Don't Look Now, but America's Tax System May Collapse Soon

In March, federal agents raided the headquarters of equipment giant Caterpillar Inc, as part of a long-running investigation into whether the company owes $2 billion in back taxes and penalties for a scheme that allegedly shifted profits to Switzerland. (Caterpillar is fighting the charges.)

Though news of Caterpillar's alleged tax avoidance hasn't made much of a dent outside the business pages, if the IRS eventually gets its hands on that $2 billion, it will make a difference. That amount of money is about 17 times what the government spends each year to help low-income homeowners weatherize. It's more than one and a half times the cost of a promising federally funded after-school program for 1.6 million low-income kids begun under George W. Bush. (Both programs are zeroed out in the Trump administration's 2018 budget proposal.) That $2 billion would be about a sixth of the IRS's annual budget, which was $11.7 billion in 2016.

But it takes money to launch probes like the one targeting Caterpillar, and Congress has slowly and quietly been bleeding the IRS dry. That trend will affect more than just relatively flashy operations like the one involving Caterpillar—it means that the federal government will be increasingly less able to collect what it's owed. Tax experts say the system could be on its way to collapse after years of neglect.

Since the Republican takeover of the House in 2010, Congress has cut the IRS budget by 18 percent in real dollars, according to a March report by the Center on Budget and Policy Priorities. The agency has lost about 13,000 employees in that period, about 14 percent of its workforce. It's shed almost a quarter of its enforcement staff. All that has happened in a period when the number of individual returns has grown by 10 million.

Leaders and experts from both parties say the IRS is losing its ability to carry out core functions. "I am concerned about the staffing of the IRS. It is an important part of fixing the tax gap," Treasury Secretary Steven Mnuchin told Congress in January during his confirmation hearings. "[If] we add people, we make money." In late 2015, six former tax commissioners—including from the last three Republicans administrations—wrote a letter lambasting the ongoing cuts. "Over the last fifty years, none of us has ever witnessed anything like what has happened to the IRS appropriations over the last five years," they said.

When a deficit-spending government cuts the budget of its tax collection agency, it's like a company that's losing money firing its accounts-receivable staff. When you need money, it's a bad idea to stop investing in the people in charge of getting you more money. Every additional $1 spent on IRS enforcement yields $6 or more in additional revenue from collecting taxes owed, according to the Treasury Department. The number of audits that the IRS conducts has been cut by more than a third since 2010 and now is down to two-thirds of 1 percent of all returns.

That all sounds like good news for taxpayers. But it's only good for tax evaders. The IRS doesn't need to audit those whose earnings come in the form of wages that get reported to the government on a W-2—if they underreport, the IRS automatically flags the return, says University of Michigan tax economist Joel Slemrod. It's tax evaders with lots of undeclared income who benefit. Fewer audits means less revenue, which in turn means that the government will have to raise taxes on wage earners to subsidize the delinquents, or run ever-larger deficits.

Congress is set to finally begin debating tax reform after its summer recess. But however ambitious legislators' plans to cut the deficit are, they'll be dwarfed by the annual underpayment to the IRS. The tax gap—the percentage owed that's never collected—hit 18 percent during 2008 to 2010, the latest years studied. In that period, the government lost $460 billion per year to tax evaders, or about $520 billion in today's dollars. By comparison, the 2013 compromise Simpson-Bowles plan for deficit reduction, which was never acted on, would have saved only about $250 billion a year.

And the gap is widening slowly over time, points out Bill Smith, managing director at the national tax office of CBIZ MHM, a tax accounting and employee benefits firm. In 2006, it was about 17 percent, according to the IRS.

So could Republicans writing a tax reform package include more funding for the IRS as a way to make the numbers look better? Not the way the rules for scoring legislation are currently set—in assessing the effects of a tax package, the Congressional Budget Office doesn't take into account changes in the IRS budget, says Eric Toder of the Urban Institute and Brookings Institution's Tax Policy Center.

In any case, Republicans don't seem inclined to beef up the IRS—the Trump administration's 2018 budget proposal actually cuts the IRS budget by almost $240 million. It's an odd position for a tough-on-crime administration to take: The IRS's Criminal Investigations division launched about one-third fewer criminal investigations in 2016 than 2010 because it's lost 20 percent of its special agents. The division combats potential tax fraud cases like Caterpillar's and others involving identity theft, cybercrime, money laundering, and drug trafficking.

Supporters of the administration's cuts, like Americans for Tax Reform, argue that the agency just needs to be more efficient. But the former tax commissioners debunked that argument in their letter, pointing to a 2015 report from the Organization of Economic Cooperation and Development that found that per dollar of tax collected, the IRS spends half of what other OECD countries do.

What happens if the administration and Congress ignore the warnings? "At some point, we're going to put at risk the entire compliance system, and that's not an on-off switch," current IRS commissioner John Koskinen told Congress in 2015. "Once people get the idea that the system isn't working very well and they can take their chances, you can't turn that around overnight."

To anti-government activists, that may sound like the self-interested pleading of a bureaucrat. But for the experts who study the system, we're taking a plunge down an incline—and we can't see what lies at the bottom. "What undergirds tax compliance is deterrence—potentially being caught and punished," said Slemrod. The tax system won't fall apart overnight but more gradually as the IRS is less able to monitor and punish cheaters, he added.

The low audit rate doesn't escape the notice of right-wing anti-government activists. Conservative tax protester and former Republican Senate candidate Larry R. Williams writes in his book Confessions of a Radical Tax Protester that "at best only 1 percent of… taxpayers will be challenged. Those are the odds, as long as you don't stand up and shout about taxes and end up on the IRS—the 'Internal Radar Screen'—grid." And reporters are already helping taxpayers handicap their odds of getting caught—a story in March put them at a 14-year low of 1 in 143.

Tax attorney David Shuster of Manhattan-based Friedman LLP says he gets calls about once a month from people who haven't paid their taxes in years, though the number of those calls hasn't yet changed.

"We're doing an experiment now," said Toder. "It's sort of like climate change—at what point does it really start to affect people? At some point it will."

Steven Yoder writes about criminal justice and domestic policy issues. His work has appeared in Salon, Al Jazeera America, the American Prospect, and elsewhere. Follow him on Twitter .