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Profit in Forgiveness

June 06, 2004

California state tax authorities were amazed when an amnesty program aimed at investors in illegal tax shelters brought in $1.3 billion over the last year. When the amnesty measure passed the Legislature last year, the windfall had been estimated at only $90 million. One obvious conclusion is that tax cheating is more rampant than previously thought, which means more amnesty programs and stiffer enforcement of tax laws could help pull the state out of its financial sinkhole.

The recent crackdown was aimed at schemes such as phony trusts, use of foreign bank credit cards and reincorporation in states without income taxes -- Nevada, for one -- to avoid recording income. Taxpayers could report such income from past years until April 15 without fear of prosecution. Otherwise, they would have been subject to tough new enforcement provisions. With the success of the amnesty program, tax officials are optimistic about collecting more of the revenue lost to income-tax cheaters, estimated at as much as $6.4 billion a year (compared with about $34 billion actually collected). The Franchise Tax Board says roughly 80% of the lost funds are squirreled away by people who file but don't report all income or claim false deductions.

Almost everyone knows of someone -- a handyman, the cleaning lady, the kid who mows the lawn -- who works "off the books," usually paid in cash that is not reported for tax purposes. But such small-time fraud is only part of a much larger problem.

The state tax board, using data collected by Congress and the Internal Revenue Service, found that the worst offenders included antiques dealers, restaurants, grocery stores, used-car dealers, auto repairers and door-to-door sellers. The board also said that as much as 32% of all income reaped by service industries was not reported. That is a huge drain on public treasuries and on honest citizens who pay their fair share. Better compliance would have helped offset the state's budget gap this year.

One effort at closing the tax gap comes from Assemblywoman Judy Chu (D-Monterey Park). Her AB 2203 offers a broader, two-month amnesty in 2005 covering personal and corporate income and sales taxes. The program, allowing people to pay back taxes due without penalty, is expected to bring in about $300 million, while costing $10 million to $15 million to administer. Considering that the bill targets only the perpetrators of fraud and promises to painlessly boost state revenues, it's surprising that it passed the Assembly by a margin of just 44 to 31. Opposition votes were cast mostly by anti-tax members who considered the penalties too harsh. Perhaps the Senate and Gov. Arnold Schwarzenegger will see more clearly the benefits of going after tax cheats.

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