Stop the Madness!

By Derek Douglas, John S. Irons, Bobby Lepore | September 6, 2006

Dear Treasury Secretary Paulson,

As you are certainly aware, your IRS is planning on turning over 40,000 tax cases to private debt collectors starting on September 7. Before allowing this to happen, we thought you might be interested in what happened to another Treasury Secretary that allowed the IRS to hire private debt collectors.

In 1872, a handful of powerful members of Congress decided that too many Americans were behind on their taxes. They devised a program that allowed the Bureau of Internal Revenue (predecessor to the IRS) to hire private “collectors” to contact taxpayers. Few private collectors returned much money to the government.

One private collector in particular, John D. Sanborn, grew very clever; he claimed to have aided in the return of hundreds of thousands of dollars to the federal treasury (a hefty sum back in the 19^th century). In reality, Sanborn had manipulated the program to squeeze out tens of thousands of dollars in additional commissions from the government. Congress discovered that what little money had actually been “collected” by Sanborn and other private collectors would almost certainly have ended up in the hands of the Treasury anyway. After Sanborn was indicted for fraud, an outraged Congress banned the revenue bureau from outsourcing collection ever again.

Failing to learn its lesson the first time, Congress instituted a private collection pilot program in 1996. The program was deemed a disaster, and the IRS gutted the effort within a year. The IRS Inspector General found that the private collectors regularly abused consumers and violated the Fair Debt Collection Practices Act of 1977. A review from the General Accounting Office (GAO) found that once the expenses of the program were considered, the collectors failed to bring any net revenue to the treasury.

Yet, here we are again. Ten years later, Congress and the IRS are poised to make another pass at this twice-failed experiment.

Even if private collectors can buck historical trends and generate additional revenue for the treasury, privatized tax collection is still a bad idea. Several recent articles in major newspapers vividly describe cases of debt collector abuse. A recent Center for American Progress report confirms this disturbing trend, noting that 19% of all complaints received by the Federal Trade Commission (FTC) in 2005 were related to debt collectors, up from 10.5% in 1999. The FTC received more complaints about debt collection in 2005 than about any other industry—66,627, a 560% increase over the last six years.

There is no reason to believe that collectors chosen by the IRS will be an exception to this dismal picture. One of the collectors already awarded a contract has previously been indicted for bribery and is currently under FBI investigation for other illicit activities. The same firm has also has received an “unsatisfactory” rating from the Better Business Bureau (BBB). The other two companies, though maintaining a “satisfactory” rating, appear to have well above the industry average of complaints filed against them.

The structure of the IRS program encourages abuse. Under the program, collectors are awarded as much as 24 cents of every dollar they collect, in addition to a $100 bonus for every account they close. This provides incentives for collectors to push the limits of legality to extract a little more revenue from their targets. As part of the IRS Restructuring and Reform Act of 1998, Congress, fearing overly aggressive collection practices, explicitly prohibited the IRS from compensating its own collectors based on the amount of money they collect. If Congress believes that incentive-based pay will cause official IRS collectors to cross the line, why would they think private collectors would behave any differently?

As National Taxpayer Advocate Nina Olsen has rightly criticized, this plan also takes unnecessary risks with taxpayer privacy, since contracted collection companies will have access to sensitive taxpayer information.

For the IRS to outsource collection to private debt collectors is like Ford outsourcing car assembly or Microsoft outsourcing Windows. Collecting tax revenue is the core job of the IRS, and it should continue to bear that responsibility while protecting taxpayer rights. IRS employees cost only 3 cents for every dollar they collect, making them many times more cost-effective than private collectors. In 2002, former IRS Commissioner Charles Rossotti advocated dramatically increasing spending on enforcement, arguing that such spending would pay for itself 30 times over. Even current Commissioner Mark W. Everson admitted to a House committee that hiring new IRS collectors would be vastly more efficient, but lamented the fact that Congress has not appropriated (nor has the Administration requested) the necessary funds. If the Administration is serious about collecting on delinquent accounts, then you, the IRS, should pressure Congress to appropriate the funds to hire additional in-house collectors.

Privatized tax collection was a bad idea in 1872, it was a bad idea in 1996, and it remains a bad idea today. When the first attempt at private collection ended miserably in 1874, Treasury Secretary William A. Richardson lost his job. This plan was hatched before you, Secretary Paulson, arrived at the Department. This leaves you with a unique opportunity to prevent a similar catastrophe. We urge you to order the IRS to keep private debt collectors away from hardworking American taxpayers.

Derek Douglas is the Associate Director for Economic Policy, John Irons is the Director of Tax and Budget Policy, and Robert Lepore is an Economic Policy Intern at the Center for American Progress.