Just Taxes Blog by ITEP

Large and Growing Tax Gap Underscores the Need to Adequately Fund the IRS

October 17, 2023

As the battle over IRS funding continues in Congress, new figures show the difference between what Americans paid and owed in taxes grew to $688 billion in 2021, a significant jump from previous estimates. This new data underscores that last year’s boost to IRS funding under the Inflation Reduction Act was absolutely necessary and should be protected by lawmakers.

The $688 billion figure is the gross tax gap – the difference between estimated taxes owed and the amount of tax that is paid on time. It covers three main areas: non-filing ($77 billion), underreporting ($542 billion), and underpayment ($68 billion). The IRS estimates that late payments and agency enforcement efforts will generate $63 billion for 2021, narrowing the net tax gap to about $625 billion.

If the federal government could close the tax gap entirely, in theory that could eliminate most of the government’s primary deficit, the spending aside from interest payments that exceeds federal revenue, projected to be around $800 billion to $900 billion a year over the coming decade. Of course, no tax system is enforced perfectly so some tax gap will always exist, but there is no justification for its current size.

The new IRS funding will start to close the tax gap, thus generating revenue not by raising taxes but by enforcing tax laws already on the books. Funding for customer service is essential to helping honest, law-abiding taxpayers file timely and accurately. And funding for enforcement is critical to cracking down on tax cheats, especially the wealthy and large businesses who the IRS has struggled to adequately audit due to budget cuts.

It’s worth noting that these tax gap measurements don’t fully account for a wide range of tax avoidance, including the abuse of offshore tax havens and non-payment involving digital assets and cryptocurrency. In other words, the real amount of taxes not being collected is likely higher – perhaps significantly so. (The former IRS commissioner suggested that the true tax gap is more like $1 trillion a year.)

About 85 percent of taxes are paid in full and on time. The IRS is left to track down the rest and sometimes prosecute tax evasion or avoidance, especially from wealthier households and corporations, who make up most of the unpaid taxes in the gap. Inflation Reduction Act funding will increase this voluntary compliance rate by improving taxpayer service and using new technological tools. That funding already helped this tax season, cutting down this year on telephone wait times and helping taxpayers get their refunds more quickly.

Deep and persistent IRS budget cuts during the 2010s coincided with the tax gap’s rapid growth. From 2010 to 2021, lawmakers cut the IRS budget by an inflation-adjusted 19 percent, leading to a staff reduction of 22 percent even as the agency had to process a 7 percent increase in tax returns filed. The cuts to tax enforcement during this time were particularly acute, with funding reduced by 22 percent and staffing falling by 31 percent. Over the same period, the tax gap grew by 45 percent, after accounting for inflation.

The Inflation Reduction Act reversed this disinvestment by infusing the agency with $80 billion in new funding over a decade. However, House Republicans put this funding in their crosshairs immediately upon taking control of the chamber in January, ultimately leading to an agreement to cut $21.4 billion in IRS funding as part of this spring’s debt limit deal.

But that cut was not enough for some lawmakers, who have continued to push for even deeper clawbacks of the new funding. House Republicans have moved to rescind nearly all the additional IRA funding, despite the Congressional Budget Office estimating this would increase deficits by $100 billion over the next decade. And Senator Rand Paul has put forward a proposal to rescind $25 billion in IRS funding; the CBO estimates that this would lead to $49 billion in lost revenue over 10 years and therefore increase the deficit by $24 billion. It’s critically important that policymakers rebuff these attempts so we can turn the tide and start to shrink the tax gap after decades of growth.


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