WASHINGTON—If President Biden is to implement his ambitious economic agenda, he will have to rely on a beleaguered arm of the government: the Internal Revenue Service.
The U.S. tax agency, shrunken after a decade of budget cuts, is sending $1,400 payments to most Americans, the third such logistical challenge in a year. Last month’s $1.9 trillion relief law requires the IRS to create a system outside of annual tax filings for issuing child tax credit payments. And, further complicating an already messy filing season in which the April 15 deadline was pushed back to May 17, the agency must implement a retroactive change to taxation of unemployment benefits received in 2020.
More challenges await. The Biden administration and congressional Democrats are considering tax increases on companies and top earners that would require significant implementation and enforcement. They also hope to collect hundreds of billions of dollars by expanding the IRS and beefing up audits.
Getting all that done likely will require a transformation of the U.S. tax agency. Although the IRS still inspires fear and anger in many, it lost a net 15% of its employees between 2010 and 2020, including thousands who pursued tax avoidance and answered taxpayers’ queries. It opens about half as many criminal investigations as in 2010. In fiscal 2019, the percentage of individuals audited reached its lowest level in at least 40 years.
The result: At least $381 billion in taxes owed goes uncollected annually, according to agency estimates for tax years 2011 through 2013. Inflation and budget cuts since then mean the current number is likely much larger, and IRS Commissioner
said last week that it could be as high as $1 trillion annually, which is more than the annual defense budget.
Getting more than half that missing money would require much more intrusive enforcement. But picking up the easiest quarter could yield as much revenue as Mr. Biden’s proposed corporate tax-rate increase. To the agency’s backers, this is a no-brainer, the rare government program that more than pays for itself.
IRS officials have prepared a six-year turnaround plan to modernize aging technology and improve customer service. Mr. Rettig, a veteran California tax lawyer who was appointed by then President Donald Trump and whose term lasts until November 2022, has been seeking billions to implement it.
Democratic control of the White House and Congress assures political support for funding that plan, the new law’s provisions and tougher enforcement—for now. The relief law gives the IRS about $2 billion for implementation and modernization. Agency officials say that money will accelerate long-overdue computer revamps, but emphasize that they need support to continue, which is never a certainty. The Biden administration’s first budget calls for another $1.2 billion boost over baseline funding, plus $417 million as part of a multiyear increase in enforcement.
“A healthy IRS is very important to a healthy country,” said
the deputy commissioner who oversees information technology and back-office operations. “We need consistent, timely and multiyear funding, and we need increases.”
In recent years, Republicans haven’t been pushing to further shrink the IRS, but they haven’t voiced support for Democrats’ drive to dramatically expand enforcement. GOP lawmakers backed the recent increases in IRS funding and last year’s one-time boosts to implement the pandemic response.
A turnaround takes more than money. It is a management challenge as complex as the IRS itself. The agency is a collections company, police force, law firm, financial institution, call center and high-security information-technology shop rolled into one. It operates with political constraints no private company faces, such as budgets that fluctuate with election results and pushback from influential businesses large and small when it ramps up enforcement.
“If I hadn’t lived in Washington for 50 years, I would say, ‘Wow, this is the moment, definitely,’ ” said
a former IRS commissioner who has urged sustained attacks on tax avoidance. “I’m a little more cautious.”
The IRS’s recent record has been mixed, at times offering glimmers of what Democrats seek. It notched court victories against Coca-Cola Co.,
and promoters of land-rights tax-break deals. It implemented a major tax law after 2017, then implemented more changes during the pandemic with employees working from home. It churned out hundreds of millions of stimulus checks last spring, faster than in 2008, then beat that pace in the second and third rounds.
“The IRS was able to demonstrate that we are a can-do agency,” said
the chief taxpayer experience officer. “American citizens are getting an opportunity to look at the IRS differently.”
In other ways the IRS seems hopelessly broken. Taxpayers wait longer to get phone calls answered—or never get them answered at all. Paper tax returns and other correspondence piled up in trailers last year, and the agency is still working through the backlog. The IRS erroneously sent hundreds of thousands of warning notices to people whose returns were caught up in those delays. Audit rates dropped steadily since funding peaked in 2010, so many noncompliant taxpayers get away with not filing or not paying.
A recent inspector general’s inquiry found that a group of taxpayers with average incomes of $1.6 million had uncollected balances topping $2.4 billion. The report warned that such noncompliance by high-income individuals can have corrosive effects on tax administration and further the perception that the tax system favors the wealthy. A new study from IRS researchers and academic economists estimated that the top sliver of high-income Americans dodge significantly more in taxes than previously thought.
Aging technology can make it hard for employees to track cases across the system, requiring multiple calls and letter exchanges. That can be particularly hard on low-income people who can’t afford lawyers and accountants.
IRS enforcement is hampered by the complexity of tax-avoidance strategies and sophisticated opponents with the resources and incentives to risk audits and court battles. Disputes with multinationals such as Facebook Inc. drag on for years.
The agency’s multiyear campaign against so-called syndicated conservation easements shows how time-consuming and labor-intensive it can be to take on high-income taxpayers. In these land deals, landowners donate rights to develop their property to conservation groups. Those restrictions reduce the value of the land, and the landowner can claim that diminished value as a charitable deduction. Developers and promoters created a mini-industry that relies on aggressive appraisals to channel tax breaks to people trying to cut their bills. They make money on the deals while offering investors quick profits.
In 2016, the IRS labeled the syndicates questionable and required participants to highlight the transactions on their tax returns so the government could identify them more easily for audits. It filed the first criminal charges in late 2020. Two Georgia promoters pleaded guilty to conspiracy to defraud the U.S. in a case involving $250 million in taxes. But the deals persist, partly because promoters can flood the system with transactions, setting aside money in each deal to fight the government and knowing the IRS can’t challenge them all.
In 2013, one group claimed a $6.9 million deduction on land in Tennessee. To challenge it, the IRS needed its auditors, an in-house forestry expert, a drone-based video camera showing rows of pine trees, a team of lawyers and expert witnesses. The court case required analysis of timber economics and residential real-estate development absorption rates in middle Tennessee after the financial crisis. The IRS finally prevailed in a 2019 trial when U.S. Tax Court Judge
denied the deduction and imposed penalties. But the verdict has been appealed, and there are dozens more such cases in the pipeline.
Similar valuation disputes arise when the IRS challenges estates and large businesses. Democrats are considering changes to estate and capital-gains taxes, which would generate more such fights over what businesses’ assets are worth.
Though it gets much less attention, tax dodging also is common at small businesses, according to IRS estimates. Almost no wage-earners underreport their incomes, because they know their employers send the IRS a W-2 form disclosing salaries and withheld taxes.
Many cash-dependent restaurants and rental-home owners, though, are largely black boxes to the IRS. Without withheld taxes or third-party reporting of income, noncompliance reaches 55%, the IRS estimates. Of $352 billion in taxes uncollected annually in tax years 2011 through 2013 because of underreported income, $110 billion was attributable to businesses, often small, that pay through their owners’ individual returns, and another $45 billion to self-employment income, according to the IRS.
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The IRS plans to address some of its shortcomings with technology, including data analytics to guide enforcement work. Technology already means the government no longer needs armies to process paper returns. Automation and self-service, like the popular “Where’s My Refund” web tool, free employees to take more complex calls.
The IRS also developed fraud-detection systems that prevented billions of dollars in erroneous refunds. Document-matching programs identify discrepancies between individual tax returns and other information the IRS receives, improving compliance without audits.
At its core, the agency’s advocates say, what the IRS needs is more people, particularly skilled agents to dig through the finances of wealthy people, complex partnerships and companies, and that can’t happen overnight, even if Congress is willing to throw billions at the agency.
New workers have to be recruited and trained, which requires pulling experienced IRS employees out of the field temporarily, said Deputy Commissioner
Then it takes several years before they are producing revenue and operating at full strength, particularly as they work complicated, contentious cases involving high-income taxpayers or partnerships.
“If we get funding—let’s say tomorrow or next year—for a lot of revenue agents that would be fantastic, but the results take a long time,” Ms. Lough said.
The Obama administration boosted IRS funding from $10.9 billion in 2008 to $12.1 billion in 2010 and 2011. It also leaned on the tax agency to implement priorities: the 2009 stimulus law and the 2010 Affordable Care Act, along with a 2010 law aimed at curbing Americans’ use of offshore accounts.
Those laws came with urgent deadlines, requiring the IRS to create systems and forms, push other work to the back burner and pull employees from other projects.
Once Republicans took control of the House of Representatives in 2011, additional money started drying up. Like other agencies, the IRS was hit in the fiscal-austerity push that culminated in the 2011 budget deal between then-President
and congressional Republicans.
In 2013, the agency apologized for giving extra scrutiny to some conservative groups seeking nonprofit status, a controversy that cost the acting IRS commissioner his job. Republicans further tightened the IRS’s purse strings. Their argument: The IRS proved itself a bad steward of federal money and didn’t deserve any more.
Even after getting the $2 billion in one-time money to implement the coronavirus relief programs, the IRS’s inflation-adjusted budget is down 7% since fiscal year 2010, and the enforcement budget is down 25%, according to
a former Congressional Budget Office executive who is now at the Urban Institute, a policy research group in Washington.
Budget cuts cascaded through the agency.
a lawyer who supervised small-business cases in the Southwest before leaving in 2018, said it became harder to prepare for trials because auditors lacked time to do more than hand files to lawyers. A group of economists who analyze businesses’ transactions shrank from 20 to four, Mr. Garber said. “Stuff would just end up in the queue and not be able to come out of there,” he said.
a revenue officer in Milwaukee who is currently on leave, said the number of such employees collecting unpaid taxes in Wisconsin dropped from 100 to about 30. She estimated that it would take five or six years of hiring and training to rebuild that capacity. “The fear is that if you’re not out there knocking on doors, people notice,” said Ms. Greenwald, a former chapter president at the National Treasury Employees Union.
The level of service—the share of people wanting and receiving telephone assistance who get it—was below 50% for much of last year’s filing season, according to the Government Accountability Office.
“The public is getting shortchanged,” said Rep.
(D., Conn.), chairwoman of the House Appropriations Committee, who backs a substantial funding increase.
Ms. DeLauro is an architect of the expanded child tax credit, which requires the IRS to do something unusual for it—to distribute monthly benefits payments. That means processing frequent updates of addresses and bank accounts. The IRS will draw on experience from stimulus payments and reach out to people who typically don’t file tax returns to get them into the system.
Last week, Sen.
(R., Iowa) said he was concerned that programs like the child-tax-credit payments push the agency away from its core tax-collection mission.
While the administration hasn’t detailed its full plan for the IRS, Mr. Biden called for more enforcement during his campaign and the corporate tax proposal in his infrastructure plan emphasizes tax enforcement. His Treasury Department has hired University of Pennsylvania economist
a leading academic advocate for boosting IRS funding.
The Congressional Budget Office estimates that an additional $20 billion for enforcement would yield $60 billion more revenue, while other analysts say the deterrent effects and tougher information-reporting rules could yield up to $1 trillion over a decade.
Democrats have signaled a willingness to fund such an effort.
For now, at least, some Republicans seem willing to give the IRS more money.
Rep. Steve Womack
(R., Ark.), the top GOP member of the subcommittee overseeing IRS funding, said he has been impressed with Mr. Rettig.
“I don’t hesitate at all to help deliver what he believes he needs to help execute his mission,” Mr. Womack said. But he said he wants to make sure the public gets a return on additional investment, and he worries about the agency taking on new responsibilities outside its core areas.
“They’ve got a tough job anyway,” he said. “Remember: It is the IRS.”
Write to Richard Rubin at email@example.com
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