The impact of underfunding the IRS
Does it make sense to insulate the nation’s revenue collector from funding instability?
January 27, 2014
For the past three years, Congress has reduced funding to the IRS and other government agencies as part of broad spending-reduction efforts. IRS budget cuts can be popular among lawmakers and their constituents, especially because several IRS scandals have made news in recent months. Budget cuts can also force greater efficiency in certain areas.
The federal FY 2014 budget continues the trend: On Jan. 17, President Barack Obama signed into law the Consolidated Appropriations Act, H.R. 3547, which cuts the IRS budget by $526 million from the FY 2013 level.
Politics aside, it’s time to reexamine the underlying business sense of making large cuts to the IRS budget as if it were any other spending program—especially in light of the agency’s essential functions to enforce tax laws and serve taxpayers and tax professionals.
Here are five facts that Congress should consider when debating the IRS budget:
Fact 1: The IRS cannot collect all of what the government is already owed.
The Treasury loses $450 billion each year to taxpayer noncompliance, such as underreporting of income and failing to file or pay taxes. This amount is called the tax gap. To put that number in perspective, the tax gap is about two-thirds of the FY 2013 federal deficit.
In 2011, Congress cut the IRS budget by $300 million. Those cuts contributed to reduced IRS enforcement activity, which, in 2012, resulted in $5 billion less revenue collected. In 2012, Congress reduced the IRS budget by $600 million, the impact of which won’t be known until next year.
In 2011, former IRS Commissioner Douglas Shulman stated that each $1 cut to the IRS budget results in $7 less revenue collected. Shulman also predicted that the 2011 IRS budget cuts would cost the federal government $4 billion in lost enforcement revenue; the actual loss was 25% more. The cuts affected staffing as well, with 7,000 fewer full-time employees between the end of 2010 and 2012. Any reduction in resources would likely continue to have a multiplying effect in these areas.
Fact 2: The IRS cannot help all of the taxpayers who try to contact the agency.
IRS customer service has suffered greatly due to budget cuts. In 2012, the agency answered only 68% of phone calls and 52% of mail correspondence in a timely manner. In his book, Many Unhappy Returns, former IRS Commissioner Charles Rossotti said it best: “I have never understood why anyone would think it is good business to fail to answer a phone call from somebody who owed you money.” Budget cuts directly impact taxpayers and tax professionals who contact the IRS in an effort to be compliant.
Fact 3: Fewer IRS resources discourage voluntary compliance.
Former IRS Acting Commissioner Steven Miller discussed this problem while speaking to the House Appropriations Subcommittee on Financial Services and General Government on April 9. He stated that because of budget cuts, the IRS’s diminished ability to conduct enforcement activity will cause taxpayers to worry less, “as they realize that they have a better chance of winning the lottery than getting audited.”
According to the IRS Oversight Board, which studies taxpayer compliance behavior, accountability through IRS information-matching programs and fear of an audit are two of the most compelling factors contributing to taxpayer voluntary compliance—which is the rate that taxpayers self-report, file, and pay their taxes. Several years ago, Congress requested that the IRS reach a 90% voluntary compliance rate by 2017, compared with the current stagnant rate of 83.1%. Reducing resources for IRS compliance activity isn’t likely to increase that rate.
Fact 4: The IRS and taxpayers are overwhelmed with tax code changes.
Since 2001, the Internal Revenue Code has undergone more than 5,000 changes—the equivalent of more than one per day—and has become increasingly complex. From 1990 to 2010, filings of the easiest individual tax return, the Form 1040EZ, decreased by 3%, as filings of the most complex individual return, Form 1040, increased by 21%. The National Taxpayer Advocate estimated in 2008 that it takes the average individual taxpayer 26.4 hours to complete and file his or her taxes.
Simplicity does not appear to be on the horizon, and the IRS now also is responsible for implementing many provisions of the Patient Protection and Affordable Care Act.
With all of these changes and complexity, tax reform has become popular with many Americans. In the short term, implementing any sweeping reforms to the Code would require the IRS to help taxpayers and tax professionals navigate the changes. To do this well, the IRS would need more staffing and budget resources.
Fact 5: Budget cuts create a barrier to IRS technological innovation that would provide more efficient long-term solutions.
Many IRS computer systems are decades old, and the IRS has been struggling to replace them. When tax laws change or emerging issues arise, the IRS is forced to adapt its antiquated system. For example, in March, the IRS was still altering its computer systems to accommodate the “fiscal cliff” changes to the Code that were enacted on Jan. 2. As a result, the delays prohibited many taxpayers from filing early.
Identity theft is another emerging issue that the IRS cannot easily solve with its current technology. In 2012, the IRS prevented more than 3 million fraudulent refunds, amounting to close to $20 billion, but it needed more than 3,000 employees to work those cases. In an age when almost all businesses interact with their customers electronically, the IRS continues to rely on a paper-and-phone system to interact with taxpayers, at a detriment to customer service and revenue-collection capabilities. Without a budget that takes into account long-term solutions, the IRS will be stuck with outdated technology that undermines its own efforts.
Government and industry concerns
In September, the AICPA sent a letter urging Congress to properly fund the IRS. The letter cited concerns that budget reductions would lead to increased call wait times and excessive delays in responding to taxpayer and practitioner correspondence, failure to keep taxpayers informed of tax law changes, and excessive delays in the issuance of administrative guidance and the release and update of tax forms.
In the National Taxpayer Advocate 2012 Annual Report to Congress, IRS Taxpayer Advocate Nina Olson said that treating the IRS as a pure spending program is self-defeating. Money not spent in this area translates into multiple times less revenue collected and ultimately adds to the federal deficit.
All these challenges reflect the need for Congress to set policies that make good business sense, independent of politics. Congress should consider revising budget rules to protect the IRS from political swings in funding, so the IRS can deliver customer service and enforce tax laws. Multiple-year funding is another viable option being discussed in Congress to address this instability.With a national debt of more than $17 trillion and growing, Congress should understand that making large cuts to the IRS budget undermines voluntary compliance, revenue collection, and IRS compliance efforts.