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America's tax cheats
On Wednesday evening, Biden will introduce the "American Families Plan," a sweeping proposal that calls for hundreds of billions in spending on "child care, universal prekindergarten, and paid family and sick leave." The package would be paid for, in part, by modestly higher tax rates on capital gains and wealthy individuals. But the single largest source of funding, an estimated $700 billion over 10 years, is expected to come from cracking down on Americans who cheat on their taxes.
How is this possible?
It's not the case that the typical taxpayer is trying to shortchange Uncle Sam. The vast majority of Americans — more than 80% — pay the taxes they owe on time. For most people, cheating isn't even an option. Their taxes are automatically withheld from each paycheck. People who receive W-2 forms have a tax compliance rate approaching 100%.
But some "taxpayers with more complex sources of income, most of whom are in high-income brackets" are able to avoid paying what they owe. In recent testimony before Congress, IRS Commissioner Chuck Rettig said that he believes the "tax gap" — the difference between what is paid to the IRS and what is owed — could exceed $1 trillion annually.
A paper published in March from the National Bureau of Economic Research found that Americans in the top 1% underreport their income by an average of 21%. These individuals then hire "sophisticated lawyers and accountants capable of expanding years and significant resources on fighting IRS claims."
The privileged few are taking advantage of an agency that has been hollowed out. Years of ideological warfare have left the IRS with a small fraction of its previous capacity to enforce the law. It's easier than ever for the wealthy to get away with cheating.
Biden's plan attempts to reverse these trends. His proposal would invest about $80 billion in the IRS over 10 years in an effort to recover $780 billion.
Kneecapping the IRS
The IRS "lost more than 33,378 full-time positions" between 2010 and 2020. Many of these were auditors tasked with catching tax cheats. As of 2019, there were 8,526 auditors working at the IRS. The last time the agency had fewer than 10,000 people working in that role was 1953 "when the economy was a seventh of its current size." As a result, the IRS conducted "675,000 fewer audits in 2017 than it did in 2010, a drop in the audit rate of 42 percent." For the top 1%, audit rates "have fallen from about 8 percent in 2011 to 1.6 percent in 2019."
The IRS currently lacks the resources to pursue people who don't file their taxes at all. Investigations of non-filers dropped from 2.4 million in 2011 to just 362,000 in 2017. If the government doesn't pursue tax obligations within 10 years, the debt expires. In 2010, the IRS let $482 million in tax debt expire. By 2017, that figure ballooned to $8.3 billion.
None of this was an accident. Republicans have demanded substantial budget cuts to the agency over the last decade. This was motivated by Republicans' long-held belief that the IRS was emblematic of "big government" and by the agency's role in administering Obamacare. Overall, the IRS budget was cut by about 21% in inflation adjusted dollars between 2010 and 2020 even as the number of returns increased by 9%. Funding for enforcement fell by more than one-third.
Cracking down on the poorest Americans
As resources for enforcement shrunk, the IRS began focusing a larger proportion of its efforts on auditing the poorest filers. In 2017, about 36% of all audits were targeted at the working poor. In 2018, filers who received the Earned Income Tax Credit (EITC), which is mostly available to Americans earning less than $20,000 annually, were audited at 1.41% rate — roughly the same as the audit rate for millionaires (1.56%).
According to Senator Ron Wyden (D-OR), the IRS is focusing on auditing the poor because it is less time consuming. "While the wealthy now have an open invitation to cheat, low-income taxpayers are receiving heightened scrutiny because they can be audited far more easily. All it takes is a letter instead of a team of investigators and lawyers," Wyden said in 2019.
While the IRS ignores very wealthy Americans who don't bother to file taxes at all, "the five counties with the highest audit rates are low-income, disproportionately African American, communities."
Many of America's largest corporations are not audited
Corporations underreport income at a similar rate to wealthy individuals — about 20%. Previously, virtually all corporations with revenues of $20 billion or more were audited. Today, the IRS only has the resources to scrutinize half of these returns. Overall, "audits of corporate tax filings fell by 37 percent." Even when the IRS audits a large company, it is ill-equipped for the task.
Corporations "can pour resources into tax planning, litigation, and lobbying to try to shift the boundary between permissible tax avoidance and unlawful tax evasion — and to stretch out their cases as long as they can." The IRS has little recourse to push back. As a result the IRS frequently settles with corporations "for much smaller amounts than it believes they owe."
Biden's proposal would not level the playing field. Nor would it eliminate tax cheating by corporations and the wealthy. But it would give the IRS a fighting chance.