The Internal Revenue Service (IRS)The Internal Revenue Service (IRS) is part of the U.S. Department of the Treasury and is responsible for enforcing and administering federal tax laws, processing tax returns, performing audits, and offering assistance for American taxpayers. released its operations plan on April 6th, setting out a series of objectives and initiatives to improve the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. collection agency. The document shows how the IRS plans to use its substantial funding increase enacted in the Inflation Reduction Act (IRA) last year. While the IRS hopes to increase revenue collection and minimize additional burdens on taxpayers, uncertainty remains regarding its ability to deliver, particularly on the latter. Furthermore, some concerns about the original funding package are already surfacing, specifically around insufficient funding for taxpayer services.
Review of the IRS Funding Increase
The InflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. Reduction Act increased the IRS budget by roughly $80 billion over 10 years. The money is broken into four main categories—enforcement, operations support, business system modernization, and taxpayer services—as well as a few other small items such as an exploratory study on a potential free-file system.
|Additional Funding||Percentage Increase|
|Operations Support||+$25.33 billion||53%|
|Business System Modernization||+$4.75 billion||153%|
|Taxpayer Services||+$3.18 billion||9%|
Source: Congressional Budget Office, Inflation Reduction Act, via Brendan McDermott, “IRS-Related Funding in the Inflation Reduction Act,” Congressional Research Service, updated Aug. 9, 2022, https://crsreports.congress.gov/product/pdf/IN/IN11977; author’s calculations.
As previously noted by the Tax Foundation last August:
The new business modernization funding will go towards several projects, including “development of callback technology and other technology to provide a more personalized customer service but not including the operation and maintenance of legacy systems.”
Enforcement funding has several functions: “to determine and collect owed taxes, to provide legal and litigation support, to conduct criminal investigations (including investigative technology), to provide digital asset monitoring and compliance activities, to enforce criminal statutes related to violations of internal revenue laws and other financial crimes, to purchase and hire passenger motor vehicles.”
IRS funding for operations support will support taxpayer services and enforcement programs, including “rent payments; facilities services; printing; postage; physical security; headquarters and other IRS-wide administration activities; research and statistics of income; telecommunications; information technology development, enhancement, operations, maintenance, and security; the hire of passenger motor vehicles.”
IRS funding for taxpayer services will go towards programs such as “pre-filing assistance and education, filing and account services, and other services.”
How the IRS Plans to Spend the Money
The report provides five objectives, with a series of corresponding initiatives to achieve each objective.
|Dramatically improve services to help taxpayers meet their obligations and receive the tax incentives for which they are eligible|
|Quickly resolve taxpayer issues when they arise|
|Focus expanded enforcement on taxpayers with complex tax filings and high-dollar noncompliance to address the tax gap|
|Deliver cutting-edge technology, data, and analytics to operate more effectively|
|Attract, retain, and empower a highly skilled, diverse workforce and develop a culture that is better equipped to deliver results for taxpayers|
Source: IRS, “Internal Revenue Service Inflation Reduction Act Strategic Operating Plan, FY2023-2031,” Apr. 6, 2023, https://www.irs.gov/pub/irs-pdf/p3744.pdf.
These objectives are often co-dependent, which the report discusses. For example, attracting a skilled workforce is key to delivering technical improvements, increased IRS enforcement, and enhanced and prompt customer service.
Digging more into the specifics of enforcement, individual initiatives acknowledge some of the trade-offs in expanded enforcement operations. Within the third objective, dedicated to expanded enforcement, five of the seven initiatives involve expanded enforcement on certain types of taxpayers: large corporations, large partnerships, high-income and high-wealth individuals, other areas where IRS auditA tax audit is when the Internal Revenue Service (IRS) conducts a formal investigation of financial information to verify an individual or corporation has accurately reported and paid their taxes. Selection can be at random, or due to unusual deductions or income reported on a tax return. coverage has declined (including employment, excise, and estate and gift taxA gift tax is a tax on the transfer of property by a living individual, without payment or a valuable exchange in return. The donor, not the recipient of the gift, is typically liable for the tax. payers), and developing areas such as digital assets. The other two initiatives within expanded enforcement involve enhanced data analysis and a balanced approach focused on fairness to taxpayers.
An increase in IRS audit rates should increase tax compliance, but it could simultaneously increase compliance costs thanks to false positives: taxpayers already paying their owed liability nonetheless facing an audit. It would be ideal if the document had a more thorough or binding description of how the agency will protect or respect taxpayer rights while pursuing the (legitimate) goal of reducing the tax gapThe tax gap is the difference between taxes legally owed and taxes collected. The gross tax gap in the U.S. accounts for at least 1 billion in lost revenue each year, according to the latest estimate by the Internal Revenue Service (IRS) (2011 to 2013), suggesting a voluntary taxpayer compliance rate of 83.6 percent. The net tax gap is calculated by subtracting late tax collections from the gross tax gap: from 2011 to 2013, the average net tax gap was around 1 billion. (i.e., the gap between taxes owed and taxes collected). The document also sticks to the flawed promise of not raising IRS audit rates among taxpayers earning below $400,000. As Josh Zumbrun of The Wall Street Journal noted recently, some returns with reported income below $400,000 may be filed by taxpayers with actual income over $400,000.
Additionally, a report from the Government Accountability Office documents that most of the revenue generated from audits over the last decade has come from returns with income below $200,000. The report also shows that in 2021, for each hour spent auditing returns with income below $25,000, the IRS recommended an average additional tax liability of $2,120. And for each hour spent auditing Earned Income Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. returns, the IRS recommended an average additional tax liability of $3,130.
Broadly, the plan is light on specific targets and metrics. In the enforcement section specifically, the indicators of success are directional: decreased repeat noncompliance rates, decreased enforcement contact with the IRS for compliant taxpayers, and decreased tax gap relative to the gap without the resources provided by the IRA. It would be helpful to have additional targets beyond simply an improvement relative to the status quo.
In terms of both improved enforcement and minimized compliance cost increases (and ideally a reduction in compliance costs), the most important part of the IRS enforcement plan is the effectiveness of their investments in improved data analytics. In a best-case scenario, these investments will allow the IRS to better allocate their enforcement resources to more suspicious tax returns, leading to catching more noncompliant taxpayers while auditing fewer already-compliant taxpayers. The IRS has made analytics improvements that did deliver those results before, but past performance is no guarantee of future results.
Ongoing Concerns: Insufficient Focus on Services, Increased Cost of Complexity
So far, the IRS has improved its customer service. According to a Treasury Department official, the IRS answered 88.6 percent of phone calls in the first few weeks of the tax filing season, compared to answering around 10 percent of calls during the past two tax filing seasons. At the end of February 2023, the agency had around 2 million returns in its backlog; at the same time last year, the agency had 24 million unprocessed returns.
However, there are some cracks and caveats. For one, the IRS has also benefitted from many pandemic aid provisions expiring. During the pandemic, the IRS was pushed into the role of benefits administrator and dealt with provisions such as the expanded Child Tax Credit and the Economic Impact Payments. These new responsibilities stretched the IRS’s resources thin. With many of those provisions expiring during or before the 2022 tax year, the IRS faces less demand for assistance. And yet going forward, they may face new challenges due to complexity: the Strategic Operations Plan asks for an additional $1.2 billion in funding for taxpayer services to help deal with the new green energy credits introduced in the Inflation Reduction Act.
The substantial improvements the IRS has made may also be partly due to frontloading services spending. Within the first two months of 2023, the IRS had spent around $850 million of the total $80 billion in new funding. However, of that $850 million, $426 million was new funding for services. That accounts for over 10 percent of the initial $3.2 billion increase over 10 years, spent within the first two months. The Strategic Operations Plan notes that, barring an additional increase in funding, the taxpayer services funds to maintain both telephone and in-person services at a high level will be exhausted within four years. This vindicates some concerns that taxpayer services were neglected in favor of enforcement in the original package.
While initial service improvements are encouraging, only time will tell if the IRS can deliver the promised benefits of the funding increase.Share