The tax man has not been cometh-ing very much, and Democrats aim to fix that with a key plank of the newly passed Inflation Reduction Act. Republicans warn this is really an assault on working-class Americans, whom Democrats plan to tax into oblivion.
Regular working people who pay their taxes shouldn’t fear a beefier IRS. Democrats are trying to close the tax gap, which is the amount of tax Americans owe every year but don’t pay, for a variety of reasons. They could be hiding income. There could be honest disagreements about what actually counts as income. There could be simple mistakes. Whatever the reason, the tax gap is huge. Estimates range from an annual tax gap of $280 billion to as much as $1 trillion. Fully closing the tax gap would raise way more revenue than all the tax hikes President Biden has tried and failed to pass.
For working people earning most or all of their income from labor, as most people do, it’s very hard to cheat on your taxes. Your employer is required to report your income to the IRS and withhold taxes, so there can be little to dispute about how much you earn, and owe. Taxpayers can claim deductions, but there’s little room for creative accounting if your income is from only one source and you’re an employee rather than a business owner. The IRS estimates that only 1% of workers who fill out a W-2 form misreport their income.
It's easier to cheat the IRS if you're rich
Wealthy filers have many more opportunities to cheat, and they do. The wealthy earn far more of their income from investments, rental income, business profits and other sources where reporting to the government is indirect or nonexistent. Tax lawyers and accountants have many ways to hide income for the wealthy, such as offshore accounts and shell companies. Income underreporting rises based on how “opaque,” or hard to track, the source of income is. The IRS estimates that 55% of the most opaque income goes unreported, costing the Treasury hundreds of billions in foregone revenue each year.
The IRS has struggled to catch tax cheats because Republicans who controlled the presidency from 2017 to 2021 and Congress for several years before that have consistently whacked away at the agency’s budget. The IRS’s budget has shrunk by about 20% during the last decade, leaving it short of auditors, support staff and modern computers. A recent Washington Post expose detailed the outdated manual processes the IRS must use because its software and hardware is decades old. Some systems were made by companies no longer in business. Audit rates have plunged by 64% for the wealthiest Americans since 2010, and by 50% for the biggest corporations.
The Inflation Reduction Act, which Biden signed into law Aug. 16, provides $80 billion in additional funding for the IRS during the next decade. The agency says it will use that money to hire thousands of new employees, update its technology and improve customer response times.
Republicans are hysterical. “Do you make $75,000 or less? Democrats’ new army of 87,000 IRS agents will be coming for you,” House Minority Leader Kevin McCarthy tweeted on Aug. 9. A group of House Republicans claims ordinary law-abiding workers will have to contend with 710,000 new IRS audits. The Wall Street Journal editorial page laments a new “IRS audit wave” about to hit the middle class. All of these claims are making the rounds on conservative media.
Are Democrats really stupid enough to use their slim majority in Congress to harass middle-class voters with needless tax audits that will produce hardly any revenue? If they are, they deserve to be thrown from office and probably will be.
The IRS needs to target big fish
Here’s what’s likely to happen instead: The IRS will gradually staff up and overhaul its antiquated technology. It will take time. The labor shortage could impede hiring, and it’s notoriously difficult to upgrade government computer systems. Perhaps a few years from now, the $80 billion investment will start to show a positive return, which can only happen if the IRS targets big fish. The Congressional Budget Office estimates an extra $80 billion in funding could produce $200 billion in additional tax revenue over a decade, for a 250% return on investment. Other estimates peg the possible revenue haul as high as $700 billion.
If it wanted to, the IRS could use those new resources foolishly. It could chase low- and middle-income Americans earning some or most of their income in cash, since underreporting cash income is one way to avoid taxes. It could also hunt for low-income workers who claim the earned income tax credit, because some of those filers make mistakes on their tax returns and inadvertently underreport their income.
But that would be exceedingly stupid at a time when Americans distrust government and one of the two political parties is overtly hostile to the agency whose job is to collect federal tax revenue. Republicans will be watching for exactly this type of poor targeting and trumpeting every instance they can find. Political operatives will gin up bogus outrage stories about government thugs tormenting humble citizens.
The disinformation is already flowing. Those “87,000 new IRS agents” aren’t exactly the army of tax hounds Republicans claim they will be. The IRS could hire that many people during the next 10 years, but many of them would be replacing at least 50,000 IRS workers due to retire. Only some of the new hires would be auditors. Others would work in technology, support or other departments. Some may help ease the huge backlog of unprocessed tax returns, so Americans due a refund can get their money faster.
There won’t be 710,000 new audits of working-class Americans, either. That number comes from cherry-picked data and flawed assumptions tweaked to project a tax agency run amok. PolitiFact rates the claim “mostly false.”
Treasury Secretary Janet Yellen, whose department oversees the IRS, said in an Aug. 10 letter to the IRS commissioner that new resources “shall not be used to increase the share of small business or households below the $400,000 threshold that are audited relative to historical levels. Instead, enforcement resources will focus on high-end noncompliance.” Yellen argued that better technology and data crunching should allow the agency to avoid targeting the wrong people and more effectively identify the filers most likely to cheat.
Could she be lying? Um, okay, sure. But why? It would be self-defeating for the IRS to hector lower-income taxpayers who don’t have much money in the first place, while continuing to let wealthy evaders off the hook. Its reputation would get even worse, if that’s possible, and the backlash would be brutal in both political parties, leaving the agency with no defenders.
What the IRS should and almost certainly will do is use the new resources to look where the money is: among wealthy filers and big businesses sitting on most of the unreported income. Congress and external watchdogs should pay close attention to make sure the IRS uses these new resources to improve tax compliance where it matters most. If it works, it should make the tax system a bit more fair and maybe even improve trust in government a little. The tax man should only be your enemy when you stiff him.