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Sense and Nonsense About the IRS’ Funding Increase From Congress

Sept. 16, 2022, 8:45 AM

The Inflation Reduction Act will help rebuild the IRS with 10 years of funding, but politicians and commentators have attacked this plan with misleading claims that it’ll create a huge new army of IRS agents who will harass everyday middle-income taxpayers.

  • Sen. Lindsey Graham (R-S.C.) said hiring 87,000 new IRS agents is “supposed to be for the rich,” but the rich have “a bunch of lawyers and accountants,” and more than half of IRS audits are conducted on people making less than $75,000 per year. “If you think the federal government is out of control now, God help us when you get 87,000 new IRS agents who are looking under every rock and stone to get money out of your pocket,” he said.
  • Commentator Marc Thiessen wrote that the legislation “could add at least 49,600 IRS agents and auditors. This new army of tax collectors would be 6½ times the size of our Border Patrol, which has just 19,536 agents trying to handle the worst border crisis in American history.”
  • Sen. Rick Scott (R-Fla.) published a letter to “American job seekers,” saying the “massive expansion of the IRS will make it larger than [the] Pentagon, Federal Bureau of Investigation, Customs and Border Protection and the State Department combined.” He urged people not to join the IRS because “you not only need to be ready to audit and investigate your fellow hardworking Americans, your neighbors and friends, you need to be ready and, to use the IRS’s words, willing, to kill them.”

These and many similar statements about the IRS funding are not just misleading and nearly hysterical in tone—they’re also just dead wrong on the facts.

Audit Plans

Let’s start with the claim that the IRS will be increasing auditing of average taxpayers “looking under every rock,” to use Graham’s comment. Treasury Secretary Janet Yellen stated flatly that auditing won’t increase for taxpayers with less than a $400,000 income. Can this be true if the IRS is looking to recover money from the $600 billion per year tax gap (taxes owed but not paid)?

Yes, it’s true, because the biggest losses from underreported income are from a small fraction of upper income people with opaque sources of income. IRS research shows that when income is not reported by a third party, as is the case with much business income, only about half is reported. So if the IRS wants to recover some of that tax, where should it look? Simply put: wealthy people.

A taxpayer who has $400,000 of income and reports half of it will on average fail to pay $51,866, while a taxpayer with $50,000 of income who reports only half will fail to pay $2,185. Auditing the $400,000 taxpayer will recover more than 23 times as much as an audit of the $50,000 taxpayer. For fairness and efficiency, it only makes sense for the IRS to focus its audits on upper income taxpayers.

And will the IRS look to collect every dollar of missing tax? Not even close. Treasury estimated the new funding will allow it to collect about $300 billion over 10 years, which is less than 5% of the tax gap over that period—hardly turning over every rock—but yes, collecting at least some of the most serious cases of missing tax.

And that missing tax is heavily concentrated in a small fraction of upper income taxpayers. For example, 80% of the $1 trillion income from pass-through entities (partnerships and S corporations) is from taxpayers making over $400,000. Very little of this income is reported by third parties, and the IRS audited a negligible one-tenth of 1% of these returns.

Hiring Agents

What about the idea of putting agents on every corner? In the mid-1990s, just before I became commissioner, the IRS had 15,540 revenue agents—the main category of employees who audit taxpayers. Today, the number of revenue agents has fallen to 8,200, and we estimate that will increase to about 17,000 by 2031.

So, after all the increased funding, the IRS will have barely more agents than it had 35 years earlier. In the meantime, the economy has more than doubled in size and the tax system is vastly more complex.

IRS audit resources were highly limited, even in the 1990s, and will be even more limited over the next decade, requiring the IRS to be selective in how it deploys these scare resources.

Fortunately, the taxpaying public is not buying the misleading statements about the IRS funding. A new Morning Consult/Politico survey found that 76% of voters, including 77% of Republicans, said that they were “not concerned” about “being personally audited by the IRS.”

If there are only 8,200 revenue agents in the IRS, what do the other 70,000 people do? They administer the complex $4.1 trillion tax system for individuals, businesses, and tax-exempt organizations that file 263 million returns.

The Go-To Agency

Congress has made the IRS its go-to agency for all manner of federal programs that involve handling money, ranging from subsidizing health care to shoring up the economy in the pandemic. The Joint Committee on Taxation lists 129 tax credits or other tax breaks for corporations and 179 for individuals, all administered by the IRS.

The IRS even helps track down money trails of drug dealers, human traffickers, and terrorists, which is why 2.5% of IRS employees are special agents trained to carry weapons. That huge and expanding responsibility also explains why some of the most misleading comments about the IRS compare its funding to other agencies.

The IRS handles about five times as much funds as the Social Security Administration but has a 10% smaller budget. In addition to collecting $4.1 trillion, the IRS actually sent out more cash—yes, you read that right—in the form of benefits and refunds than the Social Security Administration in 2021.

The largest US bank, JP Morgan Chase & Co., which serves fewer than 20% as many customers as the IRS serves taxpayers, has an operating budget 5.8 times as large.

This huge structural imbalance in workload and resources is the result of steady budget cuts over a quarter century while the workload has been growing. The IRS budget today is only 49% the size it was relative to the economy in 1993. Since then, the number of individual tax returns has increased by 38% and business returns by 84%.

It is curious and spurious that one of the criticisms of the IRS funding is that it will take away funding from other important programs such as national defense or border security. This is false. The IRS is the vehicle that provides almost all the funding for all federal programs. Even under the most conservative assumptions, such as those from the Congressional Budget Office, the increased IRS funding will produce more, not less, money for other federal programs.

Interacting With Taxpayers

Average taxpayers over time will see a positive effect from the increased funding—and it’s not more auditing. Over 98% of all tax revenue is paid voluntarily by taxpayers, but that doesn’t mean they never need to interact with the IRS.

Most taxpayers file an accurate return and receive a refund or pay any balance due, and that’s the extent of their interaction with the IRS. Unfortunately, it’s the exceptions that require specific services from the IRS and that understandably drive the public’s perception. And with hundreds of millions of transactions, there are plenty of exceptions, including errors by taxpayers and the IRS to the tune of 922 million interactions annually.

When a problem occurs with a return, the IRS sends the taxpayer a notice, usually requiring a response. And when taxpayers have questions, they may try to call the IRS. Too many notices are hard to understand or are incorrect, and taxpayer calls often go unanswered or are unable to resolve the problem.

The impact of the pandemic on the IRS workforce elevated these perennial problems to a crisis level. If a taxpayer called, only 11% of calls were answered. As a result, only 37% of the public thinks the IRS is doing a good or fair job.

This unacceptable level of service is directly due to longstanding underinvestment. A common misunderstanding is that IRS “service” refers only to the narrow category of routine taxpayer calls with questions about a refund or how to fill out a form. In fact, millions of interactions with taxpayers are about possible errors in returns or missing or late payments and are funded by the IRS’ enforcement appropriation.

Regardless of the source of the error, these interactions are critically important to taxpayers. The first priority of the IRS in the use of the increased funding needs to improve service for every taxpayer.

Improving Technology

Financially starving the IRS for over 25 years has created serious problems in the tax system, but it’s also true that money alone won’t solve the problems. Rebuilding the IRS into a modern, effective, and taxpayer-centered organization will take sustained and outstanding leadership internally and responsible governance externally.

For the first time in decades, the IRS can set two clear, broad goals and match them with rigorous priorities for steady execution. The first is a high standard of quality for every interaction with taxpayers, including those embedded in enforcement programs. The second is increasingly effective compliance programs that efficiently and steadily reduce the most serious parts of the tax gap.

These goals can’t be achieved simply by scaling up decades-old programs. They can only be accomplished by embedding modern technology to emulate best practices in the private sector and other agencies. In particular, it’s crucial that the IRS make far better use of data to target and streamline its enforcement programs.

A common misunderstanding is that using new technology to improve operational programs will have to wait until the IRS replaces its old tax processing software. Every large enterprise has legacy systems that it slowly replaces, but this does not stop progress in using technology to improve programs; this is the case at the IRS as well.

A large-scale change program of the kind the IRS is undertaking inevitably involves risks, some of which will show up as false starts and failed projects. The correct response to these risks is to acknowledge and learn from them and adjust as quickly as possible. Knowledgeable and constructive governance is essential to oversee this kind of process. Reconstituting the IRS oversight board could be an important step in providing effective external oversight.

Congress has provided this and subsequent administrations a rare opportunity to rebuild one of the foundational stones of the US government’s economy. No matter what else happens, we need an effective and efficient system for administering the tax code. It’s now time to stop the misleading attacks and make this opportunity real for all American taxpayers.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Charles O. Rossotti was commissioner of the Internal Revenue Service from 1997 to 2002. He is a senior adviser at Carlyle and focuses primarily on investments in information technology and business services.

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