Biden’s Stimulus for the IRS

More auditors and audits won’t yield much new revenue

WSJ editorial.

"President Biden says he wants to “revitalize” IRS enforcement to target wealthy Americans who “aggressively plan to avoid the tax laws.” No doubt tax avoiders exist. But a lot less money is likely to be found under the sofa cushions than Mr. Biden and progressives think.

The White House is hoping to use this sleight-of-math to help finance its $2 trillion cradle-to-grave entitlement plan. It projects that giving the IRS an extra $80 billion to hunt down tax dodgers will generate $700 billion in revenue over 10 years, citing a National Bureau of Economic Research study that estimates the top 1% of earners fail to pay $175 billion a year in tax they owe.

But estimates of the “tax gap”—the difference between what is owed and paid—are based on outdated and incomplete data. The NBER study examines income concealed in foreign bank accounts before Congress, in the 2010 Foreign Account Tax Compliance Act (Fatca), required foreign banks to report foreign assets held by Americans. The IRS has since cracked down on these offshore accounts.

The Administration also cites a study from economists Larry Summers and Natasha Sarin that projects that restoring the IRS budget to “historical levels” could generate more than $1 trillion over a decade. Republicans during the Obama Presidency reduced the IRS budget after discovering it was targeting conservative nonprofits. As a result, audit rates over the last decade have fallen across the income spectrum.

But the authors probably overstate the effect of IRS staffing on the wealthy. Between fiscal years 2010 and 2019, the amount the IRS dunned taxpayers with reported incomes over $1 million declined by about $4 billion—and about $4 billion for other individuals.

Audit rates increase with income. Returns of Americans making more than $1 million are examined at three to four times higher rates than those making less than $100,000. But the non-affluent account for most unpaid tax discovered during audits because they are more likely to underreport income that can be cross-checked by third-party records. 

Fraud in the earned-income tax credit is especially common. The IRS estimates the EITC improper payment rate at more than $18 billion each year. According to the IRS, EITC audits “are the most efficient use of available IRS examination resources with the average time to complete the audit of 5 hours per return.” By contrast, the average time to complete an audit for top earners ranges from 61 to 251 hours.

The IRS notes that “the rate of attrition is significantly higher among these more experienced examiners.” That’s because they can earn more in private industry. Mr. Biden wants to give the IRS more money to hire a better class of auditor, but the agency still probably couldn’t compete with billionaires or the big accounting firms.

Mr. Biden’s plan would also upgrade IRS software and require banks and other third-parties to report more information on taxpayers. The former would be useful. But requiring more third-party reporting would ensnare tens of thousands of small fish in hopes of catching a whale. Banks and platforms like PayPal could be conscripted as tax police.

The NBER study estimates that 20% of pass-through business income is under-reported. No doubt some closely held small businesses deduct some dubious expenses. But more bank records won’t reveal whether deductions are legitimate. About 40% to 60% of the unpaid tax the IRS assesses from the top 1% in non-random audits already gets contested.

As the NBER study noted, “the high frequency of disputes and litigation makes recovering revenue from the top of the distribution via audit more costly.” It can take the IRS years to litigate tax disputes, and the agency often loses. The IRS won only $1.7 billion of the $4 billion in disputed taxes and penalties in cases closed in U.S. tax court in fiscal 2019. All of this explains why the Congressional Budget Office last year projected that a $40 billion increase in the IRS budget over 10 years might only generate $103 billion in revenue.

The only silver lining is that Mr. Biden’s phony $700 billion bogey is better than another tax increase. But CBO says budget rules prohibit it from scoring revenues from increased IRS enforcement. So sorry, Mr. President. Growing the IRS won’t pay for itself or much of anything else.

Fraud in the earned-income tax credit is especially common. The IRS estimates the EITC improper payment rate at more than $18 billion each year. According to the IRS, EITC audits “are the most efficient use of available IRS examination resources with the average time to complete the audit of 5 hours per return.” By contrast, the average time to complete an audit for top earners ranges from 61 to 251 hours.

The IRS notes that “the rate of attrition is significantly higher among these more experienced examiners.” That’s because they can earn more in private industry. Mr. Biden wants to give the IRS more money to hire a better class of auditor, but the agency still probably couldn’t compete with billionaires or the big accounting firms.

Mr. Biden’s plan would also upgrade IRS software and require banks and other third-parties to report more information on taxpayers. The former would be useful. But requiring more third-party reporting would ensnare tens of thousands of small fish in hopes of catching a whale. Banks and platforms like PayPal could be conscripted as tax police.

The NBER study estimates that 20% of pass-through business income is under-reported. No doubt some closely held small businesses deduct some dubious expenses. But more bank records won’t reveal whether deductions are legitimate. About 40% to 60% of the unpaid tax the IRS assesses from the top 1% in non-random audits already gets contested.

As the NBER study noted, “the high frequency of disputes and litigation makes recovering revenue from the top of the distribution via audit more costly.” It can take the IRS years to litigate tax disputes, and the agency often loses. The IRS won only $1.7 billion of the $4 billion in disputed taxes and penalties in cases closed in U.S. tax court in fiscal 2019. All of this explains why the Congressional Budget Office last year projected that a $40 billion increase in the IRS budget over 10 years might only generate $103 billion in revenue.

The only silver lining is that Mr. Biden’s phony $700 billion bogey is better than another tax increase. But CBO says budget rules prohibit it from scoring revenues from increased IRS enforcement. So sorry, Mr. President. Growing the IRS won’t pay for itself or much of anything else."