Biden’s got the right idea with the wrong funding for the IRS

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Much attention has been focused recently on a little-known concept, the “tax gap.” The tax gap is the difference between taxes owed and taxes paid. Officially estimated at $441 billion a year ($352 billion net), the IRS commissioner recently stated it could be as high as $1 trillion annually.

Although we are highly critical of many of the Biden administration’s spending and tax proposals, we believe the president should be applauded for proposing a substantial multi-year investment in the IRS.

The Biden team’s proposed $80 billion increase over the next decade represents a more than 60 percent increase in the IRS’s budget. While the IRS requires a significant, sustained investment in its technology, taxpayer services and enforcement resources, we are concerned that the proposed increase is more than it has the capacity to expend prudently and that it may create dangerous incentives.

On a yearly budget of $12 billion, the IRS collects almost $3.6 trillion annually. To do so, it relies primarily on taxpayers to “voluntarily” report and pay their taxes (the vast majority of which they do) and secondarily on an enforcement system that has been decimated over the past decade by budget cuts.

According to the Congressional Budget Office, adjusted for inflation, the IRS budget has declined 20 percent since 2010 and spending on enforcement is down 29 percent. Despite these reductions, the IRS has performed admirably, for example, implementing the Tax Cuts and Jobs Act, including a flawless initial post-enactment filing season in 2018 and issuing three sets of more than 150 million economic impact payments in 2020 and 2021. These accomplishments required an extensive effort in a short amount of time and the IRS executed extraordinarily well. Over the past ten years, the IRS also continued to thoughtfully and judiciously allocate its ever-decreasing enforcement resources to those areas of greatest noncompliance

The constantly increasing demands on the IRS and the large budget cutbacks have taken their toll on its ability to conduct enforcement (audit rates have declined by more than 45 percent during past decade), provide service to taxpayers (longer wait times and high rates of dropped calls) and modernize its technology (significant core IRS software dates from the Kennedy era).

Our view is that three factors will impact the tax gap more than anything else: better taxpayer service (making it easier to interact with the IRS), better enforcement (more agents in the field) and most significantly, upgraded technology and data capability.  As part of the previous administration, we worked closely with the IRS to develop its six-year $2.3 – $2.7 billion “Integrated Modernization Business Plan.” The Treasury Department and independent consulting firm McKinsey made the judgement that this amount aligned with the IRS’ capacity to upgrade technology in a timely and responsible manner. We also determined that significant future modernization could be funded by reducing the high costs needed to maintain the current outdated software. In 2020 and 2021, Congress embraced, but underfunded, this plan.

We also worked with the IRS to provide Congress a detailed plan to make the IRS as easy to interact with as the best private financial institutions. This investment was estimated to be approximately $4 billion over five years, with lower annual costs in subsequent years.

Finally, three of the four years of the previous administration, the IRS proposed an additional $400 to $600 million to upgrade compliance and enforcement. Historically, every dollar spent in this area returns at least $4 of revenue. We believe the IRS could prudently expend two or three times this amount over the next five years. Still, it would take three to five years to find, recruit and deploy appropriately skilled professionals, and maybe longer considering that more than 50,000 of the IRS’s 80,000+ workforce is eligible to retire during the next six years and will need to be replaced. 

We agree that now is the time to fund the IRS adequately and begin to close the tax gap. Based on our experience, even if Congress were to increase the IRS budget by twice the amounts previously proposed, it would amount to half of the $80 billion being proposed by the administration. 

We have four primary concerns with the administration’s proposal. First, based on our work with the IRS, which was done less than two years ago, we believe that $80 billion over ten years is substantially more than the IRS can reasonably absorb. Second, setting a revenue goal for more aggressive enforcement could put pressure on the IRS to engage in overly aggressive behavior that taxpayers — most of whom are law-abiding — will not appreciate. Third, we are concerned by statements by administration officials that the increased funding would be used to audit only certain taxpayers. Who should be audited is best left to the IRS, not politicians. 

Finally, using speculative revenue projections to fund new or expanded entitlements would be highly irresponsible. The tax gap itself is computed using an inexact model which utilizes seven year-old tax data to estimate. In addition, the IRS has historically collected $4 for every additional dollar spent on enforcement; since only a portion of the $80 billion will be spent on enforcement resources (significant amounts will be spent on much-needed technology and service improvements), projecting $320 billion in additional revenue from increased enforcement is aggressive. And, the $460 billion revenue projected from a new bank account information reporting requirement (privacy issues aside) has no empirical experience to support it; in fact, as footnoted in the Treasury Department’s recent “The American Families Plan Tax Compliance Agenda” report, a new requirement in 2011, which required credit card companies to report gross payment information appears to have resulted in no significant net revenue to the government.

The president is right on in his determination to reverse years of underinvestment in the IRS. Congress should support a large multiyear investment  initiative, but should do so prudently and reasonably.

David F. Eisner was assistant secretary for management at the Treasury Department from 2018-21. David J. Kautter was assistant secretary for tax policy at the Treasury Department from 2017-21, and acting Commissioner of the IRS from 2017-18.

Tags Internal Revenue Service Tax avoidance Tax investigation Tax noncompliance Taxation in the United States

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