Focus on Tax Enforcement and the Tax Gap Welcome, but Not Enough

Senator Chuck Grassley called this week for better tax enforcement rather than additional revenues to address the budget deficit.  He’s right — and wrong.  It’s important to step up tax enforcement, but that can’t take the place of raising more revenues to reduce the deficit.

It’s true that we need to close the tax gap.  As we’ve written before, the federal government doesn’t collect hundreds of billions of dollars in taxes that are legally owed each year.  There are several straightforward steps available to narrow the gap.

First, Congress should reinstate some solid proposals that it enacted — and then repealed before they could take effect:

• 1099 Provision. Health reform had a provision to strengthen businesses’ reporting requirements, which would have helped prevent vendors from artificially cutting their tax bills.  Reinstating it would reduce the deficit by $21.9 billion over ten years, according to the Congressional Budget Office (CBO).  The massive underreporting of business income, which cost more than $122 billion in 2006, is the single largest contributor to the tax gap.  More third-party information, like this 1099 effort, would help address this problem.

• Contractor Withholding. Withholding requirements are another essential mechanism to ensure compliance.  The George W. Bush Administration secured a needed withholding requirement for government contractors, but Congress killed it in 2011.  Reinstating it would reduce the deficit by $11.2 billion over 10 years, according to the Joint Committee on Taxation.

Second, Congress must recognize that continuing to slash the IRS’s enforcement budget is a guaranteed way to hamper tax enforcement.  Congress funded IRS enforcement in fiscal year 2012 at $207 million below the 2011 level and $668 million below the President’s 2012 request.  House Republicans also blocked efforts to prevent the 2011 Budget Control Act from further eroding IRS tax compliance activities, even though CBO concluded that they would have generated net budget savings.

Former IRS Commissioner Douglas Shulman estimated that the proposed fiscal year 2012 cuts to the IRS budget would reduce revenue collection seven times as much as the cuts.  As we face the possibility of across-the-board spending cuts (“sequestration”) in March, which threaten to further slash the IRS enforcement budget by hundreds of millions of dollars — and consequently increase the deficit by several times as much — it’s important to remember what we’re trying to accomplish.

It’s shortsighted to cut funding for activities that are a net positive for the budget.  But it’s also wishful thinking that greater tax enforcement, however important, can be a substitute for more revenues in deficit reduction.