Consider that the tax gap, or the difference between what taxpayers owe and what they actually pay, averaged $496 billion from 2014 through 2016 (the agency’s most recent estimates). Even after audits and enforcement actions, the agency collected only 14% of total taxes owed but unpaid, or $68 billion.
Part of the problem is that the people who owe the most are rarely checked. The agency simply doesn’t have the money to conduct such audits, thanks to funding cuts over the past decade. For individual taxpayers with incomes of $1 million or more, the audit rate fell from 8.4% in 2010 to just 2.4% in 2019. Almost all of the largest companies were audited in 2010, compared to just half in 2010 year 2019
And when conducting audits, the IRS often picks the wrong targets or finds itself outmaneuvered by experienced attorneys. Nearly 40% of large company audits in 2019 returned “no change,” meaning everything reported on tax returns was justified, Janet Holtzblatt, a senior fellow at the Urban Brookings Tax Policy Center, told Congress . About 38% of individual taxpayers with incomes over $1 million either had “no change” or received a refund. This means that the money spent on the audits did not bring in any revenue.
Worse, audits don’t make much of a difference when it comes to future behavior. Studies have found that some taxpayers become even more brazen tax cheats after an audit, believing that a one-off target reduces their chances of being re-examined.
Republicans are using these facts to say that the IRS is incompetent and shouldn’t be getting money for abuses anymore — so one of the first jobs for House Republicans was to bring the $80 billion in funding approved by the Joe Biden administration to the delete agency. The GOP would allow the IRS to keep $4.8 billion to upgrade its aging technology, but without the $25 billion allocated to support ongoing operations, that money would be pretty much useless.
In addition, the Congressional Budget Office this week estimated that the House Republicans’ bill would cut government revenue by nearly $186 billion and increase the budget deficit by $114 billion over the next 10 years.
Serious, long-term money for technology is the only thing that can help the IRS overhaul its audit system and stand a chance of reclaiming the billions, if not trillions, of dollars that go uncollected each year.
Because the key to better tax compliance isn’t just doing more audits, it’s making smarter use of taxpayer data. If the IRS can reconcile tax returns with third-party income data, such as B. a W-2 tax form sent to him by an employer, compliance rates are close to 99%. If this is not possible, the compliance rate drops to 50%.
The biggest offenders of underreporting are usually entrepreneurs. It is difficult, not to mention time consuming, for the IRS to verify what it reports using its current verification process and technology system. And I’m not talking about small business owners. According to Charles Rossotti, who served as an IRS commissioner in New York, it is estimated that a significant portion of the tax gap comes from experienced pass-through entrepreneurs (sole proprietors who report business income on their personal tax returns) who have incomes well in excess of $400,000 report late 1990s.
Keep in mind that better technology doesn’t mean the IRS will get their hands on new data. This is all the information that the agency already has on hand but cannot look through. Rossotti estimates that the IRS currently has approximately 2 billion tax information reports, generating approximately $18 trillion in revenue, but uses only a fraction of that data due to funding constraints and outdated technology.
For example, the IRS has approximately 30 million K-1 forms reporting income from partnerships with combined income of $1.2 trillion, but is essentially blind to it. If it had the technology to systematically use the data on K-1s and cross-check it with the information on income tax returns, it could go a long way toward identifying tax scoffers.
Such changes would have a chilling effect. When high-earning business owners and savvy tax planners know the IRS is starting to use their data, they will change their behavior.
Yes, there will always be shrewd tax attorneys and accountants who will be able to manipulate tax laws and minimize their clients’ taxes in the gray area of not entirely tax evasion, but not entirely fair either. That’s the responsibility of the legislature to address, not the IRS. But in the meantime, give the agency the money it needs to enforce the laws already on the books.
More from the Bloomberg Opinion:
• The Republican rebels in the House of Representatives are right: David A. Hopkins
• The IRS Has Problems That $80 Billion Won’t Solve: Tyler Cowen
• The concession McCarthy shouldn’t have made: Jonathan Bernstein
This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.
Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax reporting for Bloomberg News.
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