Don’t worry about a beefier IRS, unless you’re a tax cheat

The taxman hasn’t come much, and Democrats aim to fix that with a key piece of the recently passed Inflation Reduction Act. Republicans warn this is really an assault on working-class Americans, whom Democrats plan to tax into oblivion.

Regular workers who pay their taxes should not fear a tougher tax. Democrats are trying to close the tax gap, which is the amount of tax Americans owe each year but don’t pay, for a variety of reasons. They could be hiding income. There could be some honest disagreements about what actually counts as income. There may be simple mistakes. Whatever the reason, the tax gap is huge. Estimates range from an annual tax gap of $280 billion to $1 trillion. Closing the tax gap completely would generate far more revenue than all the tax hikes President Biden has tried and failed.

For workers who derive most or all of their income from work, like most people, it is very difficult to cheat on your taxes. Your employer is required to report your earnings to the IRS and withhold taxes, so there’s not much to dispute about how much you earn and owe. Taxpayers can claim deductions, but there’s little room for creative accounting if your income comes from a single source and you’re an employee rather than a business owner. The IRS estimates that only 1% of workers who file a W-2 form misreport their income.

It’s easier to fool the IRS if you’re rich

Rich filers have a lot more opportunities to cheat, and they do. The wealthy derive much more of their income from investments, rental income, corporate profits and other sources where reports to government are indirect or non-existent. Tax lawyers and accountants have many ways to hide wealthy income, such as offshore accounts and shell companies. Income under-reporting increases with the “opaque” or difficult to track nature of the income source. The IRS estimates that 55% of the most opaque income goes unreported, costing the Treasury hundreds of billions of dollars in lost revenue each year.

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The IRS has had a hard time catching tax cheats because Republicans who controlled the presidency from 2017 to 2021 and Congress for several years before that constantly rattled the agency’s budget. The IRS budget has shrunk by about 20% over the past 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 A recent Washington Post expose detailed the outdated manual processes the IRS must use because its software and hardware are decades old. Some systems were manufactured by companies that were no longer in business. Audit rates have fallen 64% for the wealthiest Americans since 2010, and 50% for the largest companies.

Unless you’re a tax cheat like Al Capone, you don’t have to worry about the IRS having more resources. (Photo by Daily Herald Archive/National Science and Media Museum/SSPL via Getty Images)

The Cut Inflation Act, which Biden signed into law on August 16, provides $80 billion in additional funding to the IRS over the next decade. The agency says it will use the money to hire thousands of new employees, update its technology and improve customer response times.

Republicans are hysterical. “Do you earn $75,000 or less? The Democrats’ new army of 87,000 tax officials will be coming for you,” said House Minority Leader Kevin McCarthy. tweeted on August 9. A group of House Republicans says ordinary law-abiding workers will face 710,000 new IRS audits. The Wall Street Journal’s editorial page laments a new “wave of IRS audits” about to hit the middle class. All of these claims are making the rounds in the conservative media.

Are the Democrats really dumb enough to use their slim majority in Congress to harass middle-class voters with unnecessary tax audits that will produce next to no revenue? If they are, they deserve to be removed from office and probably will be.

The IRS needs to target the big fish

Here’s what’s likely to happen instead: The IRS will gradually strengthen and overhaul its antiquated technology. It will take time. Labor shortages could hamper hiring, and it’s notoriously difficult to upgrade government IT systems. Maybe in a few years, the $80 billion investment will start showing a positive return, which can only happen if the IRS targets the big fish. The Congressional Budget Office estimates that $80 billion in additional funding could produce $200 billion in additional tax revenue over a decade, for a 250% return on investment. Other estimates put possible revenues at $700 billion.

If it wanted to, the IRS could use these new resources foolishly. This could drive out low- and middle-income Americans who earn some or most of their income in cash, as underreporting cash income is a way to avoid taxes. It could also drive out low-income workers claiming the earned income tax credit, as some of those filers make mistakes on their tax returns and inadvertently under-report their income.

US Treasury Secretary Janet Yellen said the IRS will not increase audits for those earning less than $400,000 a year.  REUTERS/Jonathan Ernst

US Treasury Secretary Janet Yellen said the IRS will not increase audits for those earning less than $400,000 a year. REUTERS/Jonathan Ernst

But that would be extremely stupid at a time when Americans distrust government and one of two political parties is openly hostile to the agency whose job it is to collect federal tax revenue. Republicans will be watching for exactly this type of mistargeting and trumpeting every instance they can find. Political operatives will spin false stories of outrage about government thugs tormenting humble citizens.

Misinformation is already circulating. These “87,000 new IRS agents” are not exactly the army of tax thugs Republicans claim they will be. The IRS could hire that many people over the next 10 years, but many of them would replace at least 50,000 IRS workers who retire. Only a few of the new recruits would be listeners. Others would work in technology, support or other departments. Some can help reduce the huge backlog of unprocessed tax returns, so Americans owing refunds can get their money sooner.

Nor will there be 710,000 new audits of working-class Americans. This figure comes from hand-picked data and faulty assumptions altered to project a tax agency gone crazy. PolitiFact rates the claim as “primarily untrue”.

Treasury Secretary Janet Yellen, whose department oversees the IRS, said in an Aug. 10 letter to the IRS commissioner that the new resources “should not be used to increase the share of small businesses or households in below the $400,000 threshold that are audited against historical levels. Instead, enforcement resources will focus on high-end non-compliance. Yellen argued that better technology and better analysis data should enable the agency to avoid targeting the wrong people and more effectively identify filers most likely to cheat.

Could she be lying? Uh, okay, of course. But why? It would be counterproductive for the IRS to harass low-income taxpayers who don’t have a lot of money in the first place, while continuing to let wealthy fraudsters off the hook. Its reputation would worsen further, if possible, and the backlash would be brutal in both political parties, leaving the agency without defenders.

What the IRS should and almost certainly will do is use the new resources to see where the money is: among the wealthy filers and the big corporations who collect most of the unreported income. Congress and external oversight bodies should pay close attention to ensuring 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 fairer and maybe even improve trust in government a bit. The taxman should only be your enemy when you stiffen him.

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