President Joe Biden wants to raise taxes on the wealthy to pay for some of his policy proposals. Part of the way he can go about that doesn’t entail touching the tax system at all — instead, he’d just have to put the IRS to work chasing down rich people to make sure they’re paying taxes they already owe.
The New York Times first reported on Tuesday that the White House plans to seek $80 billion over the next 10 years to increase IRS enforcement and beef up the agency as part of Biden’s plan to pay for his American Families Plan, the next phase of his economic recovery agenda. The idea is to try to close the “tax gap” — the difference between what the IRS collects in taxes and what is actually owed — which IRS chief Charles Rettig recently said at a Senate Finance Committee hearing could amount to $1 trillion a year. “We do get outgunned, there’s no other way to say it,” he said. Research indicates that more than a third of all unpaid federal income taxes come from the top 1 percent of taxpayers.
According to the Times, White House officials don’t think upping tax enforcement would totally close that gap — but the difference would still be substantial. They believe it could raise at least $700 billion over the course of the next decade.
Biden campaigned on raising taxes on corporations and the wealthy (he has pledged not to increase taxes on households with incomes under $400,000). And in recent weeks, he’s laid out a number of more specific proposals along those lines, including increasing the corporate tax rate, cracking down on international taxes, and increasing taxes on capital gains. Injecting money and resources into the IRS would seek to accomplish the same goals as those proposals — increasing tax revenue — but it wouldn’t require making changes to the tax code. Instead, it would just be about reviving a struggling agency and restoring its teeth — according to Rettig, the IRS has 17,000 fewer enforcement staff than it did 10 years ago.
“For the last decade, the IRS has been decimated,” said Chuck Marr, senior director of federal tax policy at the Center on Budget and Policy Priorities (CBPP).
Lots of rich people are quite good at not paying taxes
The most recent official tax gap estimate from the IRS, from 2011 to 2013, was that it amounted to $441 billion each year. That’s a big sum already, about 16 percent of total tax liability those years. But there’s reason to believe the gap is much higher — and that wealthy people are often to blame.
According to a paper published by the Washington Center for Equitable Growth in March looking at tax evasion in the US, the bottom 50 percent of earners underreport about 7 percent of their actual income, while the top 1 percent underreport 21 percent. And some of the evasion among wealthy Americans is done in such a sophisticated way that it’s rarely detected in random audits done by the IRS. The paper’s authors argue that the IRS has often underestimated the tax gap and misses tax evasion through offshore accounts and pass-through businesses, where profits flow through to the owners.
“The IRS does random audits for the purpose of collecting information on the tax gap, and then they extrapolate from there,” said Seth Hanlon, a senior fellow at the Center for American Progress, a progressive think tank. “The problem with that method is they don’t catch what they don’t catch.”
The way the system is set up now makes certain types of income a lot easier to catch than others. Income from wages and salaries are rarely misreported (generally, about 1 percent) — your employer reports to the government what it paid you, the employee gets a W-2, and that’s that. “For wage earners, it’s obviously a very big mistake to cheat,” Marr said. Wage income is one that poor and middle-class Americans are most likely to have.
Likewise, financial institutions provide 1099s that list interest income, capital gains, and dividends, which are also pretty tough to get around. “The IRS has all that information, taxpayers have all that information, and that improves compliance because it’s known,” Marr said.
The problem is the income that the IRS has far less information about. For example, with pass-through entities — companies organized as sole proprietorships, partnerships, LLCs, or S corporations that don’t pay corporate income taxes and instead pass that income to the owners, members, or partners — it’s much harder to track where money’s flowing and what’s going on. According to the IRS, the largest source of the tax gap is underreporting of pass-through income.
“There are so many layers of partnerships,” Hanlon said, “it’s much harder for the IRS to audit partnerships and do a dive deep. The further the layers go, the harder it is for the IRS to trace the real owners.”
Not to mention that the Tax Cuts and Jobs Act of 2017 lightened the tax load for pass-through entities anyway, a move that disproportionately benefited millionaires.
In 2019, Natasha Sarin, now deputy assistant secretary at the Treasury Department, and economist Larry Summers estimated that the tax gap will total $7.5 trillion from 2020 to 2029, with the majority of those benefits going to the wealthy. They calculated that underreporting was five times higher among people making more than $10 million annually than for those making under $200,000. Their rough estimate suggested that the top 1 percent could account for 70 percent of uncollected taxes.
“If you are a normal person who makes a wage, your tax compliance is 99 percent. If you are a rich person who earns dividend income and real estate income and runs a proprietorship, your compliance rate could be as low as 45 percent,” Sarin said in an interview with Vox last year.
The IRS needs time, money, and workers
If the US is to collect the revenue it’s really owed and close the tax gap, it’s going to need to put some resources behind the cops on the beat: the IRS. Many of those who don’t pay their share of taxes use sophisticated tactics, and the IRS needs sophisticated auditors and systems to catch them — on top of just more people overall to do the job, and more money.
“There are more things they need to police, because the tax code has gotten more complicated and they’re just administering more,” Hanlon said. “Over time, the IRS budget just hasn’t kept up.”
The IRS’s total budget is down by some 50 percent since 1993 as a share of gross tax collections, and appropriations for the IRS — adjusted for inflation — have fallen by 20 percent since 2010, and after Republicans in Congress sought to curtail its budget. It’s lost thousands of enforcement staff. And its enforcement abilities directly affect revenue, not only by collecting unpaid taxes but also by influencing behavior. If people know that the IRS is going to come after them for skirting taxes, they’re less likely to try it. Rettig told the House Ways and Means Committee at a recent hearing that the number of examining revenue agents, who are tasked with handling complex cases, fell by 35 percent since 2010, and field collection revenue officers, who manage the harder collection cases, fell by 48 percent. The audit rate for millionaires fell from 8.4 percent in 2010 to 2.4 percent in 2019.
As the CBPP notes, the pandemic made the IRS’s situation more apparent, and even worse. It answers just a quarter of taxpayer phone calls and has millions of pieces of mail correspondence in backlog. It also handled the stimulus checks, which were delayed for many people, and is likely to also be slow on millions of tax returns that have to be dealt with manually.
Biden’s proposal to inject funding into the IRS could go a long way in reviving the agency. Because the IRS’s budget is generally determined year by year, it makes it hard to staff up or invest in technology for the long term. Agents with the experience and know-how to deal with complex audits can take years to train and replace.
“One of the key things in this proposal is not just the money, it’s that it’s a multi-year stream of funding that would allow them to plan it and spend it out over a multi-year period,” Hanlon said.
Donald Trump’s taxes are a decent concrete frame of reference here. The former president for years talked about how complex his taxes were and said that he was under audit. What did come out about his taxes revealed that he used complex strategies to avoid taxes, including pass-through entities and blurred lines between business and personal expenses. Tax returns like that, indeed, require a robust IRS to wade through them.
Instead of asking people to pay more taxes, Biden can just get them to pay what they already owe
Most Americans are open to raising taxes on rich people — polls show Democrats and independents really like it, and many Republicans are open to it as well. Many Americans also favor a wealth tax, which would hit the super-rich.
Closing the tax gap doesn’t even require increasing taxes, it just means getting people to pay what they already owe. It seems, well, fair. When Biden is looking to pay for a lot of big spending priorities, fair is a decent place to start — and perhaps a place where he can get some consensus.
In an April 25 interview on CNN’s State of the Union, Sen. Joe Manchin (D-WV), who has expressed some qualms about tax increases, said he’d like to look at reinforcing the IRS and going after the tax gap before getting into tax hikes. “We have eviscerated the IRS. They don’t have the guts or basically the firepower they had before. All of these things should be explored before we start just raising taxes exponentially,” he said.
To be sure, not everyone is in agreement with this, or anything. John Koskinen, IRS commissioner under President Barack Obama and Trump, told the Times he’s not sure the agency will be able to “efficiently” use the $80 billion the White House is proposing. Some Republicans are certain to push back, and while political tensions over the IRS have eased in the wake of a 2013 report that some agency staffers were targeting conservative organizations, the GOP hasn’t forgotten.
Still, Democrats are in for a long, drawn-out battle ahead when it comes to taxes as they and the White House try to decipher how (and whether) to fund some of their spending priorities. Putting more money into IRS enforcement to make sure everyone pays what’s already deemed their fair share could be a way to chalk up an early win.