President Biden needs a lot of new government revenue to pay for green energy and social welfare programs he’s urging Congress to pass. Big fights over raising taxes on businesses and the wealthy are underway.
But Biden is also looking for money in a place that shouldn’t be controversial: the bulging pockets of people who already owe billions in taxes, but don’t pay.
There’s long been a “tax gap”—money taxpayers owe that the Internal Revenue Service fails to collect. Much of that tax evasion is deliberate, with money hidden in complex tax shelters the IRS has trouble finding. That makes it hard to know how big the tax gap is, since the IRS can’t count money it can’t find.
But new evidence suggests there’s a shocking amount of money that mostly wealthy Americans owe but don’t pay. On May 20, the Treasury Department published an analysis of the problem estimating the tax gap is nearly $600 billion per year. That might be a conservative estimate. IRS Commissioner Charles Rettig told Congress earlier this year unpaid taxes could total $1 trillion per year.
Whatever the number, it’s a vast sum. Biden’s plan to raise the corporate tax rate from 21% to 28% would only raise $110 billion per year, barely one-sixth the Treasury estimate of the annual tax gap. Biden’s plan to raise income taxes on the wealthy would generate just $75 billion per year. If Congress passed every tax hike Biden is asking for, it would only produce about $210 billion in new revenue per year. Closing the tax gap by half would provide all the funding Biden is looking for, and then some, without any new tax hikes.
(AP Photo/ Manuel Balce Ceneta) ·ASSOCIATED PRESS
This week’s Treasury report outlines how Biden plans to narrow the tax gap and force evaders to pay. Republicans who have controlled one or both houses of Congress for most of the last 10 years have whittled down the IRS budget and eviscerated its ability to pursue the most aggressive tax cheats. Biden would reverse that trend by providing $80 billion in new IRS funding during the next decade. That would nearly double its annual budget of about $12 billion.
The money would upgrade an antiquated computer system that runs on obsolete programming language. That would enable the IRS to use machine learning and artificial intelligence to better track sophisticated tax cheats. It would also hire and train new auditors, boosting audit rates that have plunged during the last decade. Beefing up tax enforcement would take time, but start to make a big difference by the end of the 2020s.
Going after hidden income
One big change the IRS wants to make is requiring financial institutions to report more of their clients’ activity to the agency. This highlights how the wealthy are able to abuse the tax-reporting system. Taxpayers earning most of their income from a job are already subject to such third-party reporting: Their employer reports their W-2 wages to the IRS, making it essentially impossible for taxpayers to hide or underreport that part of their income. Independent contractors can hide income if they get paid in cash, but many payments are listed on 1099 forms that also go to the IRS.
It’s much easier to hide income from sole proprietorships, S corporations, rental agencies and other types of private business entities. When the IRS gets thorough third-party reporting on a taxpayer, it uses software to look for mismatches that could indicate underpayment of taxes. But it can’t look for mismatches without the data. The agency says the “misreporting rate”—the portion reporting their income incorrectly—is just 1% for people whose employer files a W-2 form. But for taxpayers with “opaque” income sources, such as a private business, the misreporting rate is around 55%.
Biden often talks about wealthy Americans paying their “fair share,” and while there can be honest disagreement about what “fair” is, exactly, it’s inarguable that people should pay what the law says they should. Even if Biden wanted no additional spending, it should still be a priority to collect all taxes owed, if only to reduce budget deficits that were heading toward $1 trillion per year on a normalized, pre-pandemic basis.
Yet there are those who argue against stronger enforcement. The Wall Street Journal complains tougher tax enforcement “means the IRS would have to harass tens of thousands of small businesses to find spare change.” That’s like saying it's okay to cheat, as long as you’re a business. As for the “spare change,” the Journal cites one estimate that better enforcement would only generate $103 billion in new revenue, rather than $600 billion. If that’s the lowball estimate, it’s still a heckuva lot of found money.
Congress would have to pass most of these changes, which seems the simplest decision on this year’s legislative agenda. It won’t be, of course, with the laissez-faire tax-evasion lobby pressuring Republicans to kill the plan. But any member of Congress who votes against pay-what-you-owe should explain why tax evasion is in the nation’s interest—and then suggest better ways to raise money.
