Chronic IRS Underfunding Makes Modernization Nearly Impossible

A new Treasury Inspector General for Tax Administration report shows that what was billed as a once-in-a-generation IRS modernization effort under the Inflation Reduction Act has been repurposed into a de facto operating budget—revealing the costs of chronic underfunding.

The timing is hard to ignore. Even as the agency absorbs the effects of recent budget cuts, President Donald Trump has proposed another $1.4 billion reduction in annual IRS funding. If a future Congress ever wants to modernize the IRS, it must roll back this pattern of budget cuts and fund the baseline first.

The landmark 2022 tax and climate law set aside funds to upgrade the agency’s outdated technology, rebuild enforcement capacity, and drag the agency into something approaching the 21st century. But faced with budget cuts and a reduced workforce, the IRS stabilized more than it modernized.

Money intended for transformation was instead rolled into basic operations. This is hardly surprising given the agency was asked to modernize under one administration and then abruptly faced budget cuts and workforce contractions under the next.

The supplemental funding was meant to provide sustained capital to modernize core systems, improve taxpayer services, and rebuild enforcement in the areas that had been starved of attention and resources for years. But the TIGTA report revealed why the funds being redirected was inevitable after the agency saw its funding cut.

In a complex administrative system, money is fungible, absent some legal requirement. This is especially true when an agency faces a binding operational constraint such as needing to process more than 260 million tax returns each year. When integral functions such as payroll and information technology maintenance are underfunded, any new infusion of resources is going to be shifted toward those immediate needs.

That is what appears to have happened with earmarked funding. Funds that had been targeted for upgrades were instead used to cover basic labor costs and keep essential systems running—including $1.3 billion in modernization funding spent on basic IT operations and maintenance.

Compared with the numbers in a similar TIGTA report from March 2025, spending on labor and contractor compensation went up significantly—by more than a billion dollars—while business systems modernization barely ticked up from a $2.7 billion total spend to $2.9 billion. That is a functional flatline.

The sheer scale of contractor spending is perhaps the clearest signal of that shift. The TIGTA report indicates that more than $5 billion in modernization funds went toward contractor support.

That amount is difficult to square with any narrative centered on building internal capacity. Contractor use can be framed as flexibility, but it looks more like substitution in this case. It appears that as the IRS internal workforce contracted, the agency relied on outside firms to perform functions it may have no longer had the capacity to handle internally. That isn’t modernization; it’s institutional outsourcing.

TIGTA also reported that the IRS canceled or revised a significant number of contracts after substantial funds had already been spent. This left hundreds of millions of dollars tied up in efforts that were never realized, spurring a cycle that is expensive and fragile. Capacity was rented, partially deployed, and in some cases then unwound—with no additional capacity left to show for it.

Modernization requires stability, durable institutional knowledge, and the ability to absorb and implement significant change. Workforce reduction pulls in the opposite direction. The TIGTA report reflects that dynamic: Even as staffing declined, compensation costs remained elevated due to transition effects.

From buyouts to delayed separations—plus the lag between organizational change and actual cost reduction—the agency was paying for a workforce it was in the process of shrinking. At the same time, it seems it was paying contractors to replace the capacity it was bleeding, all to collect billions less in tax revenue.

The story of the tax and climate law’s modernization funding expenditures opens the door for pundits and politicians to point to “failure” as reason to starve the agency further. When resources are diverted toward managing the transition to a smaller workforce rather than building new systems, critics of providing the government with more funding can easily justify their position. After all, more than $15.7 billion in funds from the 2022 law have now been spent by the IRS—and to what end?

Stable, predictable appropriations for staffing and core operations are necessary preconditions for any meaningful modernization effort. Without such a baseline, future modernization funds will continue to be redirected to operating capital.

Any future infusions of capital should be paired with minimum baseline funding thresholds and clearer transparency requirements—no modernization funds would flow without adequate operation funding. This would help ensure future modernization dollars aren’t diverted into keeping the metaphorical lights on.

Rebuilding internal expertise will also be key. The IRS’s massive reliance on contractors offers short-term flexibility, but it does little to ensure durable capacity necessary for effective tax administration over the long term. Building a modern IRS demands consistent support and investment.

The TIGTA report didn’t just teach us that the IRS failed to modernize or that funds were misspent. It showed that Congress attempted to fund modernization without first funding the institution expected to carry it out, leaving the plan susceptible to future cuts. Under those conditions, the outcome was all but inevitable.

Andrew Leahey is an assistant professor of law at Drexel Kline School of Law, where he teaches classes on tax, technology, and regulation. Follow him on Mastodon at @andrew@esq.social.

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