The Taxman Cometh... Not
Max Sawicky's paper on "The Crisis in U.S. Tax Enforcement"
is very good and well worth reading. Three points especially seem worth a highlight. First, according to the latest estimates, about $353 billion in taxes went unpaid in 2001. If all of these taxes could be recovered, we essentially wouldn't have a deficit problem over the next ten years.
Second, the IRS, as many know, is woefully underfunded, but Max really highlights just how underfunded the agency really is, and how both population growth and the development of ever-more-sophisticated financial instruments are only going to compound the problem in the future:
There is little dispute that the workload of the IRS has been increasing more rapidly than its organizational capacity. The number of tax returns has increased steadily, partially due to a growing population and economy. There is also evidence, however, that returns have increased faster than population growth, in the form of more returns for unmarried persons and for children. Another dimension adding to the increased IRS workload involves high-income persons and the growth of pass-through entities (as noted above). Still another factor straining IRS capacity is the multiplication of highly complex and specialized financial instruments. The estimated overall increase in workload between 1992 and 2002 is 16%.
Third, poor people putting in bogus claims for the Earned Income Tax Credit are simply not the problem here, even though they're the ones that garner much of the attention whenever this subject comes up. EITC overclaims only account for around $9 billion of the tax gap—peanuts in the grand scheme of things. Moreover, many of these faulty claims are likely the result of honest mistakes rather than cheating: 40 percent of all low-income taxpayers have never even heard
of the EITC, and it's possible that a good number of folks are missing out on the tax credit or claiming too little. So by all means, clean this mess up, but let's not lose sight of the bigger picture: Contrast EITC shenanigans with corporate
tax evasion, which is both bigger and much, much less likely to be the result of an honest mistake or confusion.
Okay, actually there were four points. The crucial one: Many enforcement measures that could be put in place—cross-checking tax information, sending out Tax Delinquency Investigation notices by mail, correspondence audits (i.e., the less-fearsome sort of audit), criminal prosecution, tax preparation assistance, better withholding—all
of these things would recover far more in unpaid taxes than they cost to implement. Sometimes ludicrously so: Sending out Tax Delinquency Investigation notices by mail, for instance, costs 31 cents apiece, while the average return is over $12,000.
Sadly, the IRS has been tarred and feathered over the years, so people resist these sorts of enforcement moves. So here's one way to think about it: when it comes time to close the deficit, there's going to be a tradeoff between bulking up the IRS to nab delinquents and tax cheats, or levying even heavier
tax increases than would otherwise be necessary. You choose.