BEYOND THE NUMBERS
The Build Back Better (BBB) legislation before the House would raise revenue in part by improving IRS enforcement of the nation’s tax laws to close the roughly $600 billion annual gap between taxes legally owed and taxes collected — a gap disproportionately due to high-income filers’ noncompliance with the law. BBB would provide roughly $80 billion over ten years for this essential task. The Congressional Budget Office’s (CBO) September estimate of how much added revenue would come from improving IRS enforcement is lower than a more recent Treasury Department estimate, and even the higher Treasury estimate may be conservative. But more broadly, both agencies agree that the investment will result in a significant increase in revenues to help pay for the bill’s investments to reduce poverty, broaden opportunity, expand health coverage, and address climate change.
BBB would provide the enforcement funding via a multi-year, mandatory funding stream (that is, directly in authorizing law rather than through annual appropriations) to give the IRS the certainty it needs to rebuild its audit staff and make long-term commitments to technology upgrades. The added funding is especially vital given the depleted state of the IRS. A decade of cuts has severely undermined the agency’s ability to perform its fundamental jobs of enforcing the nation’s tax laws and helping taxpayers navigate a tax system that relies on voluntary compliance.
The Biden Administration estimates the IRS investment would raise a net $400 billion over ten years (that is, after subtracting the $80 billion investment), in large part due to additional collections stemming directly from audits. Importantly, the Administration also expects some of the additional revenue to come from greater voluntary compliance. In other words, a robust IRS enforcement division that effectively polices tax evasion, audits high-income people at higher rates, and employs advanced technology to flag problematic tax returns would likely have a deterrent effect, encouraging taxpayers to voluntarily report more of their income. It has been Treasury’s longstanding view under Presidents of both parties that deterrent effects can generate additional revenue.
CBO will soon issue estimates of the revenue that BBB’s added enforcement funding would generate as part of its analysis of the legislation as a whole. CBO’s September analysis of the Biden Administration’s 2022 budget (which included the proposed $80 billion investment) estimated that the proposal would generate $200 billion in added revenue over ten years, for a net increase of $120 billion. That’s consistent with past CBO estimates of boosting IRS enforcement funding.
To estimate the added revenues from new IRS enforcement funding, CBO makes several adjustments to the IRS’ projected returns from the new spending (that is, how much the IRS expects to raise from taxes, penalties, and interest paid by audited taxpayers). CBO reduces the value of these projected returns because, for example, it expects the IRS to prioritize the highest-value audits in early years, with later audits raising less revenue. CBO also expects that sophisticated tax evaders will eventually find new ways to avoid detection. Treasury incorporates these factors into its own estimate, but CBO appears to make more aggressive downward adjustments.
Moreover, CBO’s estimates don’t appear to account for revenue increases due to the increase in voluntary taxpayer compliance in reaction to more robust IRS enforcement. These deterrent effects may be substantial. For example, one frequently cited study found that individual taxpayers increased their reported income by around 3 percent on average in the years after they were audited; it also found that reporting of certain business income increased by more than 14 percent after an audit. To be sure, estimating the magnitude of the deterrent effect of greater IRS enforcement involves uncertainty. Recognizing this uncertainty, Treasury takes a conservative approach in its revenue estimates and includes only a small share of the potential revenue boost from increased deterrence.
In addition, neither Treasury nor CBO has estimated the potential revenue increase from BBB’s non-enforcement IRS funding. The House legislation includes $5 billion for technology modernization and $2 billion for taxpayer services. CBO has noted that IRS spending in these non-enforcement areas could increase revenue by boosting the agency’s productivity. For example, in fiscal year 2020, the IRS was able to answer just 24 percent of its phone calls; restoring customer service to appropriate levels would likely increase voluntary compliance by allowing taxpayers to easily receive information and assistance when trying to file. CBO’s revenue estimates don’t account for any such potential increases in compliance due to better taxpayer services and technology.
Even the higher Treasury estimates are viewed as conservative by some former Treasury officials. Former Treasury Secretary Larry Summers, for example, estimates that added enforcement funding could raise substantially more than Treasury estimates. Former Treasury Secretary Jacob Lew similarly claims that Treasury’s estimate understates the revenue savings from investing in the IRS.
Finally, Congress could address any remaining concerns about how much enforcement revenue BBB would generate by restoring provisions dropped from the House package that would require improved information reporting to help the IRS identify unpaid taxes. Coupling the IRS funding increases with these reporting requirements would raise an additional $460 billion, according to Treasury. Unfortunately, the banking industry mounted a misinformation campaign against the President’s information reporting proposal. Either as part of the BBB negotiations or after BBB is enacted, Congress should examine the industry’s misinformation, debunk it, and renew the effort to provide the IRS with the information it needs to enforce the tax code on behalf of honest taxpayers.