By Natasha Sarin and Lawrence H. Summers
November 17, 2019
While there’s plenty of disagreement about how the money should be used, almost everyone involved in public-policy debates agrees that it would be good if the federal government could collect more revenue without raising tax rates or reducing tax deductions or credits.
It should be indisputable that investment to make sure all citizens meet their tax obligations is desirable. Such investment would raise substantial revenue, as well as increase economic efficiency and help redress growing inequality: Our rough estimates suggest that at least 70 percent of the “tax gap”— defined as owed but uncollected taxes — comes from underpayment by the top 1 percent. This contributes to legitimate concerns that our tax system unfairly advantages the elite.
Our new analysis suggests that better-focused audits, raising Internal Revenue Service enforcement to previous peak levels, investing in information technology and broadening earnings reporting could raise more than $1 trillion in the next decade, primarily from very high-income taxpayers. This well exceeds the revenue benefit of raising the top individual rate to 70 percent.
Some basic facts about tax compliance and enforcement:
Extrapolating from the most recently available IRS information, the tax gap will be more than $7.5 trillion over a decade. You only need to close 15 percent of this gap to raise $1 trillion.
Enforcement effort — as reflected in the share of gross collections reinvested in the IRS — has declined by approximately 35 percent over the past decade, and the decline has been disproportionate for corporations and millionaires: In 2011, more than 12 percent of individuals making $1 million or more annually were audited; last year, only 3.2 percent were. Audit revenue declines proportionally to the declining audit rates.
At present, recipients of the earned-income tax credit — all of whom have incomes below $50,000 — are about as likely as those making $500,000 or more to be audited.
Only 5 percent of taxpayers earning above $5 million are audited — even though IRS data demonstrates that an extra auditor-hour spent on their returns raises almost $5,000 on average.
Fewer than 1 percent of corporate returns were audited in 2018 — even though corporate audits on average raised nearly $1 million in additional revenue.
The IRS invests less than a quarter as much in information technology as major banks and still relies on systems from the 1960s. Pilot projects suggest payoff rates on strategic IT investments could approach 50:1.
When third-party income reports exist to compare to individual tax returns, income is correctly reported more than 95 percent of the time. Almost all income earned by individuals who make $200,000 or less annually gets reported in this way. But without such substantiation, between 17 percent and 55 percent of income goes unreported (and so untaxed) — and more than two-thirds of the income of those who earn $10 million or more falls into this category.
There are more facts in this vein. But these should be sufficient to demonstrate that there is plenty of low-hanging fruit in the area of tax enforcement.
What is the overall potential? In a study released this weekend, we conservatively priced out a program of increased auditing, IT investment and greater third-party reporting. We estimated that it would be possible to close 15 percent of the tax gap by spending approximately $100 billion on additional enforcement, as would be necessary to return the IRS to its historical scale. Every $1 that is spent would generate more than $11 in greater tax collection.
Congressional scorekeepers have suggested more modest revenue potential from investment in enforcement; however, our study shows these differences can be reconciled. Their approach is based on a program that is more modest in size (only a quarter as large as our proposed restoration of enforcement effort to previous peak levels) and scope (we consider the revenue potential of targeting audit resources on high-income individuals, as well as increasing information reporting). Critically, the Congressional Budget Office does not account for deterrence effects, which Treasury Department reports suggest greatly magnify the revenue gains from increased enforcement.
Why is the federal government leaving so much money on the table? Part of the answer is that there are powerful interests that want to maintain a system that facilitates evasion.
Likely more important, though, are congressional budget procedures. Historically, it was common for congressional leaders faced with last-hour budget gaps to rely on substance-less “tax compliance initiatives” to plug holes. The practice became discredited, and revenue from increased enforcement came to be excluded from budget scoring.
What’s counted counts. When credit is not given for the revenue that will be collected from increased enforcement spending, it can hardly be surprising that tax compliance is neglected.
Restoring the IRS budget would, we believe, pay for itself many times over. It would also create a more progressive tax regime: At a time when working people pay their taxes in full, because of withholding, it would be reassuring for the tax law to be equally well-enforced on high-income earners.
Assuring compliance to the maximum extent feasible is not where tax reform should end, given the many problems with the current system and our need for significantly greater revenue. But it is where it should begin.
Natasha Sarin is an assistant professor of law at the University of Pennsylvania Law School and an assistant professor of finance at the Wharton School.