In the Inflation Reduction Act, Congress made a monumental investment in the IRS, reversing a decades-long trend of inadequate funding. A critical question is: how much was this investment worth? Government scorekeepers came up with a number of about $200 billion (yielding a $120 billion net amount, after taking into account the cost of the increased funding). But, in a new paper, The Inflation Reduction Act’s Impact on Tax Compliance—and Fiscal Sustainability, Natasha Sarin and Mark Mazur argue that these official estimates significantly understate the return on investment in the IRS. They estimate that the funding would enable the IRS to raise at least $560 billion ($480 billion, net) over the next ten years, and that, depending on taxpayers’ behavioral response, it is possible the return may actually be closer to $1 trillion.
Sarin and Mazur’s analysis is compelling for a number of reasons. Sarin and Mazur are highly qualified experts, with a blend of extensive government, as well as academic, and other, experience, including recent stints in the Treasury Department in the Biden Administration, during formulation of the Inflation Reduction Act. Their analysis reflects this deep well of experience and training, in that it draws on government data as well as academic work regarding compliance. The result is a particularly nuanced picture of how the Inflation Reduction Act funding will affect the IRS and its collection capacity. Their conclusion – that the return on IRS funding could be approximately $500 billion in the first decade and $1 trillion in the ten years thereafter – is an important one; so is their description of all the particular ways that the IRS will improve, and why this improvement is an essential part of good governance.
The analysis begins with the somewhat grim picture of IRS capacity in recent years. In addressing this history, Sarin and Mazur provide some widely known statistics, such as the very low rate of phone calls that the IRS has answered, and the high costs to taxpayers in the United States of filing their tax returns. They mix in other, striking, and less well-known information, such as the fact that antiquated IRS technology has required IRS employees to keypunch millions of tax returns by hand, simply to include the information in a tax return database. The resulting stark picture they draw of a revenue agency operating with both hands tied behind its back despite eye-popping deficit figures, is solid motivation for a better understanding of what can be gained from increased funding for the IRS.
Sarin and Mazur then expertly describe the variety of ways that official estimates likely understate the full impact of the Inflation Reduction Act’s funding of the IRS. Official estimates key off of existing estimates of the tax gap – or the amount of taxes that taxpayers owe, but do not pay. But Sarin and Mazur illustrate how these estimates of the tax gap are themselves outdated and fail to take into account some of the biggest areas of noncompliance. For instance, pass-through businesses, which have exploded in popularity since the last time they were subject to official noncompliance estimates, likely result in very high amounts of unpaid tax liability (in particular by high-income taxpayers). The difficulty the IRS has had in auditing these taxpayers means there is likely much more revenue on table than current tax gap estimates reveal, and therefore much more to be gained from the increased IRS funding.
Moreover, due to uncertainty about revenue returns from non-enforcement investments in the IRS (including in service and IT), official estimates have not attributed any return from such investments. Sarin and Mazur acknowledge that there is some uncertainty around returns from non-enforcement investments, but the return is also not likely to be zero. Instead, these investments will likely increase IRS efficiency, reduce the incidence of taxpayer mistakes, and better enable the IRS to estimate, and therefore respond to, areas of noncompliance.
Official estimates of return on funding the IRS also fail to account for the ways that a change from historically low funding levels to significantly higher funding levels is likely to have increasing, rather than decreasing, marginal returns. The IRS also now has more sources of data than in the past to help its enforcement efforts, such as more 1099-K reporting, more information from foreign financial institutions, and more K-1s reporting partnership income. Improved technology infrastructure from increased funding should allow the IRS to better leverage this data to significantly increase collections from tax enforcement.
Finally, building on academic literature about compliance, Sarin and Mazur argue that all of these direct effects of greater IRS funding may be multiplied up to three times by the indirect, general deterrence effect of increased IRS funding. Official estimates of return from increased IRS funding significantly downplay this general deterrence effect.
Importantly, Sarin and Mazur make the case that the return on increased IRS funding is not just monetary. Another important return is an improved sense of basic fairness in the tax system. At present, there are two tax systems. Most Americans, who earn income from wages paid by an employer, have their taxes automatically withheld, and therefore have little opportunity to evade. In contrast, taxpayers with income from other sources (who often are higher-income taxpayers), have more opportunities to avoid tax liability, often with the help of sophisticated tax counsel. Sarin and Mazur argue that this two-tiered system, and the distortions in the economy that result, undermine confidence in the tax system.
There is certainly a lot more to think about in terms of return on IRS funding. For instance, how should we think about allocating IRS enforcement (and service, and other) dollars among groups? How might we better incorporate non-revenue returns into the analysis? Sarin and Mazur’s analysis does not address questions such as these. But it does illustrate extremely well how much the details of the tax enforcement and compliance landscape matter in estimating the likely impact of changes in IRS funding. In this way, Sarin and Mazur model the careful analysis needed to make informed change to the IRS.
This type of analysis will continue to be critical in the coming years. The IRS’s new source of funding is far from secure. Indeed, a significant portion of it was already carved back by the debt ceiling negotiations. This, alone, means that the IRS is unlikely to be able to produce the extent of returns that Sarin and Mazur predicted. Moreover, the IRS’s operations will continue to depend on annual appropriations amounts. If Congress reduces these amounts, gains made by the IRS from the Inflation Reduction Act funding will soon be lost. Sarin and Mazur’s excellent analysis, here, and elsewhere, will be a critical part of the inevitable, continuing discussions about IRS funding in the coming years. Tax scholars, commentators, and policymakers would be well-advised to pay attention to their findings and approach.
