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Here's How the IRS Scandal Could Cost Uncle Sam Billions

May 13, 2013

Revelations that IRS civil servants used biased criteria to target conservative groups seeking tax exempt status is rightly drawing bipartisan outrage. President Obama, Senate Majority Leader Harry Reid (D-NV), Senate Finance Committee Chairman Max Baucus (D-MT) and Investigations Subcommittee Chair Carl Levin (D-MI) voiced their strong support for probes of what Obama deemed the "outrageous" conduct of agency employees. Democrats are absolutely right to join their Republican colleagues like Susan Collins (R-ME) in warning that even the perception of partisan bias at the IRS "contributes to the profound distrust that the American people have in government."
But even if scandal in question is ultimately limited to a few "bad apples" in the agency's Cincinnati field office, the impact both on the Internal Revenue Service and federal tax revenues could be severe. After all, the $600 million sequester is already causing furloughs at IRS, cutbacks which on top of previous budget reductions are already costing Uncle Sam billions of dollars in lost revenue a year. And with underreporting of income, tax evasion and outright cheating now short-changing the U.S. Treasury by up to $500 billion a year, another GOP crusade like the successful 1990's Republican war on the IRS would only make the U.S. national debt much, much worse.

In January 2012, National Taxpayer Advocate Nina E. Olson warned Congress that "the combination of the IRS's expanding workload and declining resources" was resulting in "inadequate taxpayer service, erosion of taxpayer rights, and reduced tax compliance." As tax expert David Cay Johnston documented in "Honey, I Shrank the IRS" and "The Tax Police Budget Shrinks," the budget sequestration process which began in March is under-cutting the over-burdened agency's ability to collect what Americans--and especially businesses--owe their government. As Johnston explained last month:

This fiscal year, the IRS will spend 20 percent less per capita in real terms than it did in 2002, my analysis of the official data shows. Back then the Service cost $41.98 per American, but now it is down to $33.55.
Those figures are based on the Obama administration's published sequester amount estimates. This week the IRS said the reduction is $594.5 million instead of the White House figure of $973 million or the nearly identical figure implied by the across-the-board cut of 8.2 percent. If the smaller number, which the IRS did not explain despite my request, is correct then the real reduction since fiscal 2002 would be down $7.24 per capita, or 17 percent, rather than 20 percent. Either way this is bad.
Because "revenue" is the IRS's middle name, a smaller budget means less capacity to do the job, which in turn means less tax being collected than is due.

If this movie seems familiar, it's because you saw it two years ago.
The Obama Administration wanted to increase the IRS budget from $12.1 billion to $13.3 billion in fiscal 2012 and add 5,000 IRS agents. But the House GOP said no. In April 2011, Congressional Republicans extracted $600 million in cuts from the IRS in return for a spending deal with President Obama, reductions which at the time were forecast to cost the Treasury $4 billion in lost revenue. Now, the annual report to Congress from the National Taxpayer Advocate shows, "IRS is not adequately funded to serve taxpayers or collect revenue." As the AP explained:

The Internal Revenue Service can't keep up with surging tax cheating and isn't sufficiently collecting revenue or helping confused taxpayers because Congress isn't giving it enough money to do its job, a government watchdog said Wednesday...
Congress cut the IRS budget to $11.8 billion this year. That is $300 million less than last year and $1.5 billion below the request by President Barack Obama, who argued that boosting the agency's spending would fatten tax collections and provide better service to taxpayers.

President Obama, of course, was right. As a stunned Ezra Klein of the Washington Post summed up the GOP's penny-wise, pound-foolish spending cuts" that March:

"Converting dollar bills into $10 bills is an excellent way to pay off your credit card. Except, it seems, if you're a House Republican...
As the Associated Press reported, "every dollar the Internal Revenue Service spends for audits, liens and seizing property from tax cheats brings in more than $10, a rate of return so good the Obama administration wants to boost the agency's budget." It's an easy way to reduce the deficit: You don't have to cut heating oil for the poor or Pell grants for students. You just have to make people pay what they owe."

Nevertheless, just nine months after Jonathan Cohn highlighted the Republicans' "pro-tax evasion, pro-deficits" position, National Taxpayer Advocate Olson confirmed the trend underway for years continues to worsen. "Inadequate funding," the agency web site reported, "means the IRS cannot adequately pursue unpaid tax liabilities":

The report points out that the IRS functions as the "accounts receivable" department of the federal government, as it collects more than 90 percent of all federal revenue and therefore provides the funds that make almost all other federal spending possible. On a budget of $12.1 billion, the IRS collected $2.42 trillion in FY 2011. In other words, for every $1 that Congress appropriated for the IRS, the IRS collected about $200 in return. However, current federal budgeting rules do not take into account that a dollar appropriated for the IRS typically generates substantially more than a dollar in additional tax collections, leaving the agency substantially underfunded to do its job and limiting its ability to close the tax gap and thereby help reduce the federal budget deficit.
The report points out that the size of the tax gap raises important equity concerns, because compliant taxpayers end up carrying a disproportionate share of the tax burden. For 2001, the most recent year for which a complete tax gap estimate existed when the report was written, the IRS estimated it was unable to collect $290 billion in taxes. Since there were then 108 million households in the United States, the average household paid a "noncompliance surtax" of almost $2,700 to enable the federal government to raise the same revenue it would have collected if all taxpayers had reported their income and paid their taxes in full. "That is not a burden we should expect our nation's taxpayers to bear lightly," the report says. [Last week, the IRS released updated tax gap estimates. For 2006, the IRS estimated it was unable to collect $385 billion in taxes when there were 114 million households, producing an updated "noncompliance surtax" of nearly $3,400 per household.]

But with the taxpayer population now at 141.2 million, economist Benjamin Harris of the Brookings Institution estimated the gross tax gap could range from $410 billion to $500 billion. The implications for America's $3.7 trillion annual budget and $845 billion deficit are clear. "You could go a long way toward solving our budget mess by closing the tax gap," Harris said, "But the problem is, it's not easily closed."
Especially if, as Republicans insisted during the late 1990's, the government doesn't even try.

As the Los Angeles Times reported in 1998, "Americans are failing to pay $195 billion annually in taxes owed to the federal government, the highest estimate ever of the so-called tax gap." But that before the full force of the anti-IRS jihad led by Phil Gramm and his Republican allies was brought to bear.
As Johnston explained in his 2003 classic Perfectly Legal, the GOP during the Clinton administration waged an all-out war on the IRS, turning the priorities for auditing Americans upside-down. Then as now, GOP spinmeister Frank Luntz framed the issue for his Republican allies, "Which would you prefer: having your wallet or purse stolen or being audited by the IRS?" As Senator William Roth's Finance Committee held hearings in 1997 and 1998, Mississippi's Trent Lott and Alaska's Frank Murkowski decried the IRS' "Gestapo-like tactics." Don Nickles of Oklahoma raged, "The IRS is out of control!" Congress went on to pass and Bill Clinton signed the IRS Reform and Restructuring Act in 1998.
Even as then-IRS Director Charles Rossotti warned Congress about an epidemic of tax cheating, Senator Gramm in May 1998 denounced the agency. Peddling myths of jack-booted IRS agents tormenting American taxpayers, Gramm called on Rossotti to fire his 50 worst employees. Gramm concluded:

"I have no confidence in the Internal Revenue Service of this country. You do not have a good system. This agency has too much unchecked power."

As the New York Times recounted that spring, the plan to gut the IRS advocated by Phil Gramm and his allies was a popular political gambit, but almost certain to create incentives for tax evasion:

Mr. Gramm spoke at length of how he had ''no confidence'' in the I.R.S., remarks that were in sharp contrast to those of every other senator, who emphasized that the majority of I.R.S. workers were honest and most taxpayers law-abiding.
A variety of tax experts have said in recent weeks that attacks on the I.R.S., which polls show are a potent device to win votes and contributions for Republicans, give comfort to tax cheats and discourage honest taxpayers.

Which, of course, is exactly what happened.

Those reforms in essence gave wealthier Americans carte blanche to cheat and fundamentally undermined tax fairness in the United States. Within one year, property seizures for unpaid taxes dropped by 98%. Liens were sliced by three quarters and levies on bank accounts by two-thirds. Johnston describes (p. 134) the overnight shift of tax policing onto poorer Americans:

In 1999, for the first time, the poor were more likely than the rich to have their tax returns audited. The overall rate for people making less than $25,000 a year was 1.36%, compared with 1.15% of returns by those making $100,000 or more...Over the previous 11 years audit rates for the poor had increased by a third, while falling 90 percent for the top tier of Americans.

Making matters worse, a Bush administration unable to permanently repeal the estate tax instead sought to cripple enforcement by laying off IRS lawyers responsible for estate tax reviews. By 2006, the IRS reported that 85 percent of large taxable gifts it audited shortchanged the government. As the Times detailed at the time:

Over the last five years, officials at both the I.R.S. and the Treasury have told Congress that cheating among the highest-income Americans is a major and growing problem.

Five years ago, Congressional Democrats sought to plug at least some of the leak. As then-Congressman Rahm Emanuel put it, "The tax gap is the logical place to go." As the New York Times reported at the time:

House and Senate Democrats say the government could collect as much as $100 billion more a year by whittling the tax gap -- the unpaid taxes, mostly on unreported earnings, that the I.R.S. estimated was about $300 billion a year...
Mark W. Everson, the I.R.S. commissioner, has expressed far greater optimism. At a hearing of the Senate Budget Committee a year ago, he told lawmakers that the government could recover "between $50 billion and $100 billion without changing the dynamic between the I.R.S. and the people."

The Bush administration and its GOP allies blocked that effort, despite Emanuel's pleas that "When you have a number as high as $300 billion in unreported and uncollected income taxes, that puts a burden on everybody." Especially, it turns out, because Republicans believe that some people are more equal than others.
Mercifully, President Obama and Capitol Hill Democrats have taken steps to recapture some of the lost revenue and restore at least some fairness to the tax system. Better late than never, the IRS has finally reversed its decade-long bias for the wealthy. The agency is once again offering the carrot and stick of an amnesty program and prosecution for Americans hiding unreported offshore bank accounts. As the AP reported in December 2009, the IRS is now less likely to audit those earning below $200,000 a year. The result, Politico explained just last week, is a reversal of the approach under Republicans even as the total number of audits (1.5 million, or 1.1 percent) is largely unchanged:

In the 2011 fiscal year, 12.5 percent of those with income of $1 million and higher were audited by the IRS, up from 8.4 percent in 2010, according to the agency's enforcement and service results. From 2004 through 2009, the percentage of audits for this income group had hovered between 5 percent and 6.5 percent.
Meanwhile, just 1 percent of those with incomes of $200,000 or less were audited by the IRS last year, indicating no significant change from previous years.

"We base our audit decisions on tax issues, nothing else," IRS spokeswoman Michelle Eldridge told the AP. "We don't play politics here."
If the IRS's own inspector general and Congressional investigators find they did, there should be hell to pay. But with Republicans like Newt Gingrich already denouncing the agency and its role in enforcing the Obamacare individual mandate, the GOP will play politics with the IRS budget regardless. And the certain result will be tens of billions in less revenue annually for Uncle Sam--and more debt for the United States.


Jon Perr
Jon Perr is a technology marketing consultant and product strategist who writes about American politics and public policy.

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