As President Joe Biden tries to push his infrastructure plan over the finish line, Republicans in Congress just claimed a win: They forced him to scratch a plan to boost funding for the IRS.
Superficially, it sounds like good politics: Everyone's afraid of audits, and Republicans pride themselves in their anti-tax positions. So of course they’d want to starve the IRS.
But as former top IRS officials for Republican presidents, we think Republicans are getting something wrong here. This IRS expansion was based on a smart idea, which could also be good politics and serve the interests of both parties: Not more audits, but better technology and income tracking to catch wealthy cheaters.
The point of Biden’s plan wasn’t to boost audits but to close the “tax gap” — the amount of taxes currently owed but not paid. We know firsthand that it’s a gigantic number — in 2019 alone it totaled $574 billion, and it’s estimated to reach $7 trillion over the next 10 years. In perspective, that’s equal to the amount of federal income taxes that the bottom 90 percent of individual earners pay in federal taxes on an annual basis.
Closing the tax gap doesn’t require siccing the IRS on hard-working families and small business owners. Quite the opposite: Most of the people who don’t pay their fair share are upper-income people who use financial vehicles to avoid tax bills. Fixing the tax gap is good politics for both parties because it reduces pressure to raise taxes on law-abiding taxpayers.
Here’s an amazing stat: Workers who get a W-2 pay 99 percent of the taxes they owe. It’s those who funnel income through financial vehicles the IRS doesn’t or can’t monitor who pay as little as 50 percent of what they owe. The tax gap has grown because an increasing number of filers, particularly upper earners, do not receive W-2s or other forms that report their income. This is fundamentally unfair and unsustainable.
Biden’s idea for strengthening the IRS wasn’t to add audits, but to improve technology — which is a smart use of federal money to bring in revenue. When we were at the IRS, audits were pretty much the only tool we had to find most of that missing income. But it was and is an inefficient tool. While there is an essential role for audits, they bring in less than 0.5 percent of IRS revenue, and 20 to 40 percent of audits produce nothing.
The main reason the tax system works when it does is that taxpayers, knowing that they and the IRS have the same information about their income, simply pay what they owe. So the best way to do that for wealthy tax-avoiders is to enhance the reporting of sources of income that aren’t currently collected by the IRS. This additional reporting will increase the efficiency of the IRS’ enforcement activity and also be much less burdensome for taxpayers. Starting an audit to gather information from a taxpayer, only to find that there was no problem in the first place, is not good for anyone.
What makes the Biden administration’s plan more effective than past attempts to improve tax collection is a three-legged stool of policies. The first is improving access to income information, accompanied by more reliable funding for the agency and advancements in technology.
Over the last 10 years, the IRS has been crippled by funding cuts, growth in quantity and complexity of tax returns, staff losses and the complex process of distributing Covid relief. The Biden plan calls for a steady and manageable increase of 6 percent per year above inflation in new funding over 10 years, which should improve services for ordinary taxpayers. It also relies on information reporting and technology to pinpoint where taxpayers are not paying what they owe and reduce the proportion of unnecessary audits on taxpayers who are paying accurately.
Currently, banks and other financial institutions report on a range of transactions, from income to interest to proceeds from securities transactions. The Biden plan would require these institutions to report two additional numbers: total inflows and total outflows from certain accounts.
This will not be an onerous new requirement. Banks and financial institutions currently issue more than 3 billion 1099s on a range of transactions, from income to interest to proceeds from securities transactions. This new 1099 is a reasonable step that will impose minimal cost on banks and financial institutions, will help taxpayers file more accurate returns, and will enable the IRS to better determine where to look for scofflaws.
Modern software technology, such as that used to detect credit card fraud, would allow the IRS to analyze all the information it has, including the increased financial account reporting noted above, other information reports such as income on foreign accounts and income from businesses organized as partnerships, and results of past audits, to pinpoint returns with possible deficiencies. Currently, the IRS cannot use this information except in a laborious manual audit.
Are we talking about eliminating the whole tax gap? Of course not. The administration estimated that their plan would shrink the tax gap by around 10 percent over 10 years. Three credible, independent estimates show that the administration proposal will produce over a trillion dollars within 15 years. But that still would represent a significant amount of new revenue without imposing new taxes.
As Congress has done in the past when it grants legislative authority to the IRS, it also should provide additional taxpayer protections and insist on clear goals for the IRS to ensure that funds are used in a way that will produce the most increase in revenue from voluntary compliance as well as enforcement, and with the minimum burden on taxpayers. Setting these goals and protections in law will also provide Congress an effective means of conducting oversight.
At a time when Congress is considering tax increases that would be paid by those who already pay what they owe, it is especially important to seize this opportunity to collect a significant portion of the tax gap. That goal can be attained by using modern technology to analyze information and increase service to taxpayers, not by more auditing alone.
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