administration. Chairman Manzullo. And I would note that, first, this is put out and then come the meetings with the industry. Is that order correct? Mr. Brown. There were some preliminary discussions with people who are familiar with the industry and who worked in the industry before we did this. And there are ongoing discussions as we speak with members of the Credit Card Association, the American Bankers Association. Chairman Manzullo. But why would you put this out? I mean, this is a statement of fact. This is a sales piece that you give to Congress. I mean you have made a factual determination that there would be no significant burden on card issuers. I mean, this is not-- Mr. Brown. Well, this refers to just the backup withholding, this particular sentence. Chairman Manzullo. Well, you have to start with that. Mr. Brown. But this is-- Chairman Manzullo. I mean how could you come to that conclusion? Mr. Brown. By talking to people who are familiar with the industry. I have worked in the industry. And this is the way the budget process works. We obviously want to work with the Congress to make sure and to work with the industries to make sure that we do this-- Chairman Manzullo. First of all, I do not believe this. I mean this is factually incorrect because every time you do something else to withhold, it is going to be new software. I mean, the software people must love you. You would have to change programs here. Mr. Brown. No. We have backup withholding regimes in place now. This really is designed to mirror the current backup-- Chairman Manzullo. No, no, no. This is something new. This is credit cards. And what I don't understand is if somebody gives you a bad TIN number, what kind of people are these? Are these crooks? What are they? Who is doing that and why do you not put them in jail or charge them with a crime if they are using somebody else's instead of going after the credit card issuer and saying this guy who was using a bogus TIN number, we want you to withhold on the money you give him? Why do you not just put him out of business or arrest him or something? That sounds like credit card fraud to me. Mr. Brown. Well, some of these are just made in error. People transpose number. So we do not jump right to back-- Chairman Manzullo. Well, I realize that goes on all the time. Mr. Brown. That is correct. Chairman Manzullo. That proposal does not even address that. Because once the error is brought to their attention, you know somebody could have interposed a number or transposed a number. Mr. Brown. The vast majority of them, correct once we notify. Chairman Manzullo. Right. But I do not understand this. I mean, if somebody gives a wrong TIN number and it is not an error, what kind of a person is that? Is that a thief? Mr. Brown. Well, it can be. Chairman Manzullo. Or what? Mr. Brown. It can be someone who is generally trying to avoid the information going to the Internal Revenue Service. And there are other reasons that you would-- Chairman Manzullo. Well, that is pretty serious, is it not? Mr. Brown. It can be. And there are also all sorts of Bank Secrecy Act provisions that would be run afoul of here, too, as well. I mean often times you are dealing with banks with taxpayer identification numbers and they want to launder money. There are a lot of reasons why people want to avoid that kind of scrutiny. Chairman Manzullo. But I mean you are really not in the business here of going after the money launders. Mr. Brown. Unfortunately I am. Chairman Manzullo. Well, not with this proposal? Mr. Brown. Not with this proposal. But I unfortunately own the Bank Secrecy Act program for the Internal Revenue Service, it is in my division. Chairman Manzullo. Okay. Well, that is another part of your portfolio. And again, this is aimed at the small business people, as finally we got the Commissioner to agree that this particular provision was. I still do not understand how you can make this statement. Because what you are talking about is that for every small business person you are going to make, and I think you said 25 million people, the credit card companies give all that information to the IRS so they can filter through all of that to see who is giving a wrong number, is that not correct? Mr. Brown. What we are looking for is an aggregate number on gross receipts, payments made to if you are a restaurant. That is the number we are looking for. And also we are looking to make sure that when the information comes in that there is a proper taxpayer identification number. Chairman Manzullo. Well, that it is interesting because now you are talking about withholding on credit cards on an aggregate number and your boss just testified to the fact that the only time that credit cards would be involved is because of a false TIN number. Mr. Brown. That is correct. No-- Chairman Manzullo. Well, why did you mention aggregate number? Because that could be something that you might be looking for, is it not? It could give reason for an audit, could it not? Mr. Brown. The third party reporting is specifically designed to give us an aggregate number for credit card receipts-- Chairman Manzullo. You have it back there? Yes. This stinks because now I know what you are doing. You want to have all the credit card companies report to you so then you can take that information and then compare it against their income tax return. So this is more than the people with the false TIN numbers, is that not correct, on credit cards? Mr. Brown. The false TIN numbers only applies to the backup withholding. The TIN numbers do not come into play other than for the backup withholding. Chairman Manzullo. Well, yes, but then what would you do? This is just a big net. Just a fishing net out here so you can get more information. Because you know what? Let me share what occurs on page 41 of this report that you guys just love. Page 34. This says, but unfortunately these are not your own words so I can't cross examine you like I did your boss, ``Appendix 3 IRS key efforts to reduce the tax gap. The IRS strategic plan outlines, it does not prioritize service and enforcments to improve compliance.'' That is not good. ``Therefore, we asked IRS officials to identify IRS' key efforts to reduce the tax gap. IRS divisions provided lists that totaled 47 efforts which are described in the following examples. The Small Business/ Self-Employed Division,'' that is you? Mr. Brown. Yes. Chairman Manzullo. Okay. ``Identified 15 efforts such as models to identify higher priority collection cases to pursue.'' Another word for modeling is profiling, is that not correct? Mr. Brown. I will agree with that. Chairman Manzullo. Good. And another one is a computer matching program to identify under reported income. That is what you want? Mr. Brown. Well, what that is referring to is, I mean, it is somewhat like Max explained before. We have a formula we use to assess returns. We do not just audit randomly. We view random audits as a waste of time. I do not want to hassle taxpayer where there is not a high probability of there being something wrong. You know, we do not have the resources to do that and, frankly, neither do the taxpayers. So the idea of the National Research Project was to get us better formulas that would allow us-- Chairman Manzullo. No. But you want that information from the credit card companies because then you could match that information with what appears on income tax returns. See, that is what you want. Ms. Olson. But that is what we do today with the 1099 information. Chairman Manzullo. Oh, I understand that. But this would be a 25 million small businesses, we are not talking about corporations. This is just little guys, small businesses. All that information would be going from their credit card company to you so you could take that information and you could measure it against what they are reporting? Mr. Brown. Yes. Chairman Manzullo. What is that going to cost the IRS to manage all that information? Mr. Brown. We do not know right now. Chairman Manzullo. You do not know? Do you not think it is important? Yes, we talked to the credit card people. We did that. We have in our office. Do you want to know the figure? Eight million transactions per second; that is the entire credit card industry. Ms. Olson. But I do not think that--I mean, this is not my proposal, but the proposal is a total for the year on a calendar year. Mr. Brown. That is right. Chairman Manzullo. Wow, goodness gracious. Eight million per second. I cannot even figure that out as a Congressman times 60 what that is. I mean, can you not see why we are excited here? Can you not see why we want to know what is this thing going to cost the taxpayers? I mean, the first thing that I would do is the guy behind with the $100 million study, all right, and you are with the IRS, right? Okay. Mark. Okay. The first thing I would do is say before I get Congressman Manzullo all excited, I am going to sit down with Mark and say ``Mark, what is this going to cost? Give me a guesstimate. Give me a ballpark figure so that when I come up with efforts to do things, I do not come up with a statement that says without imposing significant burden on cad issuers.'' You have no idea what this is going to cost, do you, That 8 million transactions per second? Mr. Brown. We do not precise numbers. That is why we are working with the industry right now. Chairman Manzullo. Well, you do not have anything. You have got nothing. Mr. Brown. That is not true. We did have meetings with people who are familiar with the-- Chairman Manzullo. No. You can have all the meetings you want. They do not know. They are in the business of issuing credit to consumers, not giving background information to the IRS. That is not their mission. Mr. Brown. But we have ready reference point with banks which do report the information to us now. Chairman Manzullo. Oh. I mean, sure you got your 1099s. I can understand. But can you not see as the Chairman of the Small Business Committee why we see this as angst? Because one thing that you could never realize is you come up with formulas and you will say well if it is a restaurant, it has got to have this amount and that it has got to be 42 percent has to be credit cards and we are going to set up our computers so that at 42 percent, whatever it is, it is not on credit cards that is going to trigger an audit. Somebody has to come up with all those figures and that is another study and you already have those secret formula that you cannot show the public. Maybe if we shared the formula with the public, then the public would know better than to cheat if they know what you are looking for. Ms. Olson. Sir, would you rather us not do those studies and go out and randomly audit taxpayers? Because the point of the studies is that if we do do an audit--I mean, I am supporter of the studies because I do not want us going out and just randomly auditing people. I want the IRS to focus its audit resources on the people who have the highest amount of noncompliance. Chairman Manzullo. No, I understand. But the problem is this: You have already spent $100 million of the taxpayer's money on a study that is lousy. If I may, if I may and I went through this last night as I was watching the basketball game. And every time I saw something, I would underline it. Every time I saw a basket made for your old alma mater, which you do not watch, I saw-- Mr. Sawicky. I was working on my testimony then. Chairman Manzullo. That probably put you to sleep. But I mean where you do not even have provisions to track your data. In other words, you do not even know what you are capturing before you are making conclusions. Let me read this to you. ``Several factors concern IRS about its data on the reasons for noncompliance which could be unintentional or intentional, though IRS is developing the system to capture better examination data.'' Yes, right. ``IRS does not have firm or specific plans to develop better data on the reasons for noncompliance even though lack of such data makes it harder to decide whether it should address specific areas of noncompliance through nonenforcement efforts such as designing clear forms of publications on enforcement efforts.'' You do not have the data for that and yet in your testimony you went after your boss where you said I am concerned because when the IRS Small Business/Self-Employed Division, that is you, Kevin, Taxpayer Education and Communication Division was merged with its Communication Liaison or Disclosure Division, education staffing was reduced from 699 in fiscal year 2003 to I believe there is a typo error in the testimony, is that correct? Mr. Brown. We might want to confirm that. Chairman Manzullo. But this says ``Is reduced from 699 to 184.'' And I think someone from the IRS contacted us and said the real number is 480. Ms. Olson. They disagree with us, but we got this off of the time keeping records. So I do not know what to tell you about that. Chairman Manzullo. Okay. Is she right? Ms. Olson. But I mean I have no numbers. Mr. Brown. No. Chairman Manzullo. She is wrong? Ms. Olson. It is all numbers from the IRS. Mr. Brown. I think the number is incorrect. Chairman Manzullo. What is the number? Mr. Brown. The number is approximately 500. But it is not accurate-- Chairman Manzullo. You went from 699 to 500? Mr. Brown. No, it is not apples-to-apples. That is what annoys me about this. The 699-- Chairman Manzullo. This is your fruit you are looking at. Mr. Brown. Yes. The 699 were people who did not work full time on education and outreach. They went off for half the year to do other duties. Now we have 500 people working full time on this. So-- Chairman Manzullo. But you are going to have to hire another 5,000 if you are going to have somebody 8 million transactions per second. Ms. Olson. If I might, sir, I think that your point about needing to know the reasons for noncompliance is very important. And I have written a lot about that in my annual reports. And I think that that actually was what was motivating to make the proposals about the voluntary estimated tax payments. Because you do not want to use an audit-- Chairman Manzullo. You mean such as salons? Ms. Olson. Well, the salons, exactly, but also to scheduling a year in advance, that you do not-- Chairman Manzullo. Yes. I do not think that there is much angst in the small business community-- Ms. Olson. About that? Chairman Manzullo. --over a system set up like that to make it easier for people to be in compliance like that, and if it is truly voluntary-- Ms. Olson. Well, the way that I looked at this was, and this really was me on relying on my own personal experience because I have prepared returns for 27 years for these folks and saw these things happening, that I believe that the vast majority of people who are behind on their payments are self- employed, it really is just a matter that they just cannot save. And I do not think that we should be using all the clubs and all the enforcements actions that the IRS has for those kinds of people. You need to think about-- Chairman Manzullo. Put them on a budget? Ms. Olson. Exactly. Chairman Manzullo. Good. Good for you. Ms. Olson. And so then what you need to reserve your enforcement resources for are those people who are the most recalcitrant, who are tending in a direction where they will never get themselves out. Chairman Manzullo. True offenders. Ms. Olson. Yes. Chairman Manzullo. Let me read something else here. This says, this is on page 4, I mean this is some pretty interesting reading. ``IRS approach for reducing the tax gap includes improving taxpayer service to increase voluntary compliance and enhance an enforcement of tax laws by detecting and addressing noncompliance, but does not incorporate some steps consistent with results oriented management. To support this approach IRS has established two broad strategic goals and identified over 40 related key efforts which includes using direct enforcement actions to address high income non-filers and using analytical models to pursue higher priority collection cases. However, IRS has not established long term quantitative compliance goals and regularly collected data to track progress is reducing the tax gap which would compliment its current important compliance efforts.'' I mean, so you have no way to determine if what you are doing is the right way to go, but you are on your way. And now you are off into a whole area, you with your own proposal, to have individuals withhold and the credit card companies to have them withhold on people that are not paying their taxes. More government, more rules, more regulations, more compliance. Ms. Olson. Well, I can only tell you that in my proposal I would insist on those controls. And I think that-- Chairman Manzullo. Yes, but you will not be there forever. Ms. Olson. Well, that is true. But one would hope that you all, someone will be in your chair and we will hope is honest. Chairman Manzullo. And it does not work that way. Because unless you have been raised in small business, you have no idea. No idea what is going on. What this is saying here is that the IRS goes off in new directions in enforcement but does not look where you have been. It does not seem to care because you have no way of measuring it. I mean you were there so long you dropped off your sleeping bag in the office last night, you stop by and see us so frequently. Ms. Everson said that the tax gap was reduced from 43.1 to 47.3 billion. Evidently, an extra 6 billion came in approximately, or 4 billion came in. Mr. Brown. That is referring to enforcement revenues. Chairman Manzullo. Enforcement revenues from one year to the next? Mr. Brown. Yes. Chairman Manzullo. How much of that came from the small businesses that we're talking about? Do you have any idea? Mr. Brown. The increase? Chairman Manzullo. Yes. Mr. Brown. I do not know. Chairman Manzullo. I will bet you do not. That is what they are talking about. Mr. Brown. No, I can get--no, I can get-- Chairman Manzullo. See, you have no way to determine it because you do not have the procedures set up for that. Mr. Brown. Oh, I can get you the number. We can get you that number. Chairman Manzullo. You have got it there? Mr. Brown. I just do not have it now. Chairman Manzullo. It is not there? Obviously, you cannot bring everything with you. The point is is that that is important to determine whether or not you are spending your resources in the same area. Do you not agree? Mr. Brown. Yes, but-- Chairman Manzullo. I mean you have to know if you are successful. Mr. Brown. Yes, but we have a number of measures that do tell us whether or not we are successful. We look at no change rates; when you have a high no change rate as the Commissioner described in the C-Corporation, area-- Chairman Manzullo. Right. Mr. Brown. -- you realize that those are not a fruitful way to spend your audit time. Chairman Manzullo. Right. So you go after the little guys? Mr. Brown. You have other measures about average adjustment, things like that. I mean, there are a number of measures there that tell you are you auditing in the right areas and are you getting anything out of the audits. Chairman Manzullo. Well then if that is the case, then why is this report so damning? Mr. Brown. Because they are talking about closing the overall tax gap, which at the time they wrote the report we did not even have a precise estimate for. Chairman Manzullo. I mean they said, GAO actually complimented IRS on having the right figure on what the tax gap was, which I thought was quite interesting. Mr. Brown. And we are also now in the process of developing. We have gotten a number of the same sorts of questions from the Senate Finance Committee. Chairman Manzullo. Why do you not develop all this stuff? Why do you not get all your facts before you come out with these proposals? I mean you know how this Congress is. I mean this could be slipped in. I think Commissioner Everson said himself that he appreciates a hearing like this because he's afraid stuff like this would get slipped in in the middle of the night into something and then everybody's scared. I know I have prolonged this beyond it. But what happened with the HOPE Scholarship thing, I mean that was $100 million a year that was imposed on higher education that would have been passed on to the students. And that got put into law. President Clinton insisted that the colleges report that. That was his language that was added to it before he signed the bill. And no one had ever done that estimate on the compliance of it. I mean you guys have got to find out what this stuff is going to cost-- Mr. Brown. We agree. Chairman Manzullo. --before you do it. And then look at the second thing is how much more of the underground economy are you going to create? Word gets out on the streets, IRS is going after credit card transactions, if you pay me in cash, I will give you 20 percent discount. Do not take any credit cards. How much are you going to push underground with this? Mr. Brown. Well, I can tell you unfortunately that is already going on. Chairman Manzullo. Well, of course. It is going to go on even more. Now do you really think that the sophisticated cheater who gets his money from Visa is going to encourage his consumers to say this transaction is priceless. He is going to say pay me in cash. And what you are proposing is going to have even more of an underground economy. It will be counter productive and then we lose on both ends. Mr. Brown. Ultimately I think time is on our side. When I can go to the Wendy's drive-through window now and use a credit card, I mean we are moving into-- Chairman Manzullo. That's Wendy's. They're big. Mr. Brown. Yes, but I can-- Chairman Manzullo. I mean, you know, what about the Shady Grove Drive-In that my dad ran from 1954. No, that was the name of it. 1954 to 1970? Mr. Brown. Even taxicab drivers are now frequently taking credit cards. Chairman Manzullo. Well, you know what? My brother never took credit cards in his restaurant. You know why? Mr. Brown. Probably the fee. Chairman Manzullo. No. That is right. His margin was so small that he was not about to pay 3 percent. And he told his customers if they came there, they wanted to give him a Visa, he said give me a personal check. The guy said I left my checkbook at home. And my brother would give him a 3 by 5 card with his name, address and the amount of the bill and the guy would send him a check in the mail. You know, our goal is to keep things simple. But you are off on a terrible road there. And as long as I sit in this chair, and unfortunately that is only until the end of this year, this will get slipped in in the middle of the night. I understand the guys over in the Senate, the millionaires over there, most of them are millionaires that do not know what it is like to meet a payroll to be raised in small business, are trying to come up with a proposal to slip this in somewhere. Okay. Well thank you guys for coming. I appreciate what a diverse background we have. Did you have fun, Michael? Mr. Fredrich. I had a thrilling time today. Chairman Manzullo. Have you ever testified before Congress before? Mr. Fredrich. I did one time on minimum wage. Chairman Manzullo. Well, to each of you thank you so much for coming, especially those that traveled a long distance. And this hearing is adjourned. 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