Deficit Math: IRS Budget Cuts Could Cost $4 Billion

Deficit Math: IRS Budget Cuts Could Cost $4 Billion

Iva Hruzikova / The Fiscal Times

In the midst of their drive to reduce federal budget deficits, congressional Republicans are also intent on cutting taxes. One way they may accomplish that is by forcing the IRS to curtail its drive to force tax cheats to pay what they owe.

Among budget cuts Republicans are proposing for the current fiscal year is $600 million in IRS spending between now and September. IRS Commissioner Douglas Shulman told a House subcommittee last week that such a budget cut over just six months likely would reduce federal revenues by $4 billion. The IRS “would need to make substantial cuts to its enforcement programs,” he said.

In other words, cut spending by $600 million, lose $4 billion in revenue and add $3.4 billion to the deficit. That’s absurd arithmetic and unfair to the large majority of taxpayers who pay what they should. Shulman said the IRS collected $2.345 trillion in fiscal 2010, ended last Sept. 30, some 93 percent of federal receipts.

The biggest beneficiaries of reduced enforcement would be those whose income isn’t reported to the Internal Revenue Service by someone else — such as many small businesses or high-income taxpayers who can take advantage of complicated tax avoidance schemes.

Ordinary folks have their wages reported on W-2 forms, interest from a bank account on 1099-INT’s, dividends on 1099-DIV’s, pensions on 1099-R’s and often other types of income on 1099-MISC’s. IRS computers later match those reports with what recipients show on their tax returns.

The income of most small businesses is reported only on their tax returns, and many don’t report all of it, according to IRS studies. Such underreporting is responsible for a large share of the so-called tax gap — the difference between what taxpayers owe and what they pay on time. In the latest estimate available, IRS pegged the gap at $345 billion in 2001, including $109 billion related to income from businesses such as sole proprietorships and $197 billion due from individuals.

The Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution, has estimated that more than 60 percent of underreported individual tax is for business and self-employment income that the IRS can’t easily verify.

Underreporting by small business is so widespread that the Bureau of Economic Analysis, the Commerce Department agency responsible for producing data for the gross domestic product or GDP — more than doubles what’s reported as nonfarm proprietors income in its calculations.

Rudy Penner, a former Congressional Budget Office director now at the Urban Institute, noted that Congress years ago prohibited CBO from crediting any increase in the IRS budget with generating more revenue, but added he doesn’t doubt that more money spent intelligently on compliance would more than pay for itself.

“I still think the evidence is pretty strong that there is plenty of money to be collected” from those who aren’t paying what they owe, Penner said in an interview. “We are far from the point of harassing the public.”

The desire to avoid paying taxes likely was a factor in the strong opposition last year to a provision of the health-care form act intended to help pay for the cost of extending health insurance to most Americans. It required all businesses to report the name, taxpayer identification number and amount paid each year to any supplier receiving $600 or more. The provision was expected to add $19 billion to federal revenue over 10 years.

The idea was denounced as an intolerable paperwork burden on small business — and even the IRS ombudsman wondered if the IRS itself would be able to cope with the flood of information, much of which would be in the form of paper. President Obama has agreed to a repeal of the provision, which Congress is expected to take up shortly.

Another reporting requirement effective this year should help reduce underreporting, however. Financial networks, such as credit card systems, that collect payments from one person or business and remit them to someone else now have to report the amounts if they exceed $1,000 in a year. In this case, the reports and the matching with tax returns can be done electronically.

Still, IRS employees will have to be involved and if the IRS shrinks, it will have an impact on revenues and thus deficits. A smaller IRS also won’t have the resources to handle the expanded duties called for in the Affordable Care Act, which Republicans want to repeal.

The IRS budget was $12.15 billion last year and Obama sought to raise it to $12.63 billion in fiscal 2011, which began last Oct. 1. But the 2011 budget was never passed and the government has been operating under a continuing resolution, with spending at the 2010 level. The cut the GOP wants would mean the IRS would have to operate for six months with no more money than it had in 2008.

In his 2012 budget, the president is seeking 9 percent more than was requested for fiscal 2011. Part of the increase is $240 million for a “targeted set of new, revenue generating tax-enforcement initiatives aimed at closing the tax gap—the difference between taxes owed and paid. When fully in place by 2014, these new efforts are expected to yield about $1.3 billion a year in additional revenue,” the latest budget said.

There was a large drop in IRS staff following an investigation by the Senate Finance Committee into alleged abuses by IRS agents in 1997. The hearings led to the Internal Revenue Service Restructuring Act, which greatly limited audits and property liens against delinquent taxpayers. Now some critics, including Rep. Pat Tiberi, R-Ohio, chairman of the House Ways and Means subcommittee on select revenue measures, want a rollback of collection efforts.

“We’re hearing from small businesses a repeat of the horror stories from more than 10 years ago,” Tiberi said. “I think you will see  House Republicans have a real discussion about the role of the IRS in this country as we are trying to grow the economy and create jobs.”

The mantra is that regulation costs jobs. Paying taxes costs jobs. But so can a lack of regulation that allows financial institutions to take on so much risk that it leads to a financial crisis that costs millions of jobs. Not collecting taxes that are owed erodes voluntary compliance by other taxpayers and enlarges deficits. Will Republicans provide any estimates of how much their spending cuts will reduce taxes and add to the 2012 deficit?

Related Links:
Tax Evasion: Crackdown on Overseas Accounts (The Fiscal Times)
Despite Enforcement Success, IRS Faces Cuts (Washington Post)
Republicans Are Right to Cut the IRS Budget (