How Biden Funds His Next Bill: Shrink the $7.5 Trillion Tax Gap

The I.R.S. is often unable to detect or fight blatant tax cheating by the rich and big businesses. Restoring the missing revenue is a solution that pays for itself.

Ms. Huang is the executive director of the Tax Law Center at the New York University School of Law.

  • March 10, 2021
How Biden Funds His Next Bill: Shrink the $7.5 Trillion Tax Gap 1
Credit…Illustration by Jim Datz/The New York Times; 3D model by AlexLMX, via Getty Images

With the passage of a deficit-financed $1.9 trillion relief bill just hours away, Democrats in Congress may soon pivot to new agenda items, including President Biden’s Build Back Better plan for infrastructure and other critical investments. And those lawmakers will inevitably face intense pressure from fiscal moderates to include tax “pay fors” in spending legislation. One of the best ways to raise plenty of revenue — and help honest taxpayers — is to effectively battle tax cheats. To do that, though, Mr. Biden and Congress must seize the chance to revamp and restore the federal government’s own infrastructure: the Internal Revenue Service.

After a decade of budget cuts for the agency, the cracks in the I.R.S. are costing taxpayers trillions of dollars and growing impossible to ignore. The agency is increasingly unable to detect or address blatant tax cheating by high-income filers and the largest businesses. In February, the I.R.S. commissioner, Charles P. Rettig, told Congress that about $570 billion in taxes owed in 2019 were not paid. That tax gap is projected to total about $7.5 trillion over this decade. Meanwhile, the I.R.S. answered fewer than a quarter of its phone calls from people seeking help with their taxes.

From 2010 to 2019, lawmakers cut the I.R.S. enforcement budget by more than 20 percent. But Mr. Biden and the Treasury secretary, Janet Yellen, have pledged to rebalance tax enforcement, and this spring presents a chance to deliver. Any responsible recovery package would include a multiyear stream for rebuilding the I.R.S. Fully funding the agency would defeat tax cheats while raising revenue for critical investments. It would help the overwhelming majority of Americans who want to pay whatever they owe. It would help honest businesses better thrive and compete. And restaffing the I.R.S. through restored funding would help fight corruption and strengthen the rule of law.

Perhaps unsurprisingly, the wealthiest are the prime beneficiaries of the status quo. Estimates suggest that the top 1 percent of filers account for at least 28 percent and as much as 70 percent of the tax gap. The wealthiest households and largest businesses often use a complex maze of financial arrangements and offshore entities that make it incredibly hard and time-consuming for the I.R.S. to untangle what taxes are owed but not paid.

Largely as a result of its budget cuts, the I.R.S. has lost a third of its staff members who are knowledgeable enough to audit highly complex returns. While audit rates have dropped for tax filers across the board, they’ve fallen most steeply for America’s highest-income filers and its largest corporations: They are now about half as likely to be audited as they were a decade ago.

Even when the I.R.S. detects the most obvious forms of tax noncompliance among the wealthy, it is stretched too thin to follow up adequately. A Treasury Inspector General for Tax Administration report published last year found the I.R.S. had failed to follow up with more than 369,000 high-income households that simply did not file a tax return in prior years.

Recent reporting by The Times on Donald Trump’s dodgy tax returns — which included his highly questionable use of deductions and expenses — was just the latest revelation of apparently different standards for the rich. But it also heightened concern among tax experts regarding the ability of the I.R.S. to do its job when it’s so deeply depleted.

Multinational corporations being audited by the I.R.S. have shown they can outgun and outlast it, stalling their cases as long as possible to run out the clock on the statute of limitations. The number of cases brought by the agency’s criminal division has dropped by about a quarter since 2010. Many recent high-profile prosecutions for tax evasion — like those of Paul Manafort, Michael Cohen and Michael Avenatti — occurred only because federal investigators were investigating them for other reasons.

Generally, people are proud to pay taxes and contribute to investments in education, infrastructure, and other public services. But they understandably resent paying taxes when others are dodging them. And honest businesses get hurt when they are forced to compete with businesses that cut corners on what they owe.

An increase in I.R.S. funding to reverse this decade of damage would also make good fiscal sense. Natasha Sarin, an assistant professor at the University of Pennsylvania law school, and Larry Summers, the Harvard economist, have a proposal to restore about $100 billion to the agency’s budget over the next 10 years.

Various estimates by the Congressional Budget Office, the U.S. Treasury and academic researchers have concluded that investing in the I.R.S. would pay for itself many times over. The Treasury Department, for instance, estimated that each additional dollar dedicated to I.R.S. enforcement results in directly recouping about $6 in taxes owed.

If the Biden administration is looking for a detailed road map, two former I.R.S. commissioners, Charles O. Rossotti (who was appointed by a Democratic president) and Fred T. Goldberg Jr. (who was appointed by a Republican), explained how a restored I.R.S., with new I.T. funding, could be made more effective and efficient.

For example, because the I.R.S. gets information on wage and salary income from workers’ tax returns and their employers — and because their taxes are often automatically withheld — compliance on this type of income is above 95 percent. The I.R.S. could use this third-party information reporting approach to verify types of income, like business income, that typically flow to high-income households and big businesses.

The bipartisan Taxpayer First Act, which was signed into law in 2019, included some modernization measures but, crucially, didn’t include needed funding. Lawmakers have the opportunity to remedy that this year and finally secure the 21st-century tools and resources the I.R.S. needs. Because reforming the I.R.S. is compatible with the budget process that lets spending bills pass in the Senate with a simple majority, there’s little excuse for inaction.

If lawmakers let the chance slip by, the integrity of the tax system could further erode — with the cheats still getting away, at everyone’s cost.

Chye-Ching Huang is the executive director of the Tax Law Center at the New York University School of Law.

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