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If the IRS had more tax cops on the beat, how much more revenue would they bring in by auditing wealthy people and corporations? And would more enforcement really lead to more taxpayers paying their full bill?
Those are complex questions with outsized significance as President Joe Biden attempts to get his $1.75 trillion social safety net spending bill through Congress. The Congressional Budget Office is expected to deliver answers by this Friday when it releases a full analysis of the Build Back Better Act.
Some lawmakers say they won’t support the package until they see the cost estimates. Biden needs their ‘yes’ votes with the razor thin Democratic majorities in the House of Representatives and the Senate.
He also needs to pay for Build Back Better, and the administration has said that more IRS auditors targeting rich households and companies would mean a lot more tax revenue. Adding $80 billion to the Internal Revenue Service budget over a decade for more staff, better technology and more audits would bring in $400 billion in new tax revenue in the next 10 years, the Treasury Department estimates.
IRS staff ranks and audit rates have been slipping for years. Approximately $600 billion in owed taxes go uncollected every year, according to Treasury Department officials, and the wealthiest 1% are responsible for more than a quarter of the unpaid bill.
More auditors would mean more tax dollars coming in, the CBO, a non-partisan office analyzing legislation, has previously said. But it might not be as much as the White House says.
$80 billion for IRS enforcement would result in $200 billion over a 10-year period, the Congressional Budget Office said in an estimate of an earlier version of the social safety net spending bill. After the $80 billion expense, that nets $120 billion.
The White House and Democratic lawmakers are now awaiting the CBO’s latest projections on the return on investment for more IRS enforcement. That’s where the complex tax compliance question goes from the world of academics and think tanks to the closely-watched political stage.
When it comes to preventing tax cheats, “the research literature on this is very mixed,” on how much audits affect taxpayers’ behavior, CBO Director Phillip Swagel said in a Monday interview for a Bipartisan Policy Center and Yahoo! Finance event.
While some see audits as having a clear impact on “deterrence,” some studies have suggested otherwise, Swagel said. Some taxpayers treat an audit as a starting point for a negotiation on owed taxes, he noted.
So what does the research say on how taxpayers react when governments focus on audits?
Actually, they tend to fall in line to avoid tangling with the taxman, according to Joel Slemrod, an economist teaching at the University of Michigan Ross School of Business.
“My view is the preponderance of the evidence suggests the deterrence effect of enforcement on evasion is clear and, in many cases, substantial,” said Slemrod, who recently co-authored “Rebellion, Rascals, and Revenue: Tax Follies and Wisdom through the Ages.”
“To say the evidence is mixed, that’s not how I view the evidence,” Slemrod added.
For example, so-called “randomized controlled trials” over the years in the U.S. and elsewhere have tested what happens when governments reach out to taxpayers about their duties, Slemrod noted. “Surprisingly, just getting a letter from a tax agency improves compliance. That’s what I call the ‘you’re-on-our-radar’ effect,” he said.
Biden’s estimate is ‘not outlandish,’ says one tax expert
Furthermore, when the IRS gets third-party reporting on income, which it does for wages and salaries, taxpayers don’t typically fudge their facts, Slemrod said. But for categories of income where there isn’t third-party reporting, Slemrod said estimated noncompliance rates can be above 60%.
The White House projections are “not outlandish,” he said. If Slemrod had to choose between the administration and Congressional Budget Office estimates, “I’d probably pick the administration number, but it’s probably somewhere in between.”
There’s a wide swath of experts who say the administration’s $400 billion estimate is on the low side, Andrew Bates, a White House spokesman, has said. That includes Larry Summers, the former Clinton-era Treasury Department secretary and director of the White House National Economic Council in the Obama administration.
In a Twitter
TWTR,
thread earlier this month, Summers said the Treasury projections are “conservative.” A $100 billion investment focused on enforcement at the top of the income ladder could reap $800 billion, he estimated.
‘Open question’ whether audits lead to more tax revenue
Others are less convinced that enforcement is a magic bullet. Though many studies point to more audits producing more deterrence and compliance, it’s still an “open question” whether increased enforcement leads to increased compliance, said Alex Muresianu, a federal analyst at the Tax Foundation.
For example, some research shows a trade-off between enforcement and trust, he noted. “If the IRS is viewed as a hostile agency, that can end up reducing voluntary compliance,” he said.
Someone who is audited may increase their payments in the following years, but the effect can be “short-lived” if there’s no third-party reporting on income, according to researchers at the University of South Carolina and Indiana University.
People with volatile income swings might slip into pre-audit behavior and sophisticated taxpayers, typically the wealthiest, may be affected less by enforcement, they noted.
What’s the ROI on an increased IRS budget?
This isn’t to suggest more audits won’t reap more money, said Jason DeBacker, an economist at the University of South Carolina and one of the authors. The return on investment for more auditing staff and funding can be very high, but it’s just a question of how much money that will be, he said.
There are diminishing returns to consider. “The first dollar of increased enforcement yields a very high [return on investment], but what about the 1 billionth dollar?,” he said. Furthermore, there’s uncertainty about the size of the tax gap itself, he noted, meaning the gap between what taxpayers owe in taxes and what the IRS actually collects.
In the Congressional Budget Office’s read of studies like these, it could be that some audited taxpayers used the experience as a teaching opportunity to ultimately continue in their ways, and some who are fresh off an audit might think it will be a while before the authorities come knocking again.
Sometimes, added scrutiny can mean more tax money from one place, but less elsewhere, the Congressional Budget Office said. In one study, when the IRS contacted certain businesses, that increased the amount of employment tax they sent over to the agency but it reduced the money sent in by subsidiaries.
On Tuesday, Bates, the White House spokesman, said the CBO “does not have experience analyzing revenue amounts gained from cracking down on wealthy tax cheats, who are taking advantage of every honest taxpayer.”
A CBO spokeswoman declined to comment.
In the back of all this debate is a big challenge for everyone, Slemrod noted. “Anything on tax evasion is hard,” he said, later adding, “You do it and you try to hide it.”
–— Victor Reklaitis contributed to this story.
