Trends in the Internal Revenue Service’s Funding and Enforcement

The Internal Revenue Service (IRS) collected $3.5 trillion in taxes in 2018, nearly 95 percent of total federal revenues. To do so, it relied largely on taxpayers to report their income, calculate the amount of tax they owed, and remit that amount to the IRS through withholding or other payments. However, some taxpayers have failed to pay hundreds of billions of dollars in taxes, the IRS estimates. Policymakers have expressed interest in how changes in IRS funding, particularly for enforcement of tax laws, could increase the federal government’s tax revenues.

This report describes how the IRS encourages and enforces compliance with tax laws. It examines the IRS’s enforcement activities between 2010 and 2018 and analyzes how the decline in those activities reflects the decline in its funding and staff over that period. On the basis of the relationship between enforcement funding and revenues, CBO estimates the effects an increase in IRS funding for enforcement could have on federal tax receipts.

How Much Tax Goes Uncollected Each Year?

The difference between the amount of taxes owed and the amount collected each year—often called the tax gap—is estimated periodically by the IRS. The gross tax gap is the amount that taxpayers do not pay by their filing deadline. As such, it measures the extent of noncompliance with the tax code. In its most recent report, the IRS estimated that the annual gross tax gap was $441 billion, on average, between 2011 and 2013.

The IRS ultimately collects some of that amount. The net tax gap, which is the gross tax gap reduced by the amount that the IRS collects through its enforcement activities, was an estimated $381 billion annually over that period. In addition, the IRS’s enforcement activities have an indirect effect on the tax gap by discouraging taxpayers from making misstatements on their returns. The size of the tax gap is also affected by whether income is visible to the IRS and by the complexity of the tax code, among other factors.

How Does the Internal Revenue Service Enforce Tax Laws?

The IRS undertakes a variety of enforcement activities:

• Auditing tax returns,
• Collecting unpaid taxes,
• Obtaining tax returns from taxpayers who did not file returns on time,
• Correcting mathematical or clerical errors,
• Using software to flag questionable refunds, and
• Verifying information reported by taxpayers against information from third parties.

How Has Funding for the Internal Revenue Service Changed Over Time?

Appropriations for the IRS have fallen by a total of about 20 percent in real (inflation-adjusted) dollars between 2010 and 2018. With the exception of 2016, real appropriations have consistently fallen below the previous year’s level over that period. Because labor costs account for about 70 percent of the IRS’s budget, measures to reduce its workforce were instituted, including a hiring freeze. Those measures resulted in a 22 percent decline in the number of employees at the agency and a 30 percent decline in the number of employees working in enforcement roles. The number of revenue agents and revenue officers, highly specialized enforcement employees who handle the most complex examinations and collections cases, fell by 35 percent and 48 percent, respectively, between 2010 and 2018.

How Have Reductions in Funding and Staffing Affected Enforcement?

As the IRS’s budget and workforce declined, so did its examination rates for both individual and corporate income tax returns. (The examination rate is the number of examinations closed in a fiscal year divided by the number of returns filed in the previous calendar year.) The overall examination rate for all returns fell by about 40 percent between 2010 and 2018. Over that period:

• The examination rate for individual income tax returns dropped by about 46 percent. About 0.6 percent of individual income tax returns were examined in 2018.
• The examination rate for corporate income tax returns fell by about 37 percent. In 2018, 0.9 percent of corporate income tax returns were examined.
• Larger corporations were more likely to have their returns examined than smaller ones over the 2010– 2018 period. However, the examination rates for large corporations—those with assets of more than $10 million—declined more steeply between 2010 and 2018 than examination rates for corporations with fewer assets did.
• Similarly, higher-income individuals were more likely to be examined than lower-income ones over the period. However, the examination rate for higher-income taxpayers fell, while the examination rate for lower-income taxpayers remained fairly stable. Nearly all examinations of lower-income taxpayers were initiated because of claims for the earned income tax credit.
• The amount of additional taxes and penalties the IRS recommended after examinations of corporate and individual income tax returns—before taxpayers appeal or challenge those recommendations—also fell from 2010 to 2018. The decline occurred because the IRS closed fewer examinations each year.

The amount of delinquent tax debt, or unpaid assessments, increased from 2010 to 2018. The amount of revenue received from that debt as a result of collections activities, however, remained between 8 percent and 10 percent of unpaid assessments over the period. The number of delinquent taxpayer accounts, resulting from returns filed without payment of all taxes due or examination assessments not paid promptly, generally increased from 2010 to 2018. The IRS is also responsible for securing returns that were not filed on time. The number of investigations of delinquent filers fell over the 2010–2018 period.

Trends are unlikely to reverse in the near future. The disruptions stemming from the 2020 coronavirus pandemic will reduce the IRS’s enforcement activities and pose new challenges for taxpayers in complying with tax laws.

How Might an Increase in Funding for Enforcement Affect Federal Tax Receipts?

On the basis of its analysis of the effects that different funding levels have had on IRS enforcement, CBO estimates that increasing the IRS’s funding for examinations and collections by $20 billion over 10 years would boost revenues by $61 billion, resulting in a $41 billion decrease in the cumulative deficit; increasing such funding by $40 billion over 10 years would boost revenues by $103 billion, resulting in a $63 billion decrease in the deficit.

CBO’s estimates for those two options are uncertain and only capture the direct effect of enforcement activities. Any indirect benefits of increasing enforcement, such as deterring taxpayers from violating tax laws, are excluded from the estimates.

Because of the budget scorekeeping guidelines used by the Congress, only the spending increases attributable to those options would be counted in a cost estimate. However, if an appropriation bill or another bill providing funding for one of the options were enacted, CBO’s next projection of the budget deficit would incorporate the estimated effects of the funding increase on tax revenues.