Charles Silver

Beefing Up the IRS with Outside Help

As Thomas Frank recently made clear, the Republican Party has worked hard to de-fund its political opponents. Tort reform advanced this objective by putting plaintiffs’ lawyers out of work. As state after state capped damages or legal fees, personal injury litigation became unprofitable and hundreds or thousands of plaintiffs’ attorneys closed their doors. Unable to support themselves, they could not support Democratic causes and candidates either.

Plaintiffs’ lawyers are good at collecting money on legal claims from wealthy corporations. This skill is in short supply. The federal government lacks it; at least, the IRS does when it comes to collecting taxes from America’s wealth elite.

The statistics are clear. The IRS is exceedingly unlikely to audit wealthy individuals. TRACIRS reports that only 30 of the nation’s 180,000 millionaires were subject to face-to-face audits in FY 2005. The IRS disputes this number, but if it is even close to right the audit rate for America’s wealthiest individuals is below one-tenth of one percent.

The IRS is actually more likely to audit poor people than rich ones. Consider the following chart, also produced by TRACIRS. People with incomes below $25,000 are more than twice as likely to be audited as people with incomes above $200,000. This focus reflects a push during the Gingrich era to carefully examine claims for payment of the Earned Income Tax Credit.

The IRS also appears to be less likely to audit partnerships and S-corporations, so-called pass-through entities, which “continue to be in the news because of their improper use of tax shelter mechanisms. While the IRS has said that cracking down on improper tax shelters is a top priority, the numbers suggest IRS actions may not have kept pace with the agency’s rhetoric.”

All told, audit rates for corporations are low and falling. “In FY 2004 … only 0.65 percent of all corporations were subject to a face-to-face audit. This rate has been in general decline for many years. Just in the last year it dropped an additional 11 percent. A decade ago the corporate audit rate was three times higher than it was [in FY 2004].”

The simplest explanation for this is that Republicans in Congress and, more recently, the Executive Branch have under-funded the IRS, which claims to need 5000 more employees. The Republican Party’s plan seems to be to force the federal government into insolvency by spending money wildly while cutting taxes and turning a blind eye tax evasion.

• Since 1992, IRS staffing has fallen 17 percent while the number of tax returns has risen 13 percent. The audit rate is below one-half of one percent, down from 1.68 percent in 1996.
• Tax evasion is widespread and getting worse. The Treasury Department estimated that there were 8.6 million non-filers in 2004. A study of a group of Fortune 500 companies found that 24 owed no taxes in 1998, up from 13 in 1997. In 1981, the estimated tax gap—the difference between income taxes owed and collected—was $76 billion. According to the IRS, it rose to about $300 billion in 2001. Closing the gap would generate enough money to cover the federal deficit.
• In 1999, the IRS allowed 668,000 known tax evaders to run off with a total of $2.5 billion simply because it had insufficient staff to pursue them. Although the IRS has identified nearly 1 million chronic non-filers, only 219 of them went to jail in 2001. The IRS cannot close the tax gap.

Recently, the IRS sought to address its manpower shortage by announcing that it would assign delinquent accounts to private collection agencies (PCAs). The decision provoked gales of criticism, much of it focusing (rightly) on the fact that PCAs are more expensive than IRS agents. Liberal economist Paul Krugman went farther. He called the use of PCAs “a retreat from modern principles of government” and accused the Bush administration of wanting to take the country “back to the 16th century.” He compared PCAs to private security contractors—so-called “mercenaries”—at work in Iraq. (Krugman, Tax Farmers, Mercenaries and Viceroys, NY Times, Aug. 21, 2006).

I am no fan of President Bush, but Krugman’s assessment is over the top. PCAs are a modern means of collecting delinquent accounts. About 40 state revenue departments and the District of Columbia use them to collect delinquent taxes. In Texas, my home state, PCAs collect a diverse array of revenues for municipalities, at fees of up to 20 percent of recovered funds.

The federal government uses PCAs to collect debts too. One source reports that “by 1995, at least twenty federal agencies were using private debt collectors.” Fact sheets prepared by ACA International (formerly the American Collectors Association) provide specific examples:

• In FY2004, PCAs working with the U.S. Department of Treasury Financial Management Services Division collected $610 million, a 12 percent increase over FY2003.
• Also in 2004, PCAs received referrals totaling $18.3 billion from the Department of Education, the Department of Health and Human Services and the Treasury.
• In the same year, PCAs recovered $532 million in payments on federally backed student loans and rehabilitated another $587 million in delinquent loans. Costs declined from 18.6 percent in FY 1999 to 16 percent in FY 2004.

Given the extent to which the federal and state governments use PCAs and the length of time PCAs have been employed, it is silly to characterize them as Krugman does.

Realistically, the choice is to ignore tax evaders or to find innovative (and off-budget) ways to make them pay. Doing nothing is bad policy. Many people pay income taxes because they think it is the right thing to do. Their conviction breaks down when they see other people getting away with cheating. A 1999 survey found that 87 percent of taxpayers regarded any cheating as unacceptable. In 2001, only 76 percent did. Tax evasion also forces the government to impose higher rates, which encourages more people to cheat. Increased use of PCAs seems inevitable.

Given the IRS’s need for off-budget manpower, the possibility comes to mind of siccing those unemployed plaintiffs’ attorneys on wealthy individuals and businesses suspected of committing income tax fraud. They know their way around the courthouse, and they’re not shy about demanding money. The False Claims Act (FCA) provides a precedent for this. Under the FCA, private individuals who report frauds receive contingent fees from the monies the federal government collects. From 1987 to 2005, the federal government recovered over $15 billion and paid out $1.6 billion in fees. That’s $13.4 billion in found money for honest taxpayers.

Posted at 2:09 PM, Sep 26, 2006 in Permalink | Comments (4) | TrackBack (0)