The Internal Revenue Service’s Enforcement Budget and Tax Compliance

The Internal Revenue Service’s Enforcement Budget and Tax Compliance

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INSIGHTi
The Internal Revenue Service’s Enforcement
Budget and Tax Compliance
January 15, 2021
This Insight examines key considerations in the debate over whether the Internal Revenue Service’s
(IRS’s) current enforcement budget is adequate to improve tax compliance—especial y among high-
income persons and pass-through business owners.
IRS Enforcement Budget
The IRS enforcement budget funds a variety of activities, including auditing tax returns, collecting unpaid
taxes, getting tax returns from individuals who did not file on time, and verifying information reported on
tax returns with similar information from third parties.
Federal tax collection is based on a system of voluntary compliance by taxpayers. Increases in tax
noncompliance, especial y among taxpayers with income that might be relatively easy to conceal from the
IRS, have the potential to erode public trust in the fairness and integrity of the federal tax system. A 2019
survey by the Pew Research Center found that 6 in 10 Americans believe that corporations and high-
income persons do not pay their fair share of the federal income tax.
Since FY2010, there has been a significant decline in the IRS’s outlays for enforcement, as Table 1
shows. From FY2010 to FY2019, the IRS enforcement budget fel by over 16% (in nominal dollars), and
the number of full-time-equivalent (FTE) IRS employees involved in collection and examination dropped
by 36%.
Table 1. IRS Enforcement Budget and Selected Audits in Fiscal Years 2010 and 2019
Percentage Change
FY2010
FY2019

2010 to 2019
Enforcement: costs incurred
(bil ions of dol ars)
$5.5
$4.6
-16.4%
Col ections and examination
workforce (end of fiscal
46,667
29,867
-36.0%
year)
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Percentage Change
FY2010
FY2019

2010 to 2019
Overal examination rate for
individuals (%)
1.1%
0.4%
-63.4%
Examination rate for
individuals with $1 mil ion or
8.4%
2.4%
-71.4%
more in income (%)
Examination rate for
individuals with $200,000 to
under $1 mil ion in income
2.9%
1.0%
-65.5%
with business income
Examination rate for C
corporations with $20
98.0%
49.9%
-49.1%
bil ion or more in assets
Source: Congressional Research Service and Internal Revenue Service Data Book, 2010 and 2019.
Tax Compliance
As shown in Table 1, one result of these cutbacks in enforcement resources has been a sharp decline
during the past decade or so in examination rates. This is a concern not only because less revenue is
collected, but also because studies have shown that audits increase future tax compliance among people
who are audited, as wel as people who are not audited.
The best available measure of the extent of tax noncompliance is the federal tax gap, which the IRS
estimates at irregular intervals; the most recent estimate covers the period from 2011 to 2013. This gap,
which is measured in gross and net amounts, is the difference between the total amount of federal taxes
owed in a year and the amount of those taxes paid in full and on time. According to the IRS, the annual
gross tax gap averaged $441 bil ion from 2011 to 2013, or 16% of federal taxes owed, which meant that
the overal tax compliance rate was 84%. After al owing for late tax payments and revenue collected
through IRS’s enforcement actions, the average annual net tax gap totaled $381 bil ion in that period. One
way to think about the tax gap is to view it as a measure of the potential revenue that could be collected if
the IRS had sufficient resources. It is not clear to what extent declines in audit rates after 2010 contributed
to the tax gap.
The tax gap has three components: nonfiling among taxpayers required to file a return (9% of the 2011-
2013 gross gap); underpayment of taxes owed (11%); and underreporting of taxable income on returns
filed on time (80%). Underreporting of taxes occurs when a taxpayer understates taxable income and
overstates tax credits, deductions, or income adjustments. Unreported noncorporate (or pass-through)
business income is the largest subcomponent of the federal gross tax gap: from 2011 to 2013, it averaged
an estimated $110 bil ion each year, or 25% of the gross gap. This income is difficult for the IRS to
monitor (and thus tax) because much of it is not subject to the third-party information reporting and
withholding that applies to wage income.
Options for Improving Tax Compliance
Concern about recent decreases in the IRS’s enforcement resources has led some to cal on Congress to
invest more in IRS enforcement over a multiyear period. Proponents of this approach say that after a
decade of reductions in staff, a primary chal enge facing the agency is rebuilding its workforce. Employee
compensation accounts for about 70% of the IRS’s overal budget. A hiring freeze from FY2011 to
FY2018 kept the IRS from bringing in new employees, and

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45% of current employees are eligible for retirement in the next two years. As proponents point out, a key
to the success of this approach is for the IRS to replenish its staff of revenue agents and examiners. The
IRS added 35 FTE employees in FY2019.
Proponents contend that large increases in IRS’s enforcement budget are likely to improve tax compliance
and reduce the net tax gap. According to a recent report by the Congressional Budget Office, a cumulative
$40 bil ion increase in IRS’s enforcement budget between 2020 and 2030 would increase revenues by an
estimated $103 bil ion, resulting in a $63 bil ion reduction in the federal budget deficit. The estimate is
based on an assumed return on investment of $6.40 of added revenue for each additional dollar spent on
enforcement.
Not everyone agrees that the solution to declining audit rates and persisting large tax gaps is to provide
the IRS with more resources for enforcement. Some maintain that the agency already has adequate
resources to address those issues and must do a better job of using the funds if the IRS is to improve tax
compliance. To il ustrate their point, some opponents of large increases in IRS’s enforcement resources
cite the cost overruns and delays that have repeatedly beset the agency’s business systems modernization
program, which began in the early 1990s as the successor to two earlier failed modernization efforts.

Author Information

Gary Guenther

Analyst in Public Finance

Disclaimer
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