While reducing the number of tax fraudsters in the United States is a worthy aim, more rigorous enforcement might have unintended consequences.
While Democrats want to approve President Biden's massive Build Back Better proposal in the House, they will almost certainly face stiff opposition in the Senate. Indeed, they’ve already been forced to scale back their proposal for Internal Revenue Service snooping on personal bank accounts after that provision’s rollout went less favorably than expected. However, that feature was only a small portion of their $80 billion IRS growth proposal, which threatens to boost taxpayer compliance costs while also jeopardizing civil freedoms.
Under the plan, the IRS would be built back bigger. It would double the IRS workforce, with three‐quarters of the expansion directed toward increasing enforcement. More enforcement, they argue, is justifiable since it would increase government income, but they overlook the costs that this will undoubtedly impose on the private sector. For many law-abiding taxpayers, increased IRS enforcement would entail additional paperwork, lawyer expenses, and agony. It may also jeopardize our financial security and privacy.
While reducing the number of tax fraudsters in the United States is a worthy aim, more rigorous enforcement might have unintended consequences. We could recruit an army of IRS agents to routinely examine every home in the country and inflict root canal audits on everyone if we wanted to reduce cheating to zero through enforcement. A free people, on the other hand, do not desire such government involvement, hence every democratic society has a "tax gap" between what is owed and what is paid.
The U.S. tax gap appears to be low by international standards. One study estimated that our tax gap, at 3.8 percent of gross domestic product, is lower than the average tax gap in Europe of 7.7 percent. Another study estimated that among 157 countries, we have the second smallest shadow economy — that is, economic activity outside the government’s tax and regulatory net.
Because the tax gap in the United States is already fairly small, the expense of closing it any further through increased enforcement is likely to be prohibitive. That is especially true of the Democratic proposal to seize data from millions of family bank accounts, which would be extremely invasive and likely result in huge compliance costs for financial companies.
Another enforcement provision in the bill would repeal taxpayer protections against unfair IRS penalties. In response to IRS abuses in the 1990s, Congress enacted tax code section 6751, which requires supervisors to sign off when IRS employees are seeking punitive 20 percent penalties. The National Taxpayer Advocate said that this “provision protects a taxpayer’s right to a fair and just tax system.” But the Democratic plan would repeal this important procedural check on the powerful tax bureaucracy.
The IRS is not staffed by angels — nor is any government department, for that matter. But this agency is particularly prone to making mistakes. As the tax‐litigation specialist Dan Pilla recently noted in these pages, “[the] IRS’s audit results are incorrect between 60 and 90 percent of the time.” More enforcement would mean more audits, many of which may produce “false positives” — or the targeting of taxpayers who are innocent. Individuals and businesses would have to invest more time and money in lawyer fees to defend themselves. The income tax already imposes compliance costs on taxpayers of more than $400 billion a year; increased enforcement actions would only push those costs higher still.
Enforcement advocates want the IRS to collect more data from individuals and businesses, but they do not sufficiently consider how such databases are ideal hacking targets for criminals and foreign governments. The IRS experiences “1.4 billion cyberattacks annually” and has a “track record of data breaches,” including data from 724,000 returns leaked in 2016.
Earlier this year, ProPublica published information on high‐income taxpayers gained from thousands of stolen tax returns it had obtained. A leaky IRS computer system could induce a rash of tax‐return theft from other well‐known figures with the aims of making a media splash, selling information, or extorting payoffs.
If more IRS data‐grabbing and enforcement is not the answer, what is? Major tax reform to simplify the code. That would make the system harder to manipulate and IRS administration much easier. The Tax Foundation estimated that a simple flat tax with no loopholes would slash taxpayer compliance costs by about 90 percent.
Unfortunately, the Democratic tax proposal would go the other way by introducing dozens of small tax benefits for energy, housing, industry, education, and other goods. This would make it more difficult for the IRS to administer the system, and it would encourage people to make more mistakes and commit fraud.
Consider the record of current narrow tax breaks. The earned‐income tax credit suffers from a huge 24 percent error‐and‐fraud rate, while the low‐income‐housing tax credit is plagued by abuse from developers because the credit is so complex and IRS oversight is minimal. Adding more tax credits and other breaks to the code would increase the tax gap.
While increasing IRS enforcement may appear tempting at first glance, it would be detrimental to the private sector in actuality. Simplifying the tax law is a viable option that would benefit everyone involved. The IRS would profit from easier administration and a smaller tax gap, while taxpayers would benefit from cheaper compliance costs and fewer civil rights incursions.