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More audits of the rich's tax returns could yield trillions

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When President-elect Joe Biden takes office in January, he’ll face a quandary: how to reform the tax system to raise much-needed government revenue. One promising option: Give the Internal Revenue Service the resources needed to ensure the wealthiest are paying the taxes they already owe.

As it turns out, Donald Trump isn’t the only affluent American partial to aggressive tax maneuvers. Private equity executive Robert Smith, who made headlines in 2019 by pledging to pay off student loans for Morehouse College graduates, recently admitted to criminal tax evasion of hundreds of millions of dollars over a 15-year period (he will pay back taxes and penalties but avoid prison). The Justice Department has also indicted software executive Robert T. Brockman, claiming he concealed approximately $2 billion in income (with Smith’s help) in an offshoring scheme featuring a computer program aptly named “Evidence Eliminator.”

Such cases are noteworthy not just for the large unpaid tax bills, but also for their extreme rarity. More commonly, high-income individuals skirt their tax liabilities with no consequence at all. Criminal tax fraud cases are at their lowest level since 2002 —
only 700 were initiated last year, down 40 percent from a decade earlier. Audit rates for taxpayers with annual incomes of $10 million or more stood at less than 7 percent in 2018, down from almost 30 percent in 2011. The Treasury’s inspector general recently estimated that the IRS missed out on more than $40 billion in revenue by failing to pursue cases against thousands of high-income individuals.

Poor Americans haven’t experienced the same leniency. The audit rate for recipients of the Earned Income Tax Credit, a program designed to keep low-wage workers out of poverty, has declined at a much slower pace — thanks in large part to Republican legislators, who have pressured the IRS to stamp out alleged fraud. The activity, often triggered by innocent mistakes or errors committed by unregulated tax preparers, generates little revenue per audit, because so few tax dollars are at stake. But it creates a huge headache for already overburdened families. Today, EITC recipients are about as likely to get audited as the top 1 percent of earners, and the five counties with the highest audit rates in the U.S. are low-income, predominantly Black communities. For these taxpayers, aggressive IRS scrutiny is yet another burden of being Black and poor.

A recent IRS report by Deputy Commissioner Sunita Lough points out that the agency does in fact audit high earners at higher rates. But while true on average, this misses important trends in enforcement. Perversely, audit rates have fallen most for those at the top of the income distribution.

Why the inequitable approach? It’s no fault of the IRS, which is being forced to make do with less: Congress has cut its budget by 15 percent since 2011, resulting in a 20 percent reduction in staff. Attrition rates have been highest among the experienced and highly skilled examiners capable of handling complex audits of high-income individuals, according to IRS Commissioner Charles Rettig. As a result, the agency cannot simply shift examination resources from the poor to the wealthy — so when the latter fail to file their tax returns, they are often pursued with no more than a series of notices, if at all.

The solution is simple: Provide the IRS with the budget needed to do its job, and direct it to focus on the cases likely to yield the most revenue. Current and former IRS officials agree, and legislation along these lines has even been introduced. Strengthening enforcement is already part of Biden’s tax plan.

Research that I conducted with former Treasury Secretary Larry Summers suggests that restoring enforcement to historical levels could generate more than $1 trillion in the next decade — more than enough to fund important policy initiatives like universal pre-K and paid parental leave.

All that’s needed is the political will to police the many wealthy Americans whose names — unlike Trump, Smith and Brockman — haven’t been in the headlines, because nobody has properly scrutinized their tax returns.

Reach Natasha Sarin at nsarin@law.upenn.edu.

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