Every year the Internal Revenue Service leaves billions of dollars in tax revenue on the table by failing to pursue high-income individuals who don’t bother to file tax returns. A report released last month by the Treasury Department’s inspector general estimated that the amount of lost revenue was nearly $50 billion between 2014 and 2016 alone — an outrage at a time of soaring deficits and growing needs.
The situation wasn’t always this way, and it can be fixed. The inspector general’s report exposes one piece of the larger “tax gap,” the difference between what the government is owed and what it manages to collect. That gap is a consequence of failing to adequately fund the IRS and the agency’s failure, even with limited resources, to focus on collecting taxes from high-income filers.
For the IRS, going after non-filers should be the easy part of fixing the tax gap. Indeed, in the early 1990s, when individuals failed to file tax returns, the IRS essentially always followed up, since this evasion is relatively simple to detect. As the report notes, “pursuing nonfilers is one of the IRS’s most efficient enforcement strategies because issuing nonfiler notices can be a cost-effective tool that requires little more than automated notices.”
But in recent years, the IRS has failed to pursue more than one-third of high-income non-filers, defined as those making $100,000 or more annually. This means that between 2014 and 2016, the IRS never worked cases involving more than 300,000 high earners who failed to file tax returns.
Even concentrating on the highest of the high-income earners would bring in significant revenue. Less than 1 percent of high-income non-filers are responsible for a full third of the high-income non-filing tax gap. Indeed, roughly one-fourth of the high-income non-filing tax gap — about $10 billion between 2014-2016 — is attributable to just the 100 most egregious non-filers in each year.
How could the IRS leave tens of billions of dollars in tax revenue uncollected by failing to police a handful of high-income individuals? This is, in part, the natural byproduct of a decade of gutting its capacity to do so. Since 2010, the IRS budget has declined by over 15 percent in real terms and its workforce has been depleted by more than 20 percent. In fact, in 2015 delinquency notices for non-filers were not even issued — and thus cases never pursued — because the IRS paused the non-filer identification program to address its staffing challenges.
With high odds of escaping IRS pursuit entirely, it is not surprising that the nation has faced an epidemic of non-filing: Between 2010-2016, the number of those failing to file returns increased by 40 percent, far outpacing the 7 percent growth in individual tax returns.
What is the revenue potential from an aggressive pursuit of high-income non-filers? It is hard to be certain. But a rough approximation follows: For the two-thirds of high-income non-filers who eventually get around to filing returns, the Treasury Inspector General collected estimates of tax liabilities and collections. Applying these collection rates to unpursued cases between 2014-2016 suggests that the IRS could capture close to half of high-earners’ unpaid taxes by working these cases.
Between 2021 and 2030, this would increase tax collection by over $105 billion, narrowing the gap from all those who fail to file by 13 percent. This revenue alone could fund recent progressive policy proposals, such as an investment in educational resources for students with disabilities or a substantial increase in Pell Grant funds for low-income college students.
This is just the tip of the iceberg: Non-filing accounts for less than a tenth of the $7.5 trillion in owed tax liabilities that the IRS will fail to collect in the next decade. Even more substantial gains could be achieved by cracking down on underreporting of income, which accounts for 80 percent of the tax gap.
Like non-filers, under-reporters are also disproportionately high-income individuals. Ordinary wage-earners automatically fulfill their tax liabilities because of withholding from their paychecks. The same is not true for the wealthy who accrue income in opaque categories, such as rental and proprietorship income, where more than half of earnings is never reported. A minor increase in IRS outlays could fund a robust attack on the tax gap: Indeed, reinvesting the $105 billion that could be collected from high-income non-filers would provide the IRS the resources it needs to raise over $1 trillion from other compliance measures.
As a matter of equity, efficiency and revenue collection, the case for a significant investment in tax compliance is clear. The result would be a much-needed increase in tax revenue — and more importantly, a fairer society.
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