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Bipartisan infrastructure deal could make it harder for tax cheats to elude IRS

$40 billion in new funding would be directed at stepping up enforcement, something experts believe would lead to boost in tax collection.

The Internal Revenue Service (IRS) headquarters in Washington, D.C., U.S., on Friday, March 19, 2021. Photographer: Samuel Corum/Bloomberg (Samuel Corum/Bloomberg)

The bipartisan deal on new infrastructure spending that President Biden reached last week with a group of moderate Democrats and Republicans in the Senate represents a significant achievement for the White House, and not only for the roughly $1 trillion it would direct to public works projects if passed into law.

The deal would also secure a boost in the budget of the Internal Revenue Service after a decade of cuts, which independent experts say is critical to ensuring businesses and the wealthiest Americans pay what they owe in taxes. As agreed, the deal would provide $40 billion in new funding for the IRS, which has seen its budget shrink by one-fifth between 2010 and 2018.

Though five moderate Republican senators signed off on the deal, its path is still uncertain in Congress, where there is strong GOP skepticism of the IRS. Republicans renewed their attacks on the agency this month after the investigative news outlet ProPublica published a story based on a vast trove of leaked confidential tax data for the richest Americans.

And the agreement for new funding is not expected to include new reporting requirements for banks, which the Biden administration has proposed in its effort to close the long-persistent “tax gap,” or the difference between the taxes that Americans owe and what they pay.

“What we don’t want is an over-intrusive IRS getting into small businesses and causing inappropriate burdens,” said Sen. Rob Portman (R-Ohio), who helped secure the deal, in describing what Republicans were trying to prevent as part of their agreement on IRS enforcement.

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IRS funding from Congress fell 20 percent in inflation-adjusted dollars between 2010 and 2018, according to a report last year by the Congressional Budget Office. The cuts resulted in a 22 percent decline in the number of IRS staff.

The number of employees in the enforcement division — the part of the IRS that goes after unpaid taxes — declined by 30 percent, with even steeper drops among the highly specialized workers who handle the most complex cases.

As a result of the cuts, the number of IRS examinations dropped by 40 percent between 2010 and 2018, even as the number of tax returns filed increased by 5 percent, the CBO found. The audit rate for returns with more than $1 million in income dropped even further, by 63 percent. And while nearly all corporations with assets of $20 billion or more were audited in 2010, just half were audited in 2018, the CBO found.

“The big corporations and the wealthiest taxpayers can take advantage of a very complicated tax code and take very aggressive positions . . . and the IRS cannot dispute them,” said Janet Holtzblatt, a senior fellow at the Tax Policy Center. “The IRS with its depleted resources is not in a strong position to dispute the argument that this is avoidance and not evasion.”

Nina Olson, executive director of the Center for Taxpayer Rights and the former U.S. national taxpayer advocate, said the IRS needs “significant resources” to improve its employees’ skills and modernize its technology.

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“There is no doubt in my mind that the IRS needs sustained investment,” Olson said. “The way that the IRS approaches enforcement now and compliance now is mired in the 20th century.”

The IRS budget cuts over the past decade were driven primarily by congressional Republicans, stemming in part from the agency’s crucial role in enacting the Affordable Care Act, President Barack Obama’s landmark domestic legislative achievement. GOP hostility toward the IRS mounted further in 2013 when an IRS watchdog alleged that the agency had targeted nonprofits affiliated with the tea party and other right-leaning groups for scrutiny.

But over the last few years, Republicans and Democrats alike have expressed concern about the extent of cuts to the IRS. Former treasury secretary Steven Mnuchin said in his confirmation hearing in 2017 that the IRS was “under-resourced to perform its duties,” and IRS Commissioner Charles Rettig, a Trump appointee, said in Senate testimony this month that “budget cuts over the past decade have resulted in an agency that lacks the capacity to address sophisticated tax evasion efforts.”

In particular, bipartisan concern has coalesced around the tax gap. In part, that is because narrowing the gap is a way to increase government revenue that would not rely on higher tax rates, which conservatives oppose. The most recent IRS research available put the annual tax gap between 2011 and 2013 at $441 billion, and a Treasury Department analysis used that figure to extrapolate forward, putting the 2019 gap at $584 billion.

“There’s just a ton of money out there that we’re not collecting,” said Charles Rossotti, a former IRS commissioner who has put forward a plan to shrink the tax gap, much of which is reflected in the Biden administration’s proposal. “Why don’t we collect some of that before we raise taxes on the people that are already paying?”

But while the extra funding agreed in the bipartisan deal will help the IRS increase revenue, it would barely make a dent in the tax gap. The CBO’s estimate, which assumes no significant changes in reporting requirements, shows that an additional $20 billion in IRS funding for examinations and collections over a decade would bring in an additional $61 billion in revenue, while an extra $40 billion in funding would bring in $103 billion. Both of those are a tiny fraction of the estimated annual tax gap.

The bipartisan deal would provide $40 billion in new money for the IRS, with an expectation that it would result in around $140 billion in new revenue, or a net $100 billion gain. Those numbers differ from the CBO estimates, and it was unclear how they were derived. The White House did not respond to questions about what period of time that money would be spent in.

Independent experts like Rossotti argue that requiring more information to be sent to the IRS is crucial to enabling the agency to collect a larger portion of the taxes owed to the federal government.

“I believe the information reporting is important, and it doesn’t have to be intrusive,” Rossotti said.

A May report released by the Treasury Department concluded that $80 billion in new resources over a decade to fund new technology and to hire and train new agents, if paired with new reporting requirements for banks and other measures, would bring in $700 billion in new revenue. The Penn Wharton Budget Model, an economic research initiative, had a more modest outlook, projecting $480 billion in new revenue over a decade from the proposed tax enforcement measures.

Republicans in Congress have said they are opposed to new bank reporting requirements, pointing to the ProPublica leak as evidence that taxpayer data is not secure. A White House fact sheet on the deal released on Thursday left the issue vague, listing “reduce the IRS tax gap” as one way the bill would be paid for, but with no numbers attached.

Any new funding would take time to have a discernible impact. It takes years to fully train a specialized IRS agent, and the agency would need to procure and deploy advanced technology that it doesn’t currently use on a widespread basis. In the meantime, the IRS will be under pressure to show results, Olson said, an approach she said would be a mistake and would potentially put vulnerable taxpayers at risk.

“There will be increasing pressure because you’ve given the IRS all this money,” she said. “Although there are many more protections now than there were for taxpayers in the mid-1990s, we have to be really careful about not putting so much pressure on the IRS to produce that you actually have excesses.”

Additional reporting by Seung Min Kim and Jeff Stein