The Build Back Better Act’s Investments in the IRS Will Substantially Reduce the Tax Gap
Treasury economists’ estimate that modernizing the IRS will net $400 billion in new revenue will not be reflected in official Congressional Budget Office scores of the bill, but the savings are real and could be even greater.
Increased IRS funding would raise revenue, reverse long-standing neglect, and address inequities
The Build Back Better Act’s tax compliance effort would reverse years of budget reductions and neglect that have substantially eroded the IRS’ ability to enforce the nation’s tax laws. This neglect has had serious consequences: Estimates of the annual revenue loss from taxes that are legally owed but not paid range from the roughly $600 billion estimated by the Treasury Department to the more than $1 trillion identified by IRS Commissioner Charles Rettig in testimony before the Senate Finance Committee earlier this year. Absent additional resources, nearly $1 out of every $6 in taxes will go unpaid over the next decade.
The tax gap—the difference between taxes owed and those paid—worsens inequities in the tax code. Wage and salary workers typically pay taxes on virtually all of the income they earn because their earnings are reported to the IRS.
Research shows that wealthy taxpayers are often able to avoid a large share of what they owe, with the top 5 percent of earners accounting for more than half of the tax gap. This disparity exists largely because high-income individuals are more likely to receive income that is subject to no or minimal reporting requirements and because of their use of accountants and advisers who help them avoid paying the taxes that they actually owe.
Diminished resources and staffing reductions—the IRS has lost 17,000 enforcement personnel over the past decade—have particularly affected the agency’s ability to examine complex tax returns and address new sources of evasion, such as the cryptocurrency sector.
While reduced resources have caused a sharp decline in audit rates of large corporations and wealthy individuals, enforcement efforts targeting low-income workers—those who file simple returns but claim the earned income tax credit—have declined at a much slower rate so that they are now audited at roughly the same rate as the top 1 percent.
This only further exacerbates inequities in the tax system. The Build Back Better Act would explicitly provide new resources for efforts that address this inequity, giving the IRS the capacity needed to tackle sophisticated tax evasion and targeting new efforts at high-income individuals and corporate taxpayers.
Treasury estimates of tax compliance revenue err on the side of caution and should be taken into account, notwithstanding more conservative CBO analyses
The Build Back Better Act would enable the IRS to invest in modern technology along with the staff needed to build the agency and improve taxpayer services and enforcement. The $400 billion estimate of revenue that would be raised by the compliance initiative—released by the White House and based on an analysis prepared by the professional staff of the Treasury Department’s OTA—concludes that investments in IRS enforcement, which the Build Back Better Act targets at high-income individuals, complex partnerships, and large corporations, would accomplish the following: 1) provide a high direct return on investment; 2) generate increasingly more revenue over time; 3) have a beneficial effect on voluntary compliance when coupled with investments in technology and taxpayer services; and 4) have a large deterrent effect that is not included in many analyses of the revenue effects of IRS investment.
The Treasury analysis concludes that the proposed investment in IRS capacity would lead to about $640 billion in added revenue but cautiously assumes a net benefit of $400 billion for budget scoring purposes consisting of $320 billion from direct enforcement activities and $160 billion from increasing voluntary compliance, minus $80 billion in added costs.
Other estimates, including a noted effort led by two former IRS commissioners, conclude that reasonable compliance efforts could generate as much as $1.4 trillion over 10 years—more than triple the Treasury’s Build Back Better Act estimate—through investments in technology, improved reporting requirements, and increased staffing.
Moreover, the OTA analysis does not assume that the Build Back Better Act’s substantial investment in new technology will result in additional revenues, despite substantial evidence that modern technology and improved service boost taxpayer compliance.
Lastly, an op-ed authored by five former Treasury secretaries, who served under both Republican and Democratic presidents, echoes the argument that President Joe Biden’s original enforcement proposal “if anything, is modest” and notes that former IRS commissioners have estimated that the agency could collect $1.6 trillion over a decade by investing in technology and enforcement.
Conclusion
Rebuilding the capacity of the IRS will provide a sound source of revenue that can support the ambitious and needed investments in climate, social and community supports, education, and health care found in the Build Back Better Act.
Investing in the IRS will improve the agency’s ability to communicate with taxpayers on a timely basis and ensure that they receive the assistance and benefits they deserve.
Importantly, by addressing long-standing problems of sophisticated tax evasion and other enforcement challenges, it will also foster a more equitable tax system that helps ensure that the wealthiest Americans and large corporations pay the taxes they owe.
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