IRS Audits of the Rich Deliver Huge Returns: New Study

By Yuval Rosenberg

Good evening. The Federal Reserve hit pause on its rate hikes today. We’ve got a look at what that means and details on new research that suggests the government will lose out on a big chunk of revenue if it defunds IRS audits.

Auditing the Rich Delivers Huge Bang for the Buck, New Study Finds

Republicans have been clamoring to rescind billions of dollars in additional funding provided for the Internal Revenue Service as part of last year’s Inflation Reduction Act. They succeeded to an extent as part of the recent deal between House Speaker Kevin McCarthy and President Joe Biden to raise the debt limit, which also clawed back $21.4 billion from the tax agency.

A new study suggests that deal could be costly. Researchers at the Treasury Department, Harvard University and The University of Sydney looked at IRS data for about 710,000 in-person audits. They found that audits generate a substantial return for the government — and while audit costs rise for those with higher incomes (because wealthy people typically have more complicated tax filings) the returns rise even more. Every additional dollar spent on auditing taxpayers in the top 10% of earners generates more than $12 in revenue for the government.

Washington Post Columnist Catherine Rampell lays out another way to think about the new data: “On average, the direct revenue collected from audits exceed costs by a factor of 2 to 1,” she writes. “But, that payoff varies by income. For money spent auditing the bottom half of taxpayers, the IRS only roughly broke even. Meanwhile, the agency pulled in $3.18 for each dollar spent auditing the top 1 percent, and $6.29 for the top 0.1 percent.”

The study also found a lasting benefit from the audits: taxpayers who were audited voluntarily pay more taxes going forward — for at least 14 years after the initial audit. “For every $1 an audited person pays during their audit, they pay $3 more on their taxes in the subsequent years,” Harvard Economist Nathaniel Hendren, one of the paper’s authors, tweeted.

The Congressional Budget Office models only modest lasting effects from stepped up enforcement, but the new study finds that longer-term deterrence results in about three times the revenue of the initial audit. Taxpayers either get scared straight or correct unintentional errors they previously made, resulting in higher tax payments over time. “Our finding of significant deterrence effects throughout the income distribution differs from existing CBO scores,” Hendren notes.

Why it matters: “If the IRS spends more money on audits, and those resources actually target high earners, the payoff could be enormous — far greater than has usually been assumed,” Rampell writes. The new research also indicates that auditing top earners is a more efficient way to increase revenue than raising tax top rates. “Which means,” Rampell says, “rather than soaking the rich through higher tax rates, perhaps we should merely enforce existing law.” But if the $20 billion cut to IRS funding comes out of enforcement and audits, it could mean that lawmakers just gave up hundreds of billions more in revenue.

Fed Pauses Rate Hikes but Says More Are Coming

The Federal Reserve on Wednesday announced that it would hold interest rates steady for now, as officials declined to raise the central bank’s benchmark rate for the first time in more than a year.

Before today’s announcement, the Fed had raised rates at 10 consecutive meetings over 15 months in an effort to cool the economy and bring inflation under control. Many analysts expected the central bank to announce a pause today, thinking the Fed was likely done with rate increases, but the Fed’s policymakers surprised many observers by indicating that they expect to raise rates two more times this year, with the first of those increases potentially coming as soon as July.

“Holding the target range steady at this meeting allows the Committee to assess additional information and its implications for monetary policy,” the Federal Open Market Committee said in a statement. As before, officials said they would consider a wide variety of data points as they determine how to proceed in their campaign to return inflation to the target of 2%.

Higher for longer: Although Fed officials will wait to see what the data reveals in the coming weeks, with the path ahead still to be determined, Powell said most FOMC members believe that more rate hikes will be necessary, given the persistent and in some ways surprising strength of the economy. “Nearly all committee participants expect that it will be appropriate to raise interest rates somewhat further by the end of the year,” he said.

The economic projections released Wednesday show that most FOMC officials now believe that the benchmark rate will need to go up another half point from the current target range of 5.0% to 5.25%. Of the 18 members of the FOMC, 12 projected rates at or above the range of 5.5% to 5.75% by the end of the year.

“Inflation pressures continue to run high and the process of getting inflation back down to 2% has a long way to go,” Powell told reporters. Core inflation is still running hot, Powell said, and the labor market has proven to be resilient, indicating that pricing pressure has been slow to ease throughout much of the economy.

“Given how far we have come, it may make sense for rates to move higher but at a more moderate pace,” Powell said.

Some inflation hawks said they were glad to see the change in the Fed outlook, even with the pause in June. “Pleased to see that the Fed continues to be data dependent: they are expecting higher inflation & lower unemployment so raised their median expectation for rates by 50 [basis points],” said former Obama administration economist Jason Furman. “I wish they had gotten started on that process today, it may not be enough, but a reasonable place to land.”

Soft landing ahead? Furman and others also noted that the Fed’s economic projections show no recession, at least in the near term. “They're projecting 1.0% growth in 2023 (Q4/Q4),” he tweeted.

New York Times economics reporter Talmon Joseph Smith reached the same conclusion. “[D]espite hinting at a willingness to hike rates higher, it is now, in essence, projecting a soft landing,” he tweeted.

Powell reiterated his belief that a soft landing is a possibility. “There is a path to getting inflation back down to 2% without having to see the kind of sharp downturn and large losses of employment that we’ve seen in so many past instances,” he said. “It’s possible. In a way, a strong labor market that gradually cools could aid that along. But … the committee is completely unified in the need to get inflation down to 2% and will do whatever it takes to get it down to 2% over time.”

The projections indicate that Fed officials expect to see an inflation rate of 3.2% by the end of the year, with core inflation, which strips out volatile food and fuel prices, coming in at 3.9% — higher than the 3.6% projection made in March.

The bottom line: Strong economic data has pushed the Fed into a more hawkish stance on inflation, which more than likely means higher interest rates ahead.

Quote of the Day

“It is a system that is created to just make it hard for people to get the services they need. There’s a trapdoor wherever you step.”

— Neil Sealy, executive director of the progressive advocacy group Arkansas Community Organizations, speaking to Politico about the difficulties low-income citizens are facing during the ongoing purge of beneficiaries from Medicaid now that the Covid-19 crisis is officially over. More than 1 million people have been removed nationally from the Medicaid system since April 1, with 140,000 of them living in Arkansas. The majority have been kicked off for procedural reasons, such as failing to return paperwork on time.

“There’s so many pitfalls. You can’t just tell somebody, ‘Just look out for this,’ and then you know they’re good,” Trevor Hawkins, an attorney with Legal Aid of Arkansas, told Politico. “There’s just so many things, and there’s people that’ve done everything they could to make sure their address was up to date and all of that and they still didn’t get the notice or the notice still went to the wrong address.”

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