The IRS scandal is not going away. At TaxProf Blog, Paul Caron keeps a running list of news articles. In Monday’s Best of the Web column in the Wall Street Journal, James Taranto repeats his view that the scandal is worse if no one in the White House ordered the IRS to target its ideological or political opponents:
[I]f the Internal Revenue Service scandal turns out not to have been directed by the White House, the situation is much direr than if it turns out Barack Obama or Valerie Jarrett was giving the orders. In the latter case, we have a corrupt administration; in the former, a corrupt government (emphasis in original).
He then provides a lengthy quote from a reader who offers a public choice hypothesis: that senior career staff at the IRS may have targeted these applicants to protect their personal and bureaucratic interests:
Even if every single one of the elected federal officials were a Republican, and even if the entire federal bureaucracy were populated by Republicans, you would still get this self-protective behavior from IRS leadership and staff.
In this reader’s view, “the only remedy is to remove the institutional incentives for this kind of behavior,” and that requires eliminating the federal government’s power of direct taxation.
This inference does not hold even if the reader’s remedy is presumed to be the only one that could work. Further, the reader’s remedy would not in fact solve the problem because he has diagnosed it incorrectly.
The IRS Exempt Organizations Scandal
Part 1: Are targets protected by the Paperwork Reduction Act?
Part 2: The unapproved information collection sent to one applicant
Part 3: The Inspector General’s report
Part 4a: Which information demands were illegal?
Part 4b: Which information demands were illegal?
THE IRS SCANDAL IS UNRELATED TO ITS CORE GOVERNMENTAL FUNCTION OF COLLECTING TAX REVENUE
To understand the problem correctly, one must begin with the statutory authority delegated by Congress to the IRS. This is found in 26 USC 501 (“Exemption from tax on corporations, certain trusts, etc.”). Subsection (c) sets forth 28 categories of entities that Congress has designated to be exempt from federal income tax. Two of these categories are relevant here: 501(c)(3), which applies to public charities, and 501(c)(4), which applies to social welfare organizations.
To obtain tax exempt status as a public charity under 501(c)(3), an organization must formally ask the IRS to make an affirmative determination. This is done by filing IRS Form 1023. If the IRS does not make a decision within 270 days, an applicant may seek a declaratory judgment.
To obtain tax-exempt status as a social welfare organization under 501(c)(4), an organization may ask the IRS to make an affirmative determination. This is done by filing IRS Form 1024. The IRS has no legal obligation to issue these determinations, however. Its historic practice has been to do so because social welfare organizations and their donors want certainty about their tax status, usually before they begin operations. If the IRS does not issue a determination, or if the organization chooses not to file a formal request, then the organization may operate as a social welfare organization unless and until the IRS determines that it does not qualify. But without an IRS determination, an organization’s capacity to raise funds for its social welfare purpose may be severely hamstrung. This is the practical effect of the IRS having delayed action.
In short, the continuing scandal does not involve the IRS’ conventionally understood function of collecting direct taxes. Rather, the scandal concerns how the IRS decides who is exempt from paying income taxes.
IRS IS DIRECTED BY CONGRESS TO EXERCISE SUBSTANTIAL ADMINISTRATIVE DISCRETION TO DETERMINE ELIGIBILITY FOR TAX-EXEMPT STATUS
Tax-exempt determinations are public benefits. Other agencies do this all the time. For example, the US Department of Agriculture determines whether a person is eligible for food stamps. The Social Security Administration determines whether a person is eligible for disability payments. The Department of State determines whether a person is eligible for a US Passport. The US Patent and Trademark Office determines whether an inventor is entitled to a patent. Each is an administrative action in response to a voluntary request by a person or an organization seeking a public benefit. The agency’s propensity for abusing its administrative discretion depends on how much administration discretion Congress has delegated.
A look at the statutory text of subsections 501(c)(3) and (c)(4) show that Congress has delegated substantial administrative discretion to the IRS to make these determinations. Focusing on (c)(4), note that Congress left to the IRS the authority to decide what activities constitute “the promotion of social welfare.” Had Congress been explicit about its intentions, the IRS would not have had to define the term, nor would it have had any administrative discretion to abuse.
|Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.|
|(A) Civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare, or local associations of employees, the membership of which is limited to the employees of a designated person or persons in a particular municipality, and the net earnings of which are devoted exclusively to charitable, educational, or recreational purposes.(B) Subparagraph (A) shall not apply to an entity unless no part of the net earnings of such entity inures to the benefit of any private shareholder or individual.|
Congress can prevent the IRS from abusing its discretion in the future by amending the law so that it no longer has any significant administrative discretion. In other areas of public policy, such as determining eligibility for Social Security and Medicare, this is exactly what Congress as done. If the problem is the IRS’ institutional incentives, as Taranto’s correspondent claims, then eliminating its discretion would solve it. Agencies that have administrative discretion will always have opportunities to abuse it. Further, relieving the IRS of the discretion to make tax-exempt determinations would have no bearing on its core governmental function of collecting tax revenue.
But this may be an impractical remedy. Congress would have to enumerate in statute every conceivable variation, combination, and permutation of organizational structure and mission. General principles of regulation suggest that such an effort would fail. Some organizations that Congress intended to be covered would not qualify, and other organizations that Congress intended not to cover would slip through. For this reason, it may be inevitable that the IRS has to have administrative discretion to make these determinations. Congress could help out enormously by clarifying in statute what it means by “the promotion of social welfare.” But the likelihood that Congress will do this seems remote. It is more likely that Congress will act to either restrict the IRS’ administrative discretion without altering its responsibility for making tax exempt determinations, or to add additional layers of internal and external oversight. The first approach would condemn the IRS to failure; the second would condemn applicants to interminable delays.
FUTURE SCANDALS COULD BE PREVENTED BY STRENGTHENING THE PUBLIC PROTECTION PROVISIONS IN THE PAPERWORK REDUCTION ACT
There is at least one remedy that could prevent future abuses of discretion by the IRS more effectively and more efficiently, and do so without bollixing the IRS with unworkable constraints. That alternative is to strengthen the Paperwork Reduction Act.
In our previous posts, we have shown how the IRS violated the Paperwork Reduction Act, an obscure but important federal law. We focused on the follow-up questions that the IRS sent to one applicant for 501(c)(4) tax exempt status, chosen because letters the IRS sent were made public. The report of the IRS inspector general described these questions as “inappropriate,” but what actually made them so is they were demands for information that the IRS was not approved to collect.
The scheme established by the Paperwork Reduction Act in 1980 vested in the Office of Management and Budget the authority to approve or disapprove agency information collections. OMB had approved Forms 1023 and 1024, but many of the IRS’ follow-up questions strayed well beyond the scope of OMB’s approval.
The Paperwork Reduction Act also includes specific language protecting the public from unapproved demands for information. It appears that none of the targeted applicants understood their rights, and it is easy to see why. Form 1204, for example, discloses these protections but in a way that hardly any applicant would understand.
First, at the top right of Form 1024 there is the mandated disclosure of the OMB control number — 1545-0057. Without this, the IRS would not be allowed to legally collect the information contained in the form. Do any 501(c)(4) applicants understand this?
Second, at the bottom of Form 1024 there is a required Paperwork Reduction Act notice. It tells the public to look at page 5 of the instructions. Do any 501(c)(4) applicants know what this means, or why it is important?
How many 501(c)(4) applicants understand what this means?
A critical problem is obvious. The Paperwork Reduction Act may include protections against IRS demands for information it is not entitled to obtain, but hardly anyone knows about it. The public does not know about it because the IRS discloses the least amount of information it can get away with. OMB, to which Congress gave the authority to implement the law and protect the public from improper agency demands, allows them to do this.
This suggests two remedies.
First, OMB could require agencies to provide much more information about the public’s right not to respond to unapproved agency demands for information. It would only have to do a better job of implementing its existing regulations.
Second, Congress could amend the law to create a wider path for the public to protect itself. Under current law, the public can ask OMB to opine on whether it is required to comply:
44 USC 3517(b). Any person may request the Director to review any collection of information conducted by or for an agency to determine, if, under this subchapter, a person shall maintain, provide, or disclose the information to or for the agency. Unless the request is frivolous, the Director shall, in coordination with the agency responsible for the collection of information—
(1) respond to the request within 60 days after receiving the request, unless such period is extended by the Director to a specified date and the person making the request is given notice of such extension; and
(2) take appropriate remedial action, if necessary.
But is not clear what the public can do if OMB is unresponsive to such requests. Can the public sue OMB for declaratory relief? If the public had such a right, targeted applicants could have asked OMB to put an immediate stop to it, and sued OMB if it failed to do so.
If these reforms had been in place in 2010, it is likely that the IRS’ abuse of discretion would have been stopped before it became a scandal. If these reforms were adopted now, it is unlikely that such a scandal would occur again.