When talking about audits, stop pretending the IRS is infallible
Timothy P. Carney
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Congress recently boosted funding for the Internal Revenue Service, partly in order to increase audits of taxpayers.
The case for more audits rests on a fiscal argument and a moral argument.
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The fiscal argument is that audits result in more revenue and that added revenue far exceeds the cost to the IRS of conducting the audit. Thus, from the fiscal perspective of Uncle Sam, money invested in auditing Americans has a positive return.
The moral argument is that people should pay what they legally owe in taxes.
A new study aims to quantify just how profitable audits are for the IRS in a very detailed way. They conclude that audits of wealthier taxpayers are much more profitable than audits of middle-class taxpayers and that the marginal audits — the additional audits the IRS would conduct if they expanded their auditing — would be more profitable than the average.
The study also shows that folks who get audited not only fork over money as a direct result of the audit but they pay higher taxes in future years after being audited.
This makes a water-tight case for more audits in the eyes of left-leaning journalists.
Throughout the paper, and consistently throughout journalism on audits and IRS collection, there is a premise that is never proven: That the money the IRS collects through audits is money that was owed but never paid, and thus the money the IRS “leaves on the table” by not auditing workers and business owners more amounts to ill-gotten gains by those Americans.
This obviously is not a justified assumption.
Of course, many people underpay taxes, either intentionally and knowingly or accidentally. It’s also not likely that the IRS intentionally overcharges in the way that tax collectors did in Jesus’ time.
However it is obvious that the IRS often makes mistakes and that taxpayers end up paying taxes they don’t owe thanks to the IRS’s mistakes.
It’s not outlandish to posit that a government agency might make a mistake that would harm an innocent person. We know this happens every day, and there’s no reason to believe the IRS is immune to this.
I can think of three ways a taxpayer might hand over money he didn’t owe, but the IRS was demanding. First, is that the taxpayer might wrongly trust the IRS because taxes are complicated.
Secondly, the taxpayer might know he is right but be unable to prove it. This happened to me once: I searched everywhere for the required receipts and realized I would never find them. So even though I knew for a fact that I was right and the IRS was wrong, I paid about $1,000 I didn’t owe because I couldn’t prove my correctness to the feds.
Third, the cost of successfully fighting the IRS often exceeds the cost of paying the taxes the IRS says you owe. That study finds that the average cost of audit compliance is $2,600 for taxpayers in the lower half of income distribution.
I had an experience very similar to this. The IRS one year said I owed $800 because their records of my quarterly payments were messed up. At the time, I was trying to refinance my home, and the loan wouldn’t go through until the IRS was satisfied. After repeated efforts by phone failed, I biked over to a local IRS office and lucked upon a smart, honest, and diligent IRS agent who saw I was right and cleared my record. If I didn’t have a field office in biking distance (my wife was away with the car), I would have just paid the $800 in order to get my loan.
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A working-class guy who is audited might be told he owes $800, and even if he knows the IRS is wrong, he has every incentive to end the audit as quickly as possible, which likely means paying the IRS to go away.
It might be really hard to study, but this would be worthy of study: At different income levels, what portion of IRS collections are money that is rightly owed? What triggers for audits result in the most inappropriate collections? And finally, why do academics and journalists assume the IRS is infallible?