BEYOND THE NUMBERS
Added IRS Funding Would Help Ensure High-Income Households, Businesses Pay Their Taxes
Update, December 16th, 2022: We've updated this post.
The Senate-passed Inflation Reduction Act includes funding to help the IRS shrink the roughly $600 billion annual gap between taxes legally owed and taxes paid — a gap that disproportionately reflects high-income people’s noncompliance with the nation’s tax laws. The funding would raise $204 billion through 2031, for net savings of $124 billion, according to the Congressional Budget Office. The bill would also make health coverage and prescription drugs more affordable, begin addressing the global challenge of climate change, and reduce deficits.
The IRS budget was cut sharply during the 2010s and remains about 20 percent below its 2010 level, after adjusting for inflation. Because of these cuts, the agency has lost more than one-fifth of its staff: the number of full-time-equivalent employees has fallen by 19,000 since 2010, even as the number of returns filed and the agency’s responsibilities have both grown.
The cuts were biggest for enforcement; the audit staff who handle the most complex returns, from high-income individuals and large corporations, shrank by nearly 40 percent. As a result, audit rates of high-income people and corporations have plummeted, falling by over 70 percent and 50 percent, respectively, between 2010 and 2019.
The Inflation Reduction Act provides roughly $80 billion over ten years for the IRS to rebuild and train its staff and make long-term investments in its computer systems, which are woefully out of date. The added funding is necessary to fill the large budget hole from a decade of cuts and enable the IRS to fulfill its core responsibilities of helping taxpayers navigate the tax system and enforcing the nation’s tax laws.
The added resources would also enable the IRS to concentrate its enforcement efforts on a major source of the tax gap: the highest-income 1 percent of filers, who account for fully 28 percent of the tax gap. With the funding, the agency could hire and train audit staff equipped to conduct the complicated audits of large corporations and very high-income people — that is, the staff hit hardest by past cuts.
The tax returns of high-income and high-wealth people and large businesses are complex and auditing them is labor intensive. For example, the income of partnerships (like most investment funds, real estate businesses, and law and accounting firms) is concentrated at the top of the income spectrum and is especially hard to trace to a specific individual because of complex, multi-layered ownership structures. As a result, a significant share of partnership income — around 11 percent, according to the IRS — is misreported.
Similarly, auditing large corporations that are engaged in complex tax evasion schemes is an often time-consuming process in which the IRS may be “outgunned” by the companies’ highly paid law firms. A recent example of such a time-consuming case involves the biotech company Amgen, which allegedly owes more than $10 billion in taxes and penalties for underreporting its taxable income, according to the IRS. With more resources, the IRS would be better equipped to identify and pursue these types of high-impact cases, which ensure that corporations pay more of what they legally owe and generate large tax revenue.
IRS Commissioner Chuck Rettig made this point last week in a letter to Congress:
The resources in the reconciliation package will get us back to historical norms in areas of challenge for the agency — large corporate and global high-net-worth taxpayers — as well as new areas like pass-through entities and multinational taxpayers with international tax issues, where we need sophisticated, specialized teams in place that are able to unpack complex structures and identify noncompliance.
Given the strong case for the added funding, critics have had to resort to plain falsehoods, such as House Minority Leader Kevin McCarthy’s reckless claim that the Senate bill creates “an army of 87,000 IRS agents” who “will be coming for you.” Treasury previously estimated that it would use the added funding, in part, to hire around 87,000 staff over the next ten years, but that figure includes employees in all IRS departments, not just revenue agents. The IRS also needs customer service representatives to answer phone calls from taxpayers (roughly 7 in 10 of which went unanswered in 2019), IT staff to rebuild the agency’s aging computer infrastructure, and personnel to help process the backlog of paper tax returns.
It’s also untrue that a rebuilt IRS would target middle-class households. Treasury and the IRS have repeatedly explained that the new resources would focus on high-end tax evasion. In its initial proposal for the funding increase, Treasury said that audit rates would rise for high-income filers but “will not rise relative to recent years for those with less than $400,000 in actual income.” Treasury Secretary Janet Yellen reiterated that point this week.
The vast majority of Americans receive most of their income from wages and salaries, and because employers withhold income and payroll taxes from their paychecks, their rate of tax compliance from these sources is nearly perfect — over 99 percent, according to the IRS. These filers would generally be unaffected by an increase in enforcement funding.
Instead, a rebuilt IRS would help restore public trust in the fairness of the tax system by responding in a more timely, effective manner to taxpayer questions and enforcing the nation’s tax laws fully so that everyone pays the taxes they owe — just as the vast majority of taxpayers and businesses do voluntarily.