With each passing day, I’m starting to believe that Elizabeth Warren was right: the financial system is rigged against the average middle-class American.
Here’s the latest proof of this fact: Congress is considering an ill-advised proposal that would severely hurt millions of Americans’ credit scores.
Under the plan, which was studied by the General Accounting Office, those who owe money to the IRS would now have those obligations reported to the credit bureaus – Equifax, Experian and TransUnion.
Currently, routine IRS debts are not reported to or tracked by the credit bureaus, nor has federal tax debt ever been monitored by credit reporting agencies in the 66-year history of credit scoring.
Such a major shift in credit-reporting practices would be enormous: it would choke off access to credit, impact job-hunters’ ability to land work, cause scores of consumers to pay more for insurance, and drive up borrowing costs for entrepreneurs, as well as those seeking mortgages, credit cards, student loans or auto loans.
As mentioned, under current law tax debts are not reported to credit bureaus. However, if one is severely delinquent on a tax obligation – and has a lien from the IRS – then such overdue bills are public records and are reported to credit bureaus.
According to IRS data, in 2011, 13.5 million individuals owed $258 billion in outstanding taxes to the federal government. Some 2.9 million U.S. businesses owed another $115 billion.
So the potential move to put tax debt on individuals’ credit reports is seen as a possible way to coerce these people into more quickly forking over what they owe.
However, such credit reporting isn’t likely to achieve its desired effect. In fact, it’s likely to backfire and cause the IRS to collect less, not more, tax revenue.
Here’s why.
Unintended Consequences
Studies show that overly aggressive tax collection policies by the IRS – such as slapping people with liens and ruining their credit ratings – don’t actually generate more receipts for the U.S. Treasury.
On the contrary, these hardball IRS tactics only serve to hurt consumers and diminish the ability of the IRS to collect from those who owe, according to IRS Taxpayer Advocate Nina Olson.
Furthermore, in a scathing 2010 report on IRS practices, Olson concluded that IRS collection policies channel taxpayers into Installment Agreements (IAs) they cannot afford. Installment agreements are IRS payment plans that can last for years, until a taxpayer pays off what is owed.
“IRS employees with no training in collection or financial analysis process streamlined IAs in less than five minutes without contacting the taxpayer,” Olson’s report said.
The report added that placing taxpayers into agreements without their consent is “a practice that may violate the law. As a result, some taxpayers may be unable to meet basic living expenses or fall behind on their tax payments in the future.”
Likewise, Olson recently told the GAO in 2012 that reporting people’s tax debts could have unintended consequences – namely she said it might cause some taxpayers to opt not to file tax returns at all, or perhaps to file inaccurate returns, especially if they already know they owe back taxes.
The Case Against Reporting Tax Debt to Credit Bureaus
There are three other important reasons why the IRS should not begin reporting people’s tax obligations.
1: It would violate federal law protecting the privacy of taxpayers’ information.
This is why tax debt – again, with the exception of tax liens – is currently banned from being included in credit reports.
And how might such data be handled by the credit bureaus? You can be sure it would be sold off to other companies – with or without consumers’ consent, and perhaps sometimes in violation of the law.
Recently, Equifax as agreed to pay $393,000 to settle Federal Trade Commission charges that the credit bureau improperly sold lists of consumers who were late on their mortgage payments.
In its complaint, the FTC said Equifax sold more than 17,000 prescreened lists of millions of consumers who were 30, 60, or 90 days late on their mortgage payments to companies including Direct Lending Source, Inc., which in turn resold the lists to companies that used them to pitch debt relief and mortgage loan modification services to cash-strapped consumers.
Equifax ran afoul of the FTC because selling prescreened lists of consumers for general marketing purposes is a violation of the Fair Credit Reporting Act.
2: IRS tax debt is not a form of credit or loan.
So it’s not going to tell a potential creditor how well you might handle credit. Besides, there is absolutely no evidence of which I’m aware that proves that IRS obligations are indicative of credit risk or a person’s likelihood of repaying a debt.
The credit scoring system has been around for decades, and tax information was never before reported. If companies like FICO (creator of the FICO credit score) have been able to accurately predict credit risk for all these years – by using traditional credit data, along with sophisticated algorithms and a variety of analytics tools – why should they all of a sudden be allowed to slice, dice and micro-analyze people’s tax information as well? Remember, credit-scoring companies can use anything in your credit file that is “predictive” of risk. Your tax bill isn’t – or at least, shouldn’t be – one of those factors.
3: Small business owners who owe the IRS would be greatly damaged by this switch,
driving up their borrowing costs and hurting their business prospects. At this fragile point in America’s economic recovery, the last thing U.S. lawmakers should be contemplating is taking any steps that could hurt small businesses, which are a key source of jobs and economic growth.
As a final note, the timing of this proposal is curious, to say the least.
The IRS and Feds Giveth – Then Taketh Away?
Just this year, the IRS took great pains – as part of its bid to be a “kinder, gentler” agency – to tell U.S. taxpayers that they had far more repayment options than were previously available.
Specifically, under the “Fresh Start” initiative that began in March 2012, the IRS extended the amount of time it was giving people to pay off debts, and even allowed those who owed large sums to enter into automatic Installment Agreements.
Now, consumers who owe the IRS can enter into Installment Agreements, with repayment plans that last as long as 72 months, or six years. Previously, taxpayers had to pay off IRS debts in five years.
Also, taxpayers can now get automatic installment plans for up to $50,000 in federal taxes owed. That figure is up from a previous cap of $25,000 for automatic installment plans.
If Congress goes through with the possibility of reporting IRS tax debt to the credit bureaus, it will be quite a slap in the face of people who, in good faith, entered into installment arrangements with the IRS – as well as those who contemplate doing so in the future. And this is no small sum. In 2011, about $31 billion in federal taxes due from individuals – roughly 12% of the $258 billion that people owed the IRS – was covered by an installment agreement.
I rarely, if ever, raise conspiracy theories. But this latest proposal has me shaking my head, and wondering if maybe this was all part of some bigger plan.
Like Elizabeth Warren suggested, the system is rigged against us.
