Connect with us

Finance

Will The Inflation Reduction Act Increase IRS Tax Audits?

Published

on

There is a lot of chatter about the $80 billion of increased funding for the IRS in the Inflation Reduction Act. The bill was passed by the Senate on August 7, 2022, and the House voted to approve it on August 12, 2022. The President is expected to sign it shortly.

The burning question on everyone’s mind is whether the $80 billion of increased funding for the IRS will meaningfully increase IRS audit rates. The short answer is yes, it will, but don’t expect it to happen overnight. The IRS will have to hire and train thousands of additional revenue agents and support staff to do the work, and that is no easy task. Also, only about $46.5 billion of the headline amount has been earmarked for enforcement activity. The remainder of the funds will be used to improve operations support, to improve taxpayer services, and to modernize the IRS’s technology infrastructure, including the development of a free e-file system for individuals.

According to the 2021 IRS Data Book, the IRS in Fiscal Year 2021 had about 79,000 full-time equivalent (FTE) employees, and about 35,000 of them were dedicated to enforcement activity. Enforcement activity includes determining and collecting taxes owed, providing legal and litigation support, conducting criminal investigations, and enforcing criminal statutes related to violations of Internal Revenue laws and other financial crimes. The IRS’s total budget for FY 2021 was about $13.7 billion, with about $5 billion of such amount spent on enforcement.

Audit rates across the board typically have been less than 1%. For years 2011 through 2019, the IRS examined 0.55% of individual tax returns and 0.92% of corporate tax returns. In FY 2021, the IRS closed about 739,000 tax examinations, and it processed more than 261 million tax returns and supplemental documents. To put this examination number in number perspective, the number of tax examinations in 2021 was less than half of the number of tax examinations in 2012. The chart below shows the number of tax returns examined over a 10-year period.

MORE FOR YOU

Now let’s do some interesting (and very rough) math. If $46.5 billion of the increased IRS funding in the Inflation Reduction Act is earmarked for enforcement, then that translates into about $4.65 billion per year for each of the next 10 years. This would roughly double the $5 billion spent on enforcement in FY 2021. If we assume that half of the increased budget is spent to increase employee headcount (and this is just an assumption), then that would translate into an additional 17,500 FTE employees.

Let’s be generous and assume the IRS can hire 300 new enforcement employees each month (again, just an assumption) and ignore the effects of the ramp-up period and employee attrition. Under these assumptions, the IRS would be able to increase its headcount by 17,500 FTE employees in just under 5 years (17,500 employees / (300 employees/month * 12 months) = 4.86 years). Then, the IRS would have to train the new employees, and training revenue agents for high-income audits (i.e., for those making more than $400,000 per year) almost certainly would take longer than training them for less complex audits. For example, according to the IRS, a revenue agent “must be trained on the job for at least 2-3 years in order to have the experience and expertise to audit a complex return.”

If we assume that all of the increased budget is spent to increase employee headcount by 35,000 FTE employees, and use the same assumptions above, then it would take the IRS just under 10 years for it to reach its goal (35,000 employees / (300 employees/month * 12 months) = 9.72 years). And then it would still need to layer in the time it takes to train all the new employees.

With a near doubling of its enforcement budget for 10 years, the question remains whether the expected hiring spree at the IRS will translate into a doubling of the current audit rate – from less than 1% to less than 2%? Maybe, but it’s not likely to occur in the next few years, as we see in the examples above. But when the increase in audit rates does occur, it will focus on high-end noncompliance, according to proponents of the legislation. Treasury and the IRS have indicated that audit rates on businesses and individuals making more than $400,000 per year will increase at a rate faster than those making $400,000 or less.

We also expect the absolute number of audits of businesses and individuals making less than $400,000 to increase even though the percentage of such audits to the total will decrease. How do we know this? If you read carefully Secretary Yellin’s recent letter to IRS Commissioner Retting, it states that the increased funding should not be used to increase the “share” of small businesses or households below the $400,000 threshold that are audited “relative to historical levels.” This means that such taxpayers “will not see an increase in the chances that they are audited,” i.e., relative to the total number of audits. Instead, they should see a “lower likelihood of audit.”

The creative math in this article does not suggest taxpayers should start taking risky positions or expect to avoid an audit if they make $400,000 per year or less. Conversely, taxpayers making more than $400,000 per year should expect an increase in audit rates over time, but not an immediate and dramatic spike as some media reports would suggest. In sum, the gross number of audits for all taxpayers likely will increase over time, but the takeaway here is that the percentage of audits relative to the total will increase for those making more than $400,000 per year.

Finance

Banks Are About To Face The Same Tsunami That Hit Telecom Twenty Years Ago

Published

on

I fear global bank regulators are about to make a decision that will unintentionally “obsolete” the banks, by prohibiting a coming tech pivot. Making this mistake would guarantee that the tech industry continues going around the banks, right as internet-native payment technologies are starting to scale.

The telecom sector offers a cautionary tale: When Voice-Over-Internet-Protocol (VOIP) was invented in 1995, most people disparaged it as a technology that couldn’t scale and wasn’t a threat to the telecom giants. Then, circa 2003, the technology to scale VOIP arrived – broadband – and within a flash, most of the telecom industry’s copper-wire networks became obsolete. Useless relics.

Bitcoin is a “Money Over Internet Protocol,” as is Ethereum, potentially. Just as VOIP moves voice data around the internet natively, Bitcoin and Ethereum move value data around the internet natively. Most people disparage Bitcoin, Ethereum, et al. as protocols that can’t scale and can’t possibly threaten the incumbent financial industry, just as they denigrated VOIP. But the scaling technology is now here – it’s called the Lightning Network, which is a Bitcoin layer 2 protocol. Its throughput capacity roughly equals that of Visa, and payments made over Lightning cost virtually zero. There are other scaling technologies, too. If I’m right and scaling technologies for internet-native money protocols have arrived, then many legacy systems operating in the financial system today will be obsolete within a handful of years.

As CEO of a new breed of bank – a dada-bank (“dollar and digital asset bank,” defined as a depository institution authorized to handle both and pronounced like “databank”) – my company lives with the problems inherent in the banking industry’s antiquated legacy systems every day. Culturally, banks have a history of building complex, “walled garden” IT systems. Fintechs sprang up in recent years to provide efficient front-ends that act as “middleware” between antiquated back-end systems and the user experience demanded by customers. Culturally, fintechs build the opposite of banks’ IT systems – fintechs generally build their systems to be as open and “low-walled” as possible to create network effects. Had banks done this, fintechs wouldn’t need to exist! But, until “Money Over Internet Protocols” came along, banks still had a role because fintechs still needed to partner with a legacy bank to settle their customers’ US dollar payments.

“Money Over Internet Protocols” at scale are truly a threat to traditional banking because they enable money to move outside the traditional, antiquated payment rails. To date, the US banking industry has lost roughly $600 billion, or 3% of its deposit base, to the crypto industry – and that happened before the “Money Over Internet Protocols” scaled! Despite all the legal, regulatory, accounting and tax problems faced by their products, and all the criminals and fraudsters running rampant (who should be in jail), the tech industry has proven its ability to go around the banks.

It will take Lightning a few years to lay down that proverbial broadband (scaling) infrastructure before the “Money Over Internet Protocols” hit their tipping point at scale. But make no mistake, it’s happening. The proverbial undersea cables that scaled VOIP are being laid before our very eyes.

MORE FOR YOU

But the “aha!” of these “Money Over Internet Protocols” isn’t cost or scale. There are two “ahas” that matter far more: integration speed/cost and developer communities.

  • Integration speed/cost: Anyone in the world can become members of these emerging payment networks in the span of a few hours, using equipment that costs a few hundred dollars.

Banks’ IT systems will never be able to compete with that.

It’s not even a question whether legacy technology architectures can compete with these emerging protocols, for the simple reason that it’s fast, cheap and easy to join these networks. I recall a recent conversation with a B2B payments company, whose executive was very proud that his team whittled down to only 3 months the time required for its business customers to integrate with its system. In the legacy world, 3 months is impressive. But the paradigm has shifted: payment system integration time is now measured in hours, not in months or years – and in a few hundred dollars, not a few million dollars. It’s obvious which approach will win.

  • Developer communities: Open, permissionless protocols have huge developer communities, which compounds the speed of their ecosystem development and network effects. Network effects are all about compounding. The code libraries and developer tooling available for Bitcoin and Ethereum are critical infrastructure that banks’ proprietary systems cannot replicate. Moreover, these developer communities organically create interoperability. Banks’ “walled garden” systems with closed groups of developers will never be able to keep up with their pace of innovation.

So, what could be the role of banks in the world I’m describing? Answer: banks become software application providers, providing access-controlled applications that run on top of the open, permissionless protocols and to make them accessible even to unsophisticated users, just as the telecom companies do with VOIP. I’ll bet very few of us use the command line interface to make a phone call – even though we could use it if we wanted to, most of us pay to use telecom providers instead because they make the user interface so easy.

That’s what banks will do, too: provide access-controlled applications to ease the use of “Money-Over-Internet-Protocols.” Huge, successful businesses have been built exactly this way – as access-controlled applications running on top of open, permissionless internet protocols. Auto companies are just one of many examples – they’re software companies now, albeit providing software that runs on a different type of hardware.

What about central banks? What would be their role in the world I’m describing? No different. They’ll become providers of a software application for issuing fiat currency that runs on top of open, permissionless protocols, too.

That brings me back to my fear that global bank regulators (specifically, the BIS) are about to make a decision that “obsoletes” the banks. Why? Because the BIS is proposing bank capital treatment that would effectively block banks from interacting with open, permissionless protocols. If they do that, they are guaranteeing that the tech industry will just keep going around the banking sector.

The biggest concern of global bank regulators with banks using open, permissionless protocols, I suspect, is compliance. But banks don’t need compliance to be built into the base layer of their IT systems. Compliance can be built into applications that run above the base layer, and which control access. In fact, that’s what banks are already doing today with TCP/IP. Every bank uses TCP/IP, and yet strictly controls access to their online banking platforms. Criminals and sanctioned countries use TCP/IP today too, but banks have the tools to block them from using banks’ applications. Same thing with Bitcoin and Ethereum – banks have the tools to block illicit finance from using their applications. It’s easier to police illicit activity on open blockchain systems than it is in legacy systems.

At its pivotal juncture telecom was a heavily regulated industry, just like banking is today at its pivotal juncture. How, then, did the telecom companies pivot to become software companies and avoid obsolescence? Answer: regulators enabled them to make that pivot.

That’s what banks will become, too – software companies – but only if bank regulators enable banks to make the same pivot. If they don’t, then it will be obvious, looking back 10 years from now, why the tech industry won.

Continue Reading

Finance

Will Putin’s Military Mobilization Mean The End Of His War?

Published

on

Could Elvira Nabiullina be the next Russian President?

Last Monday evening I was driving along the contours of Cork harbour, not far from East Cork. The area has many claims to fame – for example, a local (Edward Bransfield) is credited with having discovered Antarctica in 1820. Less triumphantly, some local villages like Whitegate, Aghada and Farsid lost one third of their male populations during the Crimean War.

At the time, a great number of soldiers died from disease and the lack of basic medical procedures – whilst the French and British armies fought side by side against the Russians, casualties were far relatively far higher on the British side because of inferior medical equipment and practice – hence the acclaim with which Florence Nightingale’s techniques were greeted.

I thought of this recently when I read a post on the very different medical kits supplied to Ukrainian and Russian troops, respectively. Setting aside propaganda and donations from the West, the Ukrainian kit looked modern while that of the Russian soldiers could well have come from a museum or horror show. In that respect, the apparent wilting of the Russian army is not surprising.

Filaytev Diaries

More supporting detail on this comes from the 140 page long diaries of Pavel Filyatev, a career paratrooper in the Russian army who, driven to despair by the chaos within his regiment (in Kherson), wrote a long account of his experience in the Russian army. Armies are not pleasant places but his account of the systematic mistreatment of the Russian soldiers, their undernourishment, disorganization in battle and embarrassing under-equipment is telling, not just of the Russian army but of the Russian state. Needless to say, he is now in hiding beyond Russia.

MORE FOR YOU

In that context, the mobilization of largely experienced soldiers to start with, and the co opting of prisoners into the Russian army, opens up many risks – for both Ukraine and Russia. Additionally, the coming referenda on the accession to the Russian Federation of the Luhansk, Donetsk, Zaporizhzhia and Kherson regions is a sneaky, deadly moving of the geopolitical goalposts. Any attempt to liberate these areas of Ukraine would now, in the eyes of the Kremlin, an attack on Russia itself, and it has the right to respond as it sees fit.

From a military point of view, this elevates the risks around Ukraine, and in particular heightens the probability of a strategic mistake or tail event (i.e. such as the destruction of a NATO satellite or an attack on a Baltic state). Putin’s move also increases the risk of socio-political risk within Russia. As I am not a military expert but prefer to write on economic development and the rise and fall of states, I will focus on that.

The Filaytev diaries say much about Russia. It is a country that until recently had poor levels of human development, especially in healthcare and life expectancy (which has been rising from low levels). In this context, Vladimir Putin’s vision of Russia as a superpower is hollow – unless a nation can sustain improving levels of human development (through education, good healthcare, freedom of thought) it will not sustain the core drivers of growth, such as productivity. This a lesson for China, the UK and the US to follow. In China and the UK (productivity is falling) whereas in the USA life expectancy had dropped sharply (below that of China).

Incompetence

In coming years, I am sure many will write about the surprisingly poor quality of the Russian army, and in the context of this note, it is simply another marker for poor quality development. This is perhaps one reason why when emerging market crises strike, they happen slowly, then very quickly. Incompetent institutions, poor rule of law and a prohibition on intelligent policy making can for some time be camouflaged by superficial growth, but all very quickly melt away in moments of stress.

The risk is that other institutions go the same way. As Putin announced the mobilization there were rumours that the highly regarded head of the Russian central bank, Elvira Nabiullina, had resigned (she had apparently tried to do the same in March). This has not been confirmed but raises the question as to the seaworthiness of the full range of Russian institutions in a stormy geopolitical climate. Increasingly, the pressure will be on Russia, and from multiple angles.

As a last word, I want to return to the Crimean War. It is not inconceivable that Corkmen from villages like Whitegate were shelled by Leo Tolstoy, at the time a young artillery officer. Tolstoy’s experience of war affected him greatly. In the context of Putin’s recent mobilization it is worth recalling some advice he gave to a young man ‘all just people must refuse to become soldiers’. Many young Russians are thinking the same today.

Continue Reading

Finance

World Will Have Nearly 40% More Millionaires By 2026: Credit Suisse

Published

on

The world will have nearly 40% more millionaires in 2026 compared with the end of last year, according to a report by the Credit Suisse Research Institute released on Tuesday.

The five-year outlook “is for wealth to continue growing,” said Nannette Hechler-Fayd’herbe, Chief Investment Officer for the EMEA region and Global Head of Economics & Research at Credit Suisse.

Higher inflation “yields higher forecast values for global wealth when expressed in current U.S. dollars rather than real U.S. dollars. Our forecast is that, by 2024, global wealth per adult should pass the $100,000 threshold and that the number of millionaires will exceed 87 million individuals over the next five years,” Hechler-Fayd’herbe said in a statement.

Buoyed by rising stock prices and low interest rates, global wealth increased global wealth last year totaled $463.6 trillion, a gain of 9.8% at prevailing exchange raises, Credit Suisse said in its annual “Global Wealth Report 2022.” Wealth per adult rose 8.4% to $87,489, it said.

All regions contributed to the rise in global wealth, but North America and China dominated, with North America accounting for more than half of the global total and China adding another quarter, the report said. In percentage terms, North America and China recorded the highest growth rates — around 15% each, it said.

The United States continued to rank highest in the number of the world’s richest with more than 140,000 ultra-high-net-worth individuals with wealth above $50 million, followed by China with 32,710 individuals, the report said. Worldwide, Credit Suisse estimates that there were 62.5 million millionaires at the end of 2021, 5.2 million more than the year before.

MORE FOR YOU

By contrast, this year looks tough. “Some reversal of the exceptional wealth gains of 2021 is likely in 2022/2023 as several countries face slower growth or even recession,” the report said.

Rises in interest rates in 2022 have already had an adverse impact on bond and share prices and are also likely to hurt investment in non-financial assets, the Global Wealth Report noted.

Longer term, growth will recover, Credit Suisse predicted. “Global wealth in nominal U.S. dollars is expected to increase by $169 trillion by 2026, a rise of 36%,” from last year, it said.

The beneficiaries will be more spread out globally, the report predicted. “Low and middle-income countries currently account for 24% of wealth, but will be responsible for 42% of wealth growth over the next five years. Middle-income countries will be the primary driver of global trends,” Credit Suisse said.

Click here for the full report.

See related posts:

The 10 Richest Chinese Billionaires

Taxes, Inequality and Unemployment Will Weigh On China After Party Congress

U.S. Business Optimism About China Drops To Record Low

Pandemic’s Impact On China’s Economy Only Short Term, U.S. Ambassador Says

@rflannerychina

Continue Reading

Trending