The first funding source listed on the White House’s fact sheet for the bipartisan infrastructure agreement is “Reduce the IRS tax gap,” which is the gap between what people owe in taxes and what the IRS actually collects. Biden’s Treasury Department claimed in May that $80 billion in funding for IRS tax enforcement could raise $700 billion over the next ten years. In the wake of Democrats’ new $3.5 trillion spending proposal, the Washington Post reports, “Some congressional Democrats think that stepping up IRS enforcement in particular could help bring in as much as $1 trillion in uncollected taxes.”
The Congressional Budget Office (CBO) has looked into this question before, and its expectations were much lower. In July 2020, it found that the “IRS’s funding for examinations and collections by $20 billion over 10 years would boost revenues by $61 billion, resulting in a $41 billion decrease in the cumulative deficit; increasing such funding by $40 billion over 10 years would boost revenues by $103 billion, resulting in a $63 billion decrease in the deficit.”
We have much better reason to believe that the CBO’s estimates are realistic.
One reason is a simple look at institutional incentives. The CBO is not trying to get reelected or deliver a slate of campaign promises. Also, as a legislative-branch agency rather than an executive-branch agency, it isn’t run by political appointees who answer to the president.
Democrats could say, “Ah, but the CBO only looked at $40 billion, and we want to spend $80 billion on enforcement.” But notice what happened in the estimates: $40 billion is twice as much as $20 billion, but $103 billion is less than twice as much as $61 billion. In other words, doubling the money spent on better enforcement doesn’t double the revenue gained.
The CBO explains why: “If the IRS was given twice as much additional funding for enforcement activities as was provided in the first option, CBO estimates that the return per dollar of spending would be less than twice as high, reflecting the expectation that the IRS would focus first on initiatives that generate the most revenue.” There is probably some low-hanging fruit that could be picked with some extra enforcement money, but once you pick it, you can’t pick it again. As easier-to-catch tax fraud is caught, the remaining fraud would be more costly to catch.
If the IRS had more money for tax enforcement, they wouldn’t go after the wealthy first. As Ryan Ellis pointed out for Capital Matters, the IRS would come after relatively ordinary earners first, “people with self-employment income, big enough for the audit juice to be worth the assessment squeeze, but not so big that they have professional accounting and law firms on retainer.” Those are people who probably made honest mistakes and got lost in the tax code (which even very intelligent and conscientious people do all the time).
For the sake of argument, let’s say the IRS does get more funding and uses it effectively for better enforcement. The first year, they go after a bunch of tax cheats and get them to pay what they owe. Well, people are going to notice that, and in the next year, they are going to try different tactics to get around enforcement. Our unimaginably complex tax code will always supply new avenues for people to hide liability and shirk payment. The tax gap is not a static thing that can just be eliminated by paying more IRS agents. It’s the result of a competition between taxpayers and the IRS, and if one side innovates, the other side will too.
It’s also impossible to know just how large the tax gap really is. The IRS’s most recent official estimate puts it at $381 billion per year. In testimony to the Senate Finance Committee earlier this year, IRS commissioner Chuck Rettig speculated that it could be as high as $1 trillion.
The IRS has every reason to say the tax gap is large. Government agencies have to ask Congress for a budget every year, and the bigger the tax gap is, the stronger the IRS’s case is to ask for more money. It’s like a kid telling his parents that if they increased his allowance, he’d be more likely to do his chores.
A report from the National Taxpayers Union Foundation looked at the available data we have on tax collection and could not justify a $1 trillion tax gap. They had a hard time getting to $500 billion, let alone $1 trillion. They also make the excellent point that “if the exact amounts and sources of uncollected revenue were known, it would be far easier than it is for the IRS to collect it.”
If better tax enforcement were the funding panacea Democrats want it to be, someone would have tried it already. Pay-fors are always the hard part of budgeting, and pay-fors that don’t involve tax increases or deficit spending are political gold. Relative to what Democrats want to spend, however, better tax enforcement wouldn’t raise much money at all.