Tax gap grows: Americans cheated IRS out of $625 billion in 2021

The gap between what Americans owe the government and what they actually pay is large and growing, the IRS said Thursday, estimating the “tax gap” for 2021 at more than $600 billion.

IRS Commissioner Danny Werfel vowed an “urgent” push for more audits, particularly on the wealthy, calling it a matter of “fairness” to those who pay on time and in full.

About 85% of Americans do comply with the law, the IRS said, resulting in some $688 billion that wasn’t paid on time in 2021. Late payments, audits and fines will reduce that number to a net tax gap of about $625 billion.

That amount is 16% higher than in 2020 and 30% higher than in the early years of the Trump administration.

The IRS dropped the numbers into a raging debate in Washington over how aggressive the IRS should be in sweating out more money from Americans.

The Biden administration is pushing for an aggressive approach, saying the wealthy aren’t paying their share, while Republicans are resisting, warning that a supercharged IRS would oppress even law-abiding taxpayers.

“This increase in the tax gap underscores the importance of increased IRS compliance efforts on key areas,” Mr. Werfel said in a statement announcing the numbers.

He said the climate budget law Democrats pushed through Congress and signed by President Biden last year would help by pumping tens of billions of dollars into enforcement.

The federal government collected $4 trillion in total revenue in fiscal 2021 and spent $6.8 trillion as the government poured money into pandemic relief efforts.

About 10% of the tax gap is from people who fail to file tax returns altogether, and another 11% is from people who file their returns on time but don’t pay by the deadline.

Still, the vast majority of the problem — some 79% of the tax gap — is from people underreporting their incomes or overselling their exemptions and deductions.

Individuals are also significantly more likely than corporations to skimp on their taxes. The IRS says individual income tax filers get it right, and on time, 80.9% of the time. Corporate taxes, meanwhile, are paid correctly and on time 85.2% of the time.

Payroll taxes are paid in full and on time 91.9% of the time. Estate taxes are paid in full 81% of the time.

The IRS said it builds its tax gap estimates by extrapolating from audits. The complexity of the tax code and factors such as digital assets and offshore activities mean the estimates are likely undercounts.

Preston Brasher, a tax analyst at The Heritage Foundation, a conservative think tank, called the IRS’s estimates “rubbish.” He said the agency relies on “bogus” guesses and adjustments and is attempting to pressure Americans into accepting a more intrusive IRS.

“Please stop trotting these numbers out like they’re meaningful,” he said on social media platform X. “If you think more auditors will allow the IRS to magically find $5,200 per household, I’ve got a bridge in Brooklyn.”

Tax collection in the U.S. relies on voluntary compliance.

In 2010, about 90 out of every 1,000 returns were audited. By 2019, that had dropped to 25 out of every 1,000 returns. Audit rates for the wealthiest have slid the most, with returns of $10 million or more in income dropping from 212 out of every 1,000 to just 39 out of every 1,000.

Analysts say the tax gap is caused by more than intentional cheaters. Much of it comprises taxpayers who want to comply but make mistakes as they sift through labyrinthian tax rules. That’s particularly true for the self-employed.

At the same time, analysts say reducing the tax gap could boost confidence in the system and push others to pay what they owe.

The IRS says a 1 percentage-point increase in the voluntary compliance rate would be worth $46 billion in additional annual revenue.

Biden administration officials are eager to increase audit rates to get more money. Indeed, they counted on tens of billions of dollars in additional tax collections to pay for the climate change policies in last year’s budget law.

So far, however, the IRS has moved slowly.

Of $78 billion the IRS was given for its budget over the next decade, the agency had spent less than $2 billion as of the end of June.

The majority of that went to better taxpayer services and operational support such as office space and technology, according to the IRS’s inspector general.

The IRS plans to increase its staffing from fewer than 80,000 people last year to more than 105,000 by 2025. Roughly half of those new positions are supposed to be in enforcement.

“Therefore, in order to meet its hiring goal, the IRS will have to onboard over 52,000 employees over the next two years to keep pace with estimated attrition,” the inspector general said.

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