[Noozhawk’s note: First in a series. Click here for the second part.]

American politicians and tax bureaucrats often say that the United States has the most effective income tax system in the world because the extent of voluntary compliance by American taxpayers far exceeds that of any other nation. Many societies view taxation as a contest between tax collectors and citizens, with payment or avoiding payment of taxes as the prize. But we are different, they say, because Americans voluntarily — that is, willingly — file tax returns and pay their taxes.

If that’s true, why do we hear so much about the taxes that aren’t being paid by people who work or do business in the “underground economy”? Wikipedia noted that estimates of the unreported commercial activity in the United States amount to as much as $1 trillion a year. And, the IRS Oversight Board report for fiscal year 2007 notes that the tax gap, “the difference between what is owed and what is collected … is estimated at $345 billion of lost revenue annually.” The largest source of uncollected income taxes is the so-called “underground economy.”

Would you file a tax return if you weren’t afraid of the consequences of not filing?

Putting aside the government’s hype and PR efforts, the reason our income tax system is so successful is fear — fear of being audited, fear of being assessed, fear of tactics employed to collect unpaid taxes, fear of intrusion into our personal affairs, fear of not being able to defend ourselves against the unlimited power of the government in general and the Internal Revenue Service in particular.

I believe the IRS has carefully cultivated this image over a period of many years. Who can say that they don’t have a sudden, albeit perhaps brief, fearful reaction when they find a letter or notice from the IRS in their mail? I know I do, and I’m a retired CPA. I don’t want to hear from them — ever! When I get some sort of notice from my friendly tax agency, I just know it’s going to cost me time, money and aggravation. Perhaps you’ve noticed over the years that around tax time it’s common to see a spate of media stories about prosecutions for tax fraud. In my opinion, that’s no accident.

Beyond that, the IRS has a reputation for harassing and intimidating taxpayers, often seizing their assets, otherwise destroying them financially and hounding them into bankruptcy. Stories about IRS abuses of power have been legion for years, many of which are well founded.

In the late 1990s, congressional hearings that were held to look into IRS abuses produced a flood of testimony about the agency’s mistreatment of taxpayers, some of which was given by witnesses who were so fearful of testifying against the IRS that their identities were hidden.

Jeff Schnepper, a former professor of taxation, accounting and finance and author of Inside the IRS: How it Works (You Over), details many examples of IRS abuses of the rights of taxpayers. “What is frightening about these stories,” he said, “is that in no case did the agents of the Internal Revenue Service exceed their legitimate authority. In each instance, the then-current revenue statutes shielded their actions.”

Schnepper also noted that many tax professionals feel that the powers of the IRS exceed constitutional limits and that, at times, they “even violate due process provisions and the Fifth Amendment protection against self-incrimination.”

The IRS has more power over the nation’s citizens than any other government agency. Perhaps the most widely abused aspect of IRS power is the “Jeopardy assessment,” a device that was created by the IRS itself, through its own administrative orders.

Jeopardy assessments enable the agency to bypass its own rules to collect whatever money an IRS auditor claims may be owed by a taxpayer. The initial “jeopardy” determination is made by an IRS district director’s administrative decree, without any judicial review.

The theory behind these assessments is that they merely accelerate the date taxes are due, making taxes that would normally be payable in the future due today. It results in an immediate lien on all property owned by the taxpayer upon notice and demand for payment. In some cases, such as employment and wagering taxes, the IRS doesn’t even need to send a “notice of deficiency” to the taxpayer before seizing his property.

You may wonder how they can do this when they don’t know how much is owed? The answer is quite simple. They make it up. It’s called an estimate.

One incident reported to a subcommittee of the Senate Finance Committee in 1975 illustrates how it works: A French citizen, who was a passenger on a flight to Switzerland, was carrying $247,500 with him, which was discovered when the plane landed in New York. An IRS agent, who did not know whether the Frenchman had earned any income in the United States, nonetheless levied a Jeopardy assessment of $247,500 against the man when he refused to answer certain questions. The agent testified that he had been instructed to prepare a return showing a tax due of approximately $247,500 and that he had done so. He admitted that the cost of living figure he had used was a pure fiction.

Why was the $247,500 figure picked? Because that’s how much cash the Frenchman was carrying with him on the airplane.

Once the IRS issues a Jeopardy assessment, it gives the agency broad powers over the property of the taxpayer. In many cases, these summary proceedings can deprive the taxpayer of the ability to continue in business, pay living expenses, or even hire an attorney for defense purposes.

Jeopardy assessments are intended for cases in which the IRS believes a taxpayer might leave the country, remove or transfer his property, conceal himself or his possessions, or do anything else that might “frustrate (or jeopardize) collection of the tax.” Traditionally, they have been used as major weapons in the fight against organized crime, specifically gambling and narcotics. But they have been misused.

There is invariably a lot of talk about revamping or eliminating the nation’s income tax system, including getting rid of the IRS. Many people feel this is long overdue, while others believe such a dramatic change is far too drastic and favor a general overhaul of the existing tax laws.

Putting aside the issue of how much money is realistically needed to operate the government and its many and varied programs, the basic question seems to be whether the current tax system can be sufficiently reformed to better serve our society’s needs, or if it should simply be scrapped altogether and replaced with another form of taxation.

What say you?

— Harris R. Sherline is a retired CPA and former chairman and CEO of Santa Ynez Valley Hospital who as lived in Santa Barbara County for more than 30 years. He stays active writing opinion columns and his blog, Opinionfest.com.