The single most important thing Congress can do to have a positive effect on compliance is to radically simplify the tax code.
President Biden recently submitted his discretionary-spending request for fiscal year 2022 to Congress. Unsurprisingly, the president is seeking more money for the Internal Revenue Service: Under the plan, the agency’s budget would grow by $1.2 billion (a 10.4 percent increase from the 2021 appropriation). Almost 65 percent of the new money is directed squarely at enforcement. According to a statement from Treasury secretary Janet Yellen, the budget “will increase resources for tax enforcement by $0.9 billion.”
Specifically, the IRS wants to hire more auditors and tax collectors — including highly specialized auditors — to focus on high-income earners, corporations, and offshore transactions. The primary goal is to close the alleged “tax gap” attributable to the top 1 percent of income earners, which is claimed to be substantially higher than previously believed.
The argument driving this thinking originates from a paper in the National Bureau of Economic Research (NBER), in which the authors state that “36% of federal income taxes unpaid are owed by the top 1% [of income earners]” and that “collecting all unpaid federal income tax from this group would increase federal revenues by about $175 billion annually.”
The more government promises increased benefits to a broader segment of the population, the more desperate it becomes to collect money. And as the demand for revenue grows, it becomes increasingly necessary to break thumbs to get it. This attitude is abundantly clear in the messages sent to the public regarding the president’s proposed appropriation.
What is not abundantly clear, however, is that the push to provide the IRS with more enforcement resources is driven by at least three false narratives. Let’s evaluate each in turn.
More money will be collected through increased enforcement.
The idea here is that the only way to collect more money is through increased enforcement. The facts indicate otherwise. It is well documented by the national taxpayer advocate (NTA) in her “Annual Reports to Congress” that 98 percent of all federal revenue is paid without the need of IRS enforcement. In 2019, $3.56 trillion was raked in by the federal government — less than 2 percent of that was collected through enforcement actions.
To be sure, there are tax cheats — some of them rich — but much of the problem relating to nonpayment likely stems from ignorance or confusion rather than willful tax evasion. As documented repeatedly by the NTA, we have a tax code consisting of more than 4 million words that has been changed more than 5,900 times since 2001, not including the blizzard of changes in both 2017 (following the Tax Cuts and Jobs Act) and 2020 in response to the pandemic. The tax code is mind-numbingly complex. This causes confusion, which inevitably leads to the underpayment of taxes.
For this reason, policy-makers simply must abandon their “Go get ’em” attitude in favor of education, outreach, and assistance programs. In her 2016 annual report to Congress, then–national taxpayer advocate Nina Olson stated that the IRS is “overly focused on enforcement” at the expense of understanding the full scope of factors responsible for underpayment, chief among them being tax-law complexity. In fact, the report finds that “unnecessary coercion” can actually reduce voluntary compliance.
People will largely do what the law requires if they know what the law requires. Yet the IRS has cut down its education and assistance programs — blaming reduced resources — but does not hesitate to beef up its enforcement arms. The current budget proposal continues to operate under the false assumption that enforcement spending will lead to a significant increase in collections. The truth is that there is much more to be gained by helping people to comply with the law on the front end rather than grinding them into powder after the event. Prevention is much cheaper than cure.
Taxpayers cheat on their taxes.
If people cheat on their taxes, it follows that more audit coverage — i.e., enforcement — will catch them and yield more revenue. Logically, that is, of course, true. But that premise can be taken only so far. The problem is that the data driving this theory are proven to be unsound.
The findings in NBER’s report (mentioned above) are based exclusively on data mined by the IRS through National Research Program (NRP) audits. NRP audits are just what they purport to be — “research” audits in which the targeted returns are selected entirely at random. The audits are generally grueling, line-by-line exams. They are instituted not because the IRS believes or even suspects an error; rather, they are designed to detect patterns of “cheating” among similarly situated taxpayers. NRP audit results are then used to build a database known as the Discriminate Income Function (DIF) system.
The DIF system compares every line of every tax return with statistical averages for persons in one’s same income range and profession. If any line of the return is out of sync with the averages, the difference is scored. The higher the score, the greater the likelihood of an erroneous return — and therefore, the more likely the return will be selected for audit. About two-thirds of all returns selected for “routine” audits are selected through the DIF system. The DIF system effectively constitutes “financial profiling” of all Americans who file returns.
The problem with using NRP audit results to build the DIF database is that, as I document in my book How to Win Your Tax Audit, the IRS’s audit results are incorrect between 60 and 90 percent of the time (depending on the issue). This high error rate has a number of causes, not least of which is that tax examiners use tactics of bluff and intimidation, misinformation, and disinformation when talking to taxpayers about the law and their rights. This causes citizens to accept audit results that are inaccurate and should be challenged but typically are not.
In 1995, the IRS sought funding to run what was then known as the Taxpayer Compliance Measurement Program (TCMP), the predecessor to the NRP. It operated in exactly the same way and for the same reason. On July 18, 1995, I provided testimony to the House Ways and Means Subcommittee on Oversight in opposition to funding that project.
I articulated over a dozen reasons why the results of most audits are inaccurate. The reasons I explained then are equally valid today, especially the claim that a complicated tax code causes confusion for both tax pros and auditors. Keep in mind that my testimony was given in 1995, well before Congress treated us to the more than 5,900 tax-law changes.
Any “tax gap” analysis based on NRP audits is fundamentally flawed, because the underlying audit results upon which the research is built are simply wrong. The reality is that people don’t generally cheat on their taxes. It’s true that they make mistakes, but precious few set out to deliberately cheat, as evidenced by the 98:2 ratio of taxes paid without the need of IRS intervention. Again, the overarching problem is the complexity of the tax code.
Your tax burden increases when others don’t pay.
Lawmakers, administrators, and law-enforcement personnel all sing the same tune when it comes to nonpayment. They claim that when others don’t pay their taxes, the amount honest people must pay increases to make up the difference.
Indeed, when IRS commissioner Charles Rettig was recently asked about the allegation that the highest-income Americans were not paying their “fair share,” he responded by saying, “If people aren’t paying their fair share, it’s borne by the people who are paying their fair share.”
Legally, of course, this proposition is nonsense. There is no provision whatsoever — whether in the tax code, the regulations, IRS policy statements, or the countless thousands of court decisions interpreting tax law — that in any way imposes an increased burden on honest people because of the failures of dishonest people. Your tax liability is determined solely and exclusively by your personal and financial facts and circumstances. In fact, it is a matter of settled law that taxes can be collected only from the person who actually owes the tax.
But, even as a matter of broader principle, this claim doesn’t hold water. It may, sadly, be effective rhetorically, but factually it doesn’t stand up. This argument is used only to inflame the passions and prejudices of the masses and justify the “Go get ’em” approach to tax administration, but there is no way that tougher enforcement will to lead lower tax bills for you. Your taxes are high (and getting higher) for one reason only: Congress spends too much of your money. Period.
Conclusion
The single most important thing Congress can do to have a positive effect on compliance is to radically simplify the tax code. No, I don’t mean more tinkering around the edges such as we’ve seen for the past 25 years. It is time we come to grips with the reality that the current system is broken well beyond repair. It is time to bulldoze the graduated-income-tax system and start over with something that is truly simple, fair, and efficient.