Congress Should Act Now to Invest In a Fairer Tax System

The proposed reconciliation deal includes a desperately-needed investment in the integrity of the tax system and the rule of law. This investment would enable the IRS to rebuild its depleted staff, upgrade its outdated computer systems, help filers understand and meet their tax obligations, and shrink the $600 billion per year (or more) “tax gap” of taxes owed but not paid. And it instructs the IRS to focus enforcement resources on high-income filers, who are responsible for a disproportionate share of the tax gap.

By Michael Kaercher and Chye-Ching Huang

The proposed reconciliation bill released Wednesday night includes a desperately-needed investment in the IRS, and the tax system more broadly. This investment promises to improve the integrity of the tax system by ensuring more wealthy filers pay the taxes they already owe under the law, while helping honest taxpayers and the budget.

First, we recap why adequately funding the IRS is, as others have said, a “no-brainer,” holds “overwhelming” logic, and is “[low]-hanging, revenue-raising fruit.” Then, we explain how the reconciliation proposal for IRS funding meets the current need. And finally, we address some misleading arguments that have been used to derail IRS funding proposals in the past, concluding that the time to invest in the tax system is now.

The urgent need: a tax system at risk

The IRS has faced severe budget cuts over the last decade. Since 2010, the IRS budget overall has been cut by about 20% in inflation-adjusted terms, with the part of its budget dedicated to enforcement cut by about 24%. As a result:

• The IRS is increasingly unable to ensure that all wealthy filers and large businesses pay what they already owe. Budget cuts have resulted in the IRS losing about 40% of staff expert enough to audit the most complex returns. This has translated into audit rates on large corporations and millionaires dropping by about 50% and 70% respectively. As one former IRS employee told the House Ways & Means Committee, many multinational corporations engage in “hardball litigation […] and they have far larger budgets than the IRS. Taxpayers are understandably willing to spend millions to save billions. While the IRS has excellent, very hard working litigators, the organization has far fewer resources than taxpayers to devote to these cases.”
• Audits on working families have grown as a share of all audits. Audit rates on working families claiming the Earned Income Tax Credit (EITC) have also fallen — but far less steeply because they are easier and cheaper for the IRS to conduct, according to the IRS Commissioner. This means that audit rates on EITC filers are about the same as audit rates for the top 1 percent of filers — even though the top 1 percent of filers account for a far larger share (about 28%) of an estimated $600 billion of taxes owed but not paid each year (the “tax gap”). Estimates suggest that the most highly-audited areas of the country are now rural, southern counties that have predominantly Black residents.
• Honest filers seeking help from the IRS increasingly find none. The IRS phone response rate was as low as 11% in fiscal year 2021, and the IRS was able to afford just one customer service representative for about every 18,000 incoming calls.

The cracks in the system have widened noticeably even as reconciliation negotiations carried on over the past year. Recent reports showed the IRS facing a backlog of some 24 million returns and unopened correspondence in February, and even a lack of pens and staplers at some IRS sites. That’s in part because the IRS has only been able to meet urgent challenges with short-term patches, such as temporarily shuffling its limited staff and resources from place-to-place. Continued operation of the IRS in its current status is unsustainable, and the accumulated costs of an insufficiently funded IRS are becoming clear.

The sound solution: stable, long-term funding that can be used efficiently

The reconciliation proposal contains a sound plan for rebuilding and improving the IRS. It would:

• Provide $79 billion of additional funding that can be used through 2031. While the bulk of the ten-year funding would go towards enforcement functions that have borne the brunt of budget cuts since 2010, the proposal includes funding to improve services to taxpayers, and to support basic operations and improve IT. All of these investments are complementary: for example, it is good for compliance if the IRS is able to answer the phones to help filers understand and fulfill their tax obligations. The bill also invests in other complementary components of the tax system, such as the U.S. Treasury Inspector General for Tax Administration.
• Raise a (conservatively) estimated $203 billion in revenue from ensuring filers pay what they already owe under the law, for a net $124 billion savings. The bill proposes to put the revenues that it raises through IRS funding and other sources toward lowering the costs of health insurance and prescription drugs for millions of people, funding critical investments in clean energy, and reducing the deficit.
• Enable long-term planning and investment. The bill provides funding made available over a ten-year period. This ten-year funding window provides the certainty needed for long-term investments in hiring and project development that take time to implement and would be difficult to plan under the annual appropriations process that delivers the IRS funding for only one year at a time. For example, hiring and training the revenue agents who are expert enough to audit the complex tax returns of high-income filers and large corporations requires at least two to three years of on-the-job training before they can conduct such audits. Further, major improvements in systems and IT take time to plan and execute. At the same time, the proposal provides tools to help the IRS recruit and retain the talent needed to modernize and improve equity in the tax system, including the ability to make prompt hires into positions requiring substantial experience. To provide oversight, the proposal requires the IRS Commissioner to furnish a multi-year operational plan for how it will spend the funds, and provide quarterly updates to Congress.
• Ensure equitable tax enforcement that focuses on high-income filers and corporations that contribute most to the “tax gap.” The proposal states that the funding is “not intended to increase taxes on any taxpayer with taxable income below $400,000.” This will focus the IRS on rebalancing its enforcement efforts towards reducing tax non-compliance among the high-income filers that contribute the largest portion of the tax gap.

Misleading criticisms

In the face of a severely stretched IRS, efforts to fund the IRS have been repeatedly met with sharp but misleading criticism:

• Critics of IRS funding often point to various examples of IRS inefficiencies and imperfections, but these are not a good reason to continue to starve the agency. There is no good reason to think that an agency that is so starved that it cannot afford pens would perform better with even lower levels of staff, IT, and basic supplies. Indeed, lawmakers enacted on a bipartisan basis the Taxpayer First Act of 2019, intended to modernize the IRS and improve oversight — but they didn’t provide enough funding to fully implement the law.
• Claims of IRS misconduct should be treated seriously and thoroughly, but with caution. Past accusations have turned out to be baseless, and current concerns about privacy breaches and audit selection are still under investigation. And again, even if these investigations ultimately implicate IRS systems and procedures, there will be severe, potentially criminal penalties for staff involved. Continuing to withhold funding needed to implement statutorily-required oversight improvements will achieve nothing constructive.
• Some argue that instead of adequately funding the IRS to do what the law requires of it, policymakers should just ask it to do less. But IRS resource woes can’t be blamed just on the tax code: funding hasn’t even kept up with inflation and the growth of the population. And while calls to simplify some elements of the tax system make sense, until lawmakers achieve that, the IRS must be funded to administer the laws that exist — and implementing simplifications would initially likely mean more work for the IRS, not less.
• Some will try to scare low-and middle-income families and small businesses, by claiming that they will be more likely to be audited. These scare tactics ignore that the proposal instructs the IRS not to use this funding to “increase taxes on any taxpayer with a taxable income below $400,000.” This is consistent with Treasury’s prior commitment that it will not increase audit rates relative to recent years for filers earning below that threshold. The bill also makes a significant investment in taxpayer services, so that the IRS is better-equipped to help taxpayers understand their tax obligations before they even submit a return.

In fact, the primary beneficiaries of continuing to starve the IRS are extremely well-off, would-be tax evaders. High-profile cases, such as a billionaire hiding $2 billion of income using offshore bank accounts, and a cryptocurrency heist worth billions, have helped build support for IRS funding. A $40 billion increase in IRS funding was nearly included in last year’s bipartisan infrastructure bill, with initial support from members of both parties. However, Congress missed that opportunity due to fierce pressure by what some have aptly dubbed the “tax cheat lobby,” including groups funded by an executive that was part of a record $7 billion settlement with the IRS over tax avoidance strategies involving the abuse of financial products.

The time to invest in the tax system is now

In April, we said:

The IRS is the agency that the nation relies on to preserve the integrity of the tax system by assisting honest filers and ensuring that would-be tax cheats pay what they owe under the law. Let’s hope that by next Tax Day, lawmakers have adequately funded this critical government function.

Lawmakers should take the opportunity they have now to deliver positive transformation to the tax system, for the benefit of honest taxpayers, the rule of law, and the budget.

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