A $40 billion increase in funding for the Internal Revenue Service (IRS) was taken off the table in the infrastructure bill because of disagreements over IRS funding across the infrastructure and reconciliation bills. However, a funding increase would address the chasm between projected tax revenues and what is actually collected, which was around $381 billion annually in 2011-2013 (the IRS commissioner estimated it currently could be as much as $1 trillion).
Starved: Why the IRS Needs More Funding
The $40 billion funding bump was projected to result in a $100 billion increase in tax revenue, making up some of that gap. This windfall would be from the enforcement of existing tax law, as much of the collections gap is due to recent reduction in IRS activities. The IRS is unable to perform its duties because it is now a revenue collector, enforcement agency, and social insurance distributor, and it lacks the necessary funding to do all of it. In 2018, IRS enforcement funding was short $1.5 billion from their 2010 budget in inflation-adjusted terms, and the IRS had lost a quarter of its enforcement staff since 2010. The percentage of audited tax returns fell by nearly 66 percent between 2010 and 2019, and audits for those earning more than $1 million a year fell by 74 percent; for corporations, audits fell by 42 percent.
Reforming an Agency
Proper financial support can also assist the IRS in addressing various issues within the organization. A 2016 report noted that key systems like the IRS’ Individual Master File, the data source for taxpayer accounts, are coded in burdensome 1950’s-era Assembly Language Code. The IRS lacks sufficient in-house technical expertise to restructure it, and external technical contractors are distrusted because of insularity within the IRS and contractors’ history of expensive failures. Additionally, a lack of institutional vision has meant reforms in the 1986 Tax Systems Modernization program were left flailing. Furthermore, the current system of automated audit-targeting is regressive. Resource restrictions have forced the IRS to conduct simpler examinations, targeting low-hanging fruit such as lower-income people who incorrectly claim the EITC. The IRS needs to better identify audit-worthy returns from higher-earning individuals; in 2011-2018, audit rates dropped from 12 percent to 3 percent for returns of over $1 million in income.
Expanding personnel and technical capability, engaging in more strategic planning by creating a board of directors to oversee long-term plans, and extending commissioner term lengths are solutions because they create managerial cohesion and direction, as well as a strong technical system. These solutions all require increased funding.
How to Better Fund the IRS
There are several ways the IRS could use tax enforcement funding. First, the IRS should increase its audit rate for higher-earning and high-wealth taxpayers. Second, appropriations should be allocated to specifically support the social insurance programs the IRS already administers. Third, hiring more in-house technical and enforcement personnel would allow the IRS to build better automated auditing mechanisms that identify issues with returns from higher-earning individuals and shell corporations.
There are also many ways for Congress to pass tax reform. The IRS should build a free in-house tax filing system; tax filing companies which supply ‘free’ filing options often end up charging those who apply for social insurance. While tax filing firms have successfully lobbied to block an IRS option, Congress can reverse this restriction. The tax code is also unnecessarily complex, allowing the richest filers to underpay using loopholes. Tax simplification proposals, like eliminating the passthrough deduction, make it easier for the IRS to close the tax gap. The manner in which the IRS is funded is also important—mandatory funding in the form of predictable multi-year appropriations would allow for planning and would smooth out hiring volatility.
Financial support for the IRS is an investment the federal government will see returns from. There are several ways the IRS should utilize this investment—on technological infrastructure, personnel, or the cash transfer programs it houses. The elimination of additional funding for the IRS in the infrastructure bill puts pressure on the reconciliation process to address this need because the IRS is in dire need of support after it has been starved for the past few decades.
Audrey Xu is a poverty and welfare policy intern at the Niskanen Center and a rising senior at Rutgers University.