Over $4.1 trillion.
That's how much the Internal Revenue Service,
commonly referred to as the IRS, collected in
gross taxes in fiscal year 2021.
The IRS brings in approximately 96% of the
federal government's funding every year.
The IRS is crucial for the functioning of the
federal government, but budget cuts have made it
difficult for the IRS to carry out its duties for
a while. Funding for the agency declined by more
than 20% between 2010 and 2019 when adjusted
for inflation.
This is the part of government that brings in
money, so you have to spend money to make
money.
The vast majority of IRS funding is allocated
through congressional appropriations.
And the problem is that the Congress doesn't do a
good job of funding the government.
Nobody likes the IRS.
It's just not a popular agency.
And that's impacted the IRS's ability to do its
job.
In line with the overall shrinking of the IRS
budget of course, the audit rate has decreased
significantly as well.
And so it's not very likely that you're going
to be audited. The IRS audited 3.8 out of every
1000 returns or 0.38% during the fiscal year
2022, which was actually lower than fiscal year
2021.
For taxpayers earning over $1 million, there
has been substantial reduction in audit rates,
but they are still audited more frequently
than taxpayers earning below $200,000 on
average.
So how does the IRS work and who's the most likely
to be audited?
The IRS is the organ of government that receives,
collects if you will, almost all the money that
comes in to fund the government.
There are two primary branches of the IRS,
services and enforcement and operations support.
The services and enforcement wing is what
most people think of when they think of the
IRS, collecting taxes and making sure everyone
follows the tax code.
The services and enforcement wing is sort
of split according to the sort of types of
taxpayers that fall under categories.
The IRS was restructured in 1998 to create these
four major divisions.
Operations Support oversees the customer
services division of the agency, as well as IRS
policies, programs and activities.
The IRS also established the Taxpayer Experience
Office in 2022 as part of a long term plan to
improve customer service.
If you worked at the IRS, they would emphasize the
third word in the IRS, which is "service," and
that's providing assistance to individuals
in understanding the tax law and figuring out
where their tax refund is.
The IRS is a part of the Treasury Department, but
it operates with relative independence,
particularly on issues of enforcement.
I ran the service for just over four years and
never once discussed an enforcement matter with
anybody at Treasury.
And it's illegal to be talking to the folks at
the White House about certain subjects.
It's pretty intentional that you keep a
separation there. The IRS needs to be seen by
the American people as absolutely nonpartisan.
So there has to be a certain distance, and at
least in the enforcement matters.
Even though the IRS tries to maintain its distance
from politics, it still depends on a partisan
Congress for funding.
Every year the IRS has been coming before
Congress and asking for money and getting an
appropriation for one year at a time.
And the IRS is just one of many government
agencies competing for a pool of money.
The IRS budget hit a high point in 2010 at $14.8
billion when adjusted for inflation, but the
funding began to decrease from there.
The Budget Control Act of 2011 created a series
of automatic federal spending cuts that were
set to begin in 2013.
Those cuts as a whole are referred to as the
Sequester of 2013.
As part of the sequester, the IRS budget
was cut by $89 million.
The IRS budget continued to decline throughout the
2010's. During that period, the IRS staff
experienced a 22% reduction.
The biggest cut in that has been in enforcement
and particularly in the most highly skilled
agents who do the audits and who also do
collections. And those are the very kind of
agents that do the most sophisticated, most
difficult returns.
That reduction in money also stalled investment
in technology.
This is highly technical work and you need
experience. Somebody who's three years out of
college isn't going to be doing the technical
work on the ExxonMobil tax return.
It takes a while to get that level of knowledge
and sophistication.
The pandemic marked somewhat of a turning
point for the IRS. First, in 2020 and 2021,
the IRS received supplemental funding from
Congress due to the pandemic, which led to an
increase in full time employment at the agency.
Then in August 2022, President Joe Biden
signed the Inflation Reduction Act into law.
That set aside nearly $80 billion for the IRS to be
used over the next ten years.
The bill allocates the most money to tax
enforcement, nearly $46 billion.
It provides a little more than $25 billion to
operation support, and the remaining 9.5 billion
will go towards taxpayer services, technology,
modernization and provisions like renewable
energy tax credits.
They did that in recognition of the fact
that the funding had been cut over a period of
years. Republicans have been trying to scale it
back because they don't want to see the
enforcement arm amped up, if you will, as much
as the Biden administration is seeking
to do. It's an unusually large amount for the IRS.
The IRS generally spends 13, 14, 12 billion a
year. So that's a lot of money for the IRS.
Now, if you compare it to the Navy or the
Department of Health and Human Services, no, it's
not a large amount of money.
So it's all relative.
They hired about 5000 new employees going into this
tax season that were planned to be up to speed
by Presidents Day weekend. So it's been
reported that the phone wait times have been
significantly lower.
So if you have an IRS issue, some sort of issue
with a tax return or you get a notice in the mail,
it's more likely that you're going to actually
speak to someone on the phone this year than in
the previous two seasons.
A more grounded critique of the plan is that
taxpayer service did not receive as large of a
budget increase as enforcement did.
The bill spends a lot on the sort of stick, but
not as much on the carrot.
Relatively speaking.
I believe in more funding for the IRS.
I do not think you need all of that 80 billion.
That's quite a bit. But what I would like to see
is 3 or 4% real growth each year, because one of
the challenges is if you throw too much money at a
government agency, you can lose control.
There's an old adage, you need to spend money to
make money. The Congressional Budget
Office estimates that the $80 billion in
funding over the ten year period could, quote,
increase government revenues by approximately
$200 billion.
During the period of funding cuts in the
2010's, audit rates declined across all
income brackets, but the richest Americans saw the
biggest decrease.
In 2019, a little more than 2% of Americans
earning more than $5 million per year had
their taxes audited.
That's down from 16% in 2010.
That means only about 1 in 50 high earners were
audited in 2019, compared to about 1 in 6
in 2010.
In addition to that overall change in audit
activity, lower and middle income taxpayers
who claimed what is called the Earned Income
Tax Credit were more likely to have their
taxes reviewed.
Part of the reason why that tax credit is
scrutinized more heavily is because it is a
refundable tax credit.
And that means that if you don't have any tax
liability, you still could potentially get a
refund. Whereas nonrefundable means once
you get to $0 owed, you're not going to get
any kind of a refund if you had that benefit that
was owed to you.
The main story there is one of tax code
complexity, but the reason for that is a
cost-benefit calculation by IRS enforcement and a
sort of nature of the beast of the EITC, where
EITC returns have a very high rate of errors and
largely derived from the complexity of the
program.
There was a recent study of a team of economists
from different universities and even
from the Treasury Department that found
that Black Americans are roughly 3 to 5 times more
likely to face an IRS audit than other
taxpayers. And one of the contributing factors
to that is actually due to the Earned Income Tax
Credit.
Individual income tax auditing activity wasn't
the only thing to change in the past decade.
Going back to 2010, nearly all of the largest
corporations were audited, and that's been
down by half.
Now it's about 50% of those very large
corporations being audited.
The service has a lot of stuff that is automated
where if they get a report from your
brokerage outfit that says you sold a stock or
something, they're going to wait to see that on
your return. And some of this can be done just
automatically through matching and you'll get a
letter that says, "we don't see this income,
this dividend income.
Where is that?" But if you're talking about an
audit, somebody has got to sit down and and look
and say, what is your support for this?
Or why did you take that deduction?
And that requires people.
And as the funding decreased, or was really
in some instances just held steady and you had
inflation, that meant there were fewer people
that you could have to do these audits.
Since getting the additional funding, the
IRS plans to hire 10,000 workers.
It's an exciting time to see what's going to
happen next for the IRS and it's eager to see
what's in that plan for the 80 billion going
forward.