The Roots of the IRS Scandal

The revelation in May of this year that the Internal Revenue Service (IRS) was systematically targeting Tea Party and other conservative groups for special scrutiny under the laws governing nonprofit organizations shocked the nation and triggered one of the Obama administration’s biggest scandals to date. According to a Treasury inspector general’s report, in May of 2010, agents in the IRS’s Cincinnati office began singling out applications for nonprofit status from groups with terms such as “Tea Party” or “patriot” in their names. The agents conducted lengthy investigations of the groups to determine whether they intended to spend too much of their money on political activities that are prohibited to most nonprofits.1 The IRS required some groups to answer long lists of questions about their intentions, it demanded donor lists from others, and it even examined Facebook and Internet posts.2 Some groups simply gave up and withdrew their applications. Others spent two years waiting for a decision that never came.3

When Congress investigated the scandal, Lois Lerner, the former head of the office that oversees nonprofit organizations, invoked her Fifth Amendment right against self-incrimination and refused to testify. Later, hearings revealed that Douglas Shulman, the former head of the IRS, was cleared to visit the White House at least 157 times during his tenure and that IRS chief counsel William Wilkins, who was one of two Obama appointees at the IRS, helped develop the agency’s guidelines for investigating the Tea Party groups.4 As a result, critics of the IRS have good reason to think that the scandal reaches the highest levels of our government.

The public’s outrage over this scandal is, of course, entirely appropriate. If the government can enforce laws based on nothing more than one’s political views, then both freedom of speech and the rule of law are dead. But the outrage over the IRS’s focus on conservative groups obscures a far more important question: Why was the IRS investigating the political activities of any group? The answer to that question is more troubling than the possibility of rogue IRS agents, biased law enforcement, or even abuses of power at the highest levels. As bad as all of those things are, the bigger threat to freedom is a legal regime that requires scrutiny of Americans’ political activities and a political and intellectual culture that applauds such scrutiny and openly calls for more of it.

This is the situation in America today. Our tax and campaign finance laws impose a host of regulations on Americans based on how much time, effort, and money they spend on political speech, and many opinion leaders agitate for even more laws and investigations every day. Against this backdrop, the IRS scandal should not surprise us. Our politicians and intellectuals demanded regulation of some of the loudest voices in our political debates, and the IRS delivered.

Unfortunately, far too many critics of the IRS have accepted the premise that our laws should distinguish between groups that spend money on political activities and groups that do not. Expressing this view, Washington Post columnist Ezra Klein has argued that the real scandal was that the IRS did not treat all nonprofits as harshly as it treated the Tea Party groups.5 Using the same reasoning, congressional Democrats have attempted to blunt the scandal by claiming that the IRS also investigated some groups on the left.6 It appears that these claims are untrue, but the message is clear: As long as the government is scrutinizing everyone’s speech equally, then there is no scandal.

But this is the opposite lesson to learn from the IRS scandal. For anyone who cares about freedom of speech, the real scandal is that the government regulates Americans’ campaign spending at all. So long as laws remain on the books that do so, scandals such as this one—and far worse—are inevitable. But to understand why that is so requires a deeper understanding of the premises on which the laws are based and how the laws operate in practice.

Let’s begin by focusing on the campaign finance laws. Although the IRS scandal obviously involved the enforcement of tax laws against Tea Party groups, the two sets of laws overlap in significant ways, and the premises that led to the IRS’s actions are easiest to see in the campaign finance context.

The purpose of campaign finance laws, as the name implies, is to regulate the financing of political campaigns. The laws accomplish this purpose principally by limiting the amount of money anyone can contribute to a candidate and by requiring all money going into and out of a campaign to be tracked and disclosed to the government. Thus, campaigns must identify their donors and disclose the recipients of campaign funds.

The idea behind the laws is that campaign donations can “corrupt” politicians by tempting them to provide political favors to their donors. And even where there is no quid pro quo, the laws’ supporters argue, those who contribute large amounts of money to campaigns will have access to and influence over politicians and thus the government. In a “democracy,” which operates on the principle of one person, one vote, goes this argument, no one should have any more influence over what the government does than any other person.

There is a great deal wrong with this argument. Among other things, it ignores the difference between voting and influencing the government in other ways. Although each of us is entitled to cast only one vote, that doesn’t preclude us from supporting the politicians we favor or trying to persuade others to change their votes. The argument for campaign finance laws also ignores the nature and cause of government corruption. Our government spends a large portion of the wealth Americans produce each year and redistributes vast quantities of that wealth from those who earn it to those who don’t. It subsidizes industries, pays people not to work, and regulates an ever-greater share of our private decisions. Each election cycle our politicians invite every conceivable interest group to join in the plunder. If supporters of campaign finance laws were serious about corruption, they would try to rein in the size and scope of government, rather than whining about campaign contributions.

But put aside for a moment the question of whether these arguments are true and just consider their implications. The first and most obvious implication is that the campaign finance laws must end up limiting speech. A campaign is an effort to convince voters to elect a given candidate. That effort requires money—money to pay for campaign staff, travel expenses for the candidate, and the television and radio ads, campaign signs, and any other method of speaking out that might convince people to vote for the candidate. Restricting the money the candidate can raise necessarily restricts the speech the campaign can produce.

The second implication is that the laws must end up restricting not only the speech of candidates, but also the speech of anyone who wishes to speak out about the candidates. People who wish to support candidates are not dumb. If the law prevents them from donating large amounts of money directly to a candidate, they will spend that money on their own—for things such as billboard ads, radio and television ads, Internet commentary, YouTube videos, and the like. All of these things benefit candidates and are thus subject to the same arguments that support regulations of the financing of campaigns. Inevitably, then, the campaign finance laws must restrict the independent activities, and thus the independent speech, of anyone who wishes to support or oppose a candidate.

Indeed, this is the rationale behind the laws that prevented corporations from spending money on political ads that were at issue in the Citizens United case. Corporations and other groups can benefit candidates and influence government just as effectively with independent spending as they can through direct contributions. So if the law restricts one, it must restrict the other. And, predictably, when the Supreme Court struck down the ban on corporate independent spending in Citizens United, critics wailed about the millions in donations that corporations and other groups could now make to candidates, ignoring entirely that the increase in spending was all for independent ads, not direct contributions to candidates. That distinction made no difference to the critics, because in their view it was all equally beneficial to candidates and thus all equally nefarious. And if you accept the premise that benefiting a candidate or influencing an election is bad, then that argument makes a lot of sense.

The third implication of the argument in favor of campaign finance laws is that the more you spend, the worse you are in the eyes of the law. If the purpose of campaign finance laws is to prevent anyone from benefiting a candidate or influencing an election “too much,” then those who spend a lot are worse than those who spend only a little. We might be able to tolerate a little spending, according to this view, because that is unlikely to change anything. But spend a lot, and you might actually make a difference.

The same logic applies to the most effective speakers. The more effective you are at communicating the virtues of one candidate and the vices of his opponent, the more you will be able to benefit and thus influence that candidate. Thus, if we take campaign finance laws seriously, we ought to try hardest to muzzle the loudest and most effective speakers.

Of course, the whole point of speaking out during an election is to influence voters, candidates, and ultimately the actions of the government. The campaign finance laws are therefore an attack on representative government and the right to free speech.

But to the critics of political spending, this is a feature, not a bug. According to Yale law professor Owen Fiss, the government “may have to silence the voices of some in order to hear the voices of others. Sometimes there is simply no other way.”7 Many intellectuals, and probably most academics, agree with this sentiment. The amount of money spent during elections is “obscene,” they say.8 Corporations and other groups that spend much of this money are able to “buy” elections. The barrage of political ads they purchase drowns out the voices of the little guys, who cannot hope to compete.9 What’s the solution? According to law professor and former regulatory czar Cass Sunstein, we need a regulated marketplace of ideas, just as we have a regulated marketplace of goods and services.10

So what group would be likely to draw the ire of anyone who agrees with these views? How about an almost spontaneous movement of ordinary Americans who took their name from the most famous antigovernment protest in the history of the nation? A movement that is able to muster hundreds of thousands of citizens to stage protests in Washington, D.C. and in major cities across the nation? A movement whose members are organized and motivated, who educate themselves about issues, who hold debates and conventions, and who take every opportunity to express themselves to politicians? A movement that was ultimately instrumental in putting several prominent politicians in office, including Senators Rand Paul, Ted Cruz, and Marco Rubio? It is hard to think of any group in recent times that has been as influential as quickly as the Tea Party has been.

To be sure, Tea Party groups are not the only ones with influence in politics these days, but they, among a handful of other conservative and libertarian groups, have drawn the harshest criticism from intellectuals, many politicians, and the biggest critics of political spending in recent years. When the Tea Party came on the scene in 2008, critics wasted little time branding it and its supporters as racists, gun nuts, and even the American Taliban. And since the Citizens United decision came down, most of the criticism of campaign spending has been focused on conservatives and libertarians such as Karl Rove and the Koch brothers or business groups such as the Chamber of Commerce.11 The point is that disdain for campaign spending and disdain for groups that oppose the growth of government or promote other conservative or libertarian causes have generally gone hand in hand.

But even if we accept that the campaign finance laws provided the government with a motive to go after these groups, the fact remains that the IRS investigated them. The IRS’s domain is tax law, not campaign finance law, which is the Federal Election Commission’s domain. How is the IRS’s enforcement of tax laws in any way connected to campaign finance laws or the ideas that support them?

The answer is that, to the critics of campaign spending, the IRS had the ability to help correct a gap in the campaign finance laws created by two important court decisions. Those decisions were Citizens United and a case out of a lower federal appellate court in D.C. called SpeechNow.org v. FEC—the case that unleashed Super PACs. When Congress failed to pass additional disclosure laws after these decisions, critics turned to the IRS for some action against the tide of new campaign spending they knew would come.

Citizens United, which was decided in January 2010, struck down laws that had prohibited corporations from spending their own money on independent ads and other speech advocating the election or defeat of candidates. The SpeechNow.org
case came down about two months later. It struck down fund-raising limits on groups that wanted to spend their money on the same type of independent speech at issue in Citizens United. Together, these court decisions allowed groups to raise and spend unlimited amounts of money as long as they did so independently of candidates—meaning that they did not work with or coordinate their activities with candidates. Many took that opportunity. During the 2010 election cycle, corporations, advocacy groups, and Super PACs spent roughly $250 million on speech supporting and opposing candidates. During the 2012 cycle, that number increased to almost $1 billion.12

Predictably, supporters of campaign finance laws went apoplectic. Barely a week went by that someone in the media did not editorialize about the torrent of cash flowing into election coffers. Typically, the villains were conservatives, libertarians, and business groups. But because the court decisions prevented the government from restricting independent spending directly, the critics called for the next best thing: more disclosure laws.

Comprehensive disclosure laws have been part of the campaign finance legal regime since the first modern campaign finance laws were passed in the 1970s. Disclosure laws typically require campaigns to identify donors, including their addresses and employers, and to track and report all of their spending. The putative purpose of the laws is to enable the public to help police political corruption. If the public knows who is funding a politician’s campaign or spending money to get him elected, the argument goes, people can determine whether the politician is favoring those interests after he is elected.

That’s the theory, anyway. In practice, however, it often seems much more likely that disclosure laws are designed to enable political smear tactics. Supporters of disfavored causes are “outed” and then publicly shamed so they won’t dare support the same cause again. We can see this tactic at work all the time in politics. The Koch brothers, who have funded a wide range of conservative and libertarian causes for decades, have recently become the “Kochtapus” whose supposedly nefarious influence allegedly reaches all the way to the U.S. Supreme Court.13 During the last presidential election, one of the president’s campaign websites listed Romney donors under the heading “Behind the curtain.” It claimed that they had “less than reputable records,” had been “on the wrong side of the law,” and had profited “at the expense of so many Americans.”14 But none of these donors had done anything wrong. Instead, they were “guilty” of things such as outsourcing jobs, opposing “gay rights,” and owning firms that foreclosed on homes—in short, positions that Democrats opposed.15 (One of them ended up getting audited by the IRS.)16

To be sure, these tactics often go in both political directions, as anyone who remembers President Nixon’s enemies list can attest. But the broader point is that smear tactics are inevitable under a regime that forces people to disclose their political and ideological affiliations to the government. Indeed, the premise on which these tactics are based is built right into the campaign finance laws. If influencing politicians and elections is evil, then so is anyone who funds those efforts. We can see that attitude at work in the metaphors the critics of political spending have used since Citizens United was decided. Rivers of “dark money” are flowing from “shadowy groups” to corrupt our government and subvert democracy.17 The message is hard to miss.

The point is, people have many good reasons for wanting to maintain their privacy and keep the causes to which they contribute and the people who support them secret. The American Founders understood this well. Much of their public commentary was done behind pseudonyms such as “Publius,” “The Federal Farmer,” “Brutus,” and the like. They not only wanted to protect their privacy; they wanted the public to judge the message apart from the messenger, so an argument would stand or fall based on its merits, not on the politics of personality.

Despite these points, the Supreme Court has upheld most disclosure laws over the years. And, in fact, it upheld them again in Citizens United. So did the court in SpeechNow.org. The campaign finance disclosure regime remained entirely intact after these two cases, and the laws are incredibly broad. For individuals and corporations that occasionally spend money on independent ads, the laws make them disclose the amounts spent and anyone who contributes money for those ads. For Super PACS and other groups whose primary purpose is to influence elections, the laws make them “political committees.” A political committee is a regulated entity whose entire operations are carefully tracked and reported to the government and almost all of whose donors are disclosed.18

This point bears repeating. Citizens United and SpeechNow.org—the most despised campaign finance decisions in a generation—upheld disclosure laws, leaving intact the same disclosure regime that had existed for years. Yet the critics reacted to the cases by claiming that we needed more disclosure laws.

But if Citizens United and SpeechNow.org upheld these disclosure laws, then what was left to be disclosed that wasn’t already being disclosed? According to the critics of campaign spending, the answer was donors to certain types of nonprofits called “social welfare” groups, otherwise known as “501(c)(4)s” for the provision of the Internal Revenue code that applies to them.

A social welfare group is simply a nonprofit group that wants to advocate a position or educate people about some public issue. Hundreds of social welfare groups in the nation address issues from the environment, to tax policy, regulation, health care, foreign policy, and pretty much any other issue that people might care about. For example, the Sierra Club is a 501(c)(4), as is FreedomWorks.

As nonprofits, social welfare organizations do not pay taxes on the money used to fund their activities the way a corporation would pay taxes on the money it earns. But unlike 501(c)(3) nonprofits, which are charities, churches, and certain educational organizations, donations to social welfare organizations are not tax deductible to the donor. So the donor to a 501(c)(4) has to pay taxes on the money he donates, but the organization does not pay taxes on the money it raises from such donors.19

The reason for this distinction between 501(c)(4)s and 501(c)(3)s is that (c)(4)s are permitted to spend a certain amount of their money on political activities, whereas (c)(3)s are barred from political activities entirely. The rationale is that a (c)(3) gets the benefit of tax-deductible contributions, so the tax-free money it receives should not be used to influence politics. By the same token, because a
(c)(4) does not receive the same tax benefit, allowing it to engage in some political activities is permissible. As a result, if you want your group to be able to influence politics—say, by encouraging people to vote for particular candidates or measures in elections—you would form a social welfare 501(c)(4). If you don’t want to influence politics, you would more likely form a 501(c)(3) and get the benefit of tax-deductible contributions.

The story gets a little more complicated, however, in that there is one more relevant type of nonprofit group to consider—the “527,” which, like the others, is known for the section of the tax code that applies to it. Section 527 applies to political committees such as Super PACs and the committees that candidates form to run their campaigns. Like 501(c)(4) social welfare groups, 527s are exempt from taxes on the money they raise. Also like social welfare groups, donors to 527s may not deduct donations from their taxes. Unlike 501(c)(4)s, however, the tax code requires 527s to disclose their donors.

How do you know whether your group has to be a 501(c)(4) that does not have to disclose its donors, or a 527 that does? The answer depends on how much political spending you want to do. If you want to spend most of your money on political activities—that is, your “primary purpose” is political—then you must become a 527 and disclose all your donors. If politics is not your primary purpose—if you also want to educate people, talk about issues, and the like—then you become a 501(c)(4).

But how do you tell if your “primary purpose” is political? Every advocacy group is trying to change society in some way. If you argue that the government should pass more or fewer environmental or tax laws, is that “political”? If you oppose ObamaCare because it will ruin health care in America, is that “political”? If you argue that the government should get tough on terrorism, is that “political”?

It turns out that this question, like everything else in this area, is complicated. In fact, there are two different tests for determining whether an organization’s purpose is political, one for tax law and one for campaign finance law. The campaign finance test turns on the amount you spend on so-called “express advocacy”—that is, speech that says “vote for Smith” or “vote against Jones.” Spend more than half of your funds on express advocacy, and the campaign finance laws make you a political committee that must disclose all donors who contribute at least $200. Spend less than that, and you only have to disclose the donors who fund particular ads.

But the test the IRS uses is considerably fuzzier than this. It looks at all the “facts and circumstances” to determine whether an organization’s true purpose is “social welfare” or influencing politics. The problem, of course, is that these terms are vague and undefined, and thus their meaning is entirely subjective. The predictable result is that to figure out whether a group’s purpose is to promote “social welfare” rather than to influence elections, the IRS must conduct intensive investigations aimed at divining the intentions of the group’s founders.

In short, the IRS must conduct exactly the type of investigations to which it subjected the Tea Party groups. And, not surprisingly, after the Citizens United ruling, many so-called watchdog groups urged the IRS to do just that.20

Perhaps the simplest way to understand the IRS scandal is this. The government had both the motive and the means to go after the loudest and most effective groups. The motive came from the premise underlying the campaign finance laws—the notion that influencing voters, elections, and candidates is bad, and anyone who does it well is worse. The means ultimately did not come from the campaign finance laws themselves, because the courts had struck down some of those laws, and the critics of campaign spending were unsuccessful in getting additional disclosure mandates passed. So critics turned to the IRS to “do something,” and, not surprisingly, it did. It investigated Tea Party groups for doing what everyone already thought was bad—spending too much money on political speech. It just did so under a different set of laws—the tax laws—and based on a slightly different rationale—that nonprofits get a special gift under the laws that they must pay for, either by avoiding political speech or by disclosing their donors.

Consider the implications of the position taken by the many critics of these groups. The Citizens United and SpeechNow.org cases struck down laws that prevented people from raising and spending money for political speech. By depriving them of the means of funding their speech, the laws prevented people from advocating effectively for their political views. Simply put, the laws denied them their right to freedom of speech.

Following these decisions, many Americans exercised the rights they now enjoyed to spend money advocating for and against candidates. They organized and formed advocacy groups. They spent a lot of money to speak out in two highly contentious national elections that involved seminal issues concerning the future of the country. They complied with the campaign finance laws, either disclosing all their donors if they were Super PACs or disclosing those donors who funded specific ads that triggered the disclosure laws.

Yet critics complained bitterly about all this “spending,” arguing that the groups had falsely claimed their purpose was to promote “social welfare” rather than to influence elections. But even the IRS does not know how to distinguish between these purposes. And how could anyone know how to do that? If you agree with the goals of an organization—if, for example, you agree with a Tea Party group’s smaller government message—you will likely conclude that the organization is serving the ends of society. If not—if you are like the agents in the IRS office who conducted the Tea Party investigations, almost all of them Democrats—you will likely conclude that the organization is not operating for the benefit of society.

Critics also claimed that 501(c)(4) groups were unfairly taking advantage of a tax benefit. Their tax exemption is a “gift” from society, this argument holds; if we are going to allow them to spend their tax-free funds to influence politics, they should be forced to disclose their donors. But this argument misunderstands the nature of the tax exemption nonprofits receive. A 501(c)(4) nonprofit is, in essence, a group of individuals who pool their money to spend on advocacy of one sort or another. The tax exemption for 501(c)(4)s applies only to the organization itself. Donors to the group pay taxes on the money they donate, but the group is not subject to taxes on that money, the way a corporation has to pay taxes on the money it earns.

One way to think of a nonprofit is that it is a group whose purpose is to spend the money that its donors provide. In this sense, nonprofits have no income (i.e., earnings). Their donors are already taxed on the money they donate, so to subject the group to income taxes on the same money, just because it was given to the nonprofit, would amount to double taxation. The tax exemption is thus not a gift, but simply a logical application of the income tax laws.21

In any event, groups that organize as nonprofits have a legitimate reason for doing so. They take the law as they find it and organize themselves in the most sensible way possible. And, ultimately, all they want to do is speak.

Stripped of all the breathless claims about “dark money” and “buying elections,” the critics’ arguments amount to this: All those groups that spent money on political speech after Citizens United may have complied with the letter of the laws, but they ignored the “spirit” of those laws. So what is the spirit of the laws?

During floor debates on the McCain-Feingold law in 2001, Senator John McCain pointed out that if the law prevents groups from spending money on independent ads “you will see a lot less of that. If you demand full disclosure for those that pay for those ads, you’re going to see a lot less of that.”22 More recently, when Congress took up the issue of new disclosure laws after Citizens United, Senator Charles Schumer pointed out that “the deterrent effect” of the new law “should not be underestimated.”23 The spirit of the campaign finance laws, simply put, is to prevent people from using money to express ideas that might influence elections and politics—which means, to prevent people from speaking in a way that might change someone’s mind.

One might be tempted to say it is surprising the IRS took so long to go after the Tea Party groups, but the fact is, it didn’t take long at all. Citizens United and SpeechNow.org were decided in early 2010. By May 2010, the IRS had started targeting the Tea Party groups. It only seems like it took a long time for the IRS to take action because we only found out about it recently.

Is it unfair to suggest that the timing of the IRS investigations was no accident? Perhaps. We have no evidence at present that anyone ordered IRS agents to go after the Tea Party groups because of these cases. What we have, instead, is a chorus of voices among opinion leaders of all types—from the president to the media—condemning Citizens United and calling for more and more restrictions on spending for political speech.

The point is that we don’t need evidence of a conspiracy to explain why the IRS scandal happened. It happened because our laws and our intellectuals made it happen. If we want to prevent another scandal like this and secure our right to freedom of speech, then that is the lesson to learn.

About Steve Simpson

Steve Simpson is a writer for the Ayn Rand Institute and a former senior attorney at the Institute for Justice in Arlington, Virginia. He litigated campaign finance and other First Amendment cases nationwide. He was lead counsel in SpeechNow.org v. FEC, a challenge to federal campaign finance laws, and Sampson v. Buescher, a challenge to Colorado's ballot issue campaign finance laws. Mr. Simpson has authored numerous Supreme Court amicus briefs in a wide variety of cases and has spoken and written widely on campaign finance and other issues. Before joining the Institute for Justice, he spent five years as a litigator with the international law firm Shearman & Sterling and two years clerking in the Federal District Court for the Southern District of Florida. Mr. Simpson is a graduate of New York Law School and a member of the bars of New York, New Jersey, and the District of Columbia.

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