Today, the Congressional Budget Office (CBO) released a score for the Israel Supplemental Appropriations Act of 2024, indicating its belief that the legislation will increase the federal deficit by billions over ten years due to reduced revenues from tax collection.
Some commentators within the Beltway and on Capitol Hill have suggested that this deficit increase should be taken as prophecy, but fail to provide the appropriate context that this cost estimate requires.
The bill would provide $14.3 billion in new emergency spending with an equal offset to reduce tax enforcement funding to the Internal Revenue Service (IRS). The deficit impact results from CBO’s estimate that the reduction in the IRS’s budget will decrease revenues by $26.8 billion. However, there are several points of uncertainty regarding this amount.
Others have expressed outrage that the funding reduction might help wealthy tax evaders and ignore the fact that increased audits will likely fall primarily on taxpayers making $75,000 or less, as 50 percent of audits currently do. More worryingly, in 2021, taxpayers with $25,000 or less in gross receipts were audited at a rate 5 times higher than average.
The IRS funding windfall was originally intended to pay for the Inflation Reduction Act’s (IRA) green subsidies. With this in mind, Members of Congress who truly believe that this $26.8 billion estimated reduction of tax revenues is cause for financial alarm should agree that the rest of the billions of deficit-spiking tax credits under the IRA should be on the chopping block as well. This is even more crucial given America’s financial state, because current estimates peg the cost of the IRA’s tax credits at hundreds of billions more than originally anticipated.
IRS Funding Boost “Paid” for Biden Green Subsidies
The increased IRS enforcement budget was part of the IRA; legislation which we were told – by its supporters and CBO – would have minimal to no impact on deficits. Yet, this summer, a newer analysis pointed out that the smorgasbord of tax credits within the IRA would cost more than $1.2 trillion – hundreds of billions more than expected. Coupled with the potential impacts of Biden’s push for electric vehicle (EV) uptake, the Environmental Protection Agency’s (EPA) tailpipe rule, and the National Highway Traffic and Safety Administration fuel economy standards, the actual impact will likely outpace original estimates by hundreds of billions of dollars. The EPA itself estimates that its tailpipe rule would convert two thirds of the existing passenger car fleet to electric vehicles by 2032.
As noted by NTU's Bryan Riley:
“The [CBO] and Joint Committee on Taxation estimated that these EV subsidies would cost $7.5 billion over 10 years, in addition to another $6.7 billion for qualified used vehicles, commercial vehicles, and EV charging equipment. As NTU pointed out at the time, a $7,500/vehicle subsidy is equal to about 100,000 EV purchases a year.
That’s not much compared to annual average light vehicle sales of 15.6 million per year since 2000. CBO estimated that total clean energy subsidies would cost $391 billion, two-thirds of which would be provided through tax credits.
More recently, Goldman Sachs reportedly estimated that the actual cost of EV subsidies for light vehicle purchases would be $300 billion, contributing to a total green energy subsidy cost of $1.2 trillion. Credit Suisse has estimated the total federal cost of climate spending to be $800 billion.”
Revenue Assumptions Were Meant to Close Imaginary $1 Trillion Tax Gap
These massive subsidies were hidden under the fig leaf of huge revenue estimates from increased IRS activities during passage of President Biden’s IRA. Part of the legislative history of the IRA was based on spenders in Congress operating on a disproven estimate in 2021 by then-IRS Commissioner Charles Rettig that the tax gap was close to $1 trillion. News pundits ran with the $1 trillion figure and went further by providing aircover to the IRA spending bonanza. A recent 2021 analysis from the IRS itself estimates that the tax gap was $688 billion in Tax Year 2021.
Furthermore, simply assuming that increased funding will result in a linear correlation in reducing the tax gap (the difference between estimated total tax bills and actual collections), ignores the realities of why the tax gap exists and the IRS’s current and past failings when it comes to managing their core functions. CBO estimated that increasing IRS enforcement funding by $20 billion over the next decade would increase revenue collections by $61 billion, while increasing enforcement funding by $40 billion over that same time period would increase revenues by $103 billion. Based on these estimates, it is exceedingly unlikely that increasing IRS funding by $80 billion over a decade would yield $780 billion in additional revenue.
According to the IRS, the tax gap has three components:
The non-filing gap: individuals, families, or businesses that owe taxes but do not file a tax return;
The underreporting gap: individuals, families, or businesses that underestimate or underreport their taxable income, and as a result do not pay as much in taxes as they owe; or
The underpayment gap: individuals, families, or businesses that properly report their income but do not pay their entire tax bill in a timely manner.
As noted by NTU Foundation in a tax complexity study:
“It is also worth pointing out that the vast majority of the tax gap is generated not by knowing efforts to defraud the federal government but instead by inadvertent errors on the part of taxpayers dealing with a confusing and expensive tax code that eats up nearly eight billion hours in compliance time each year.”
And as as former Taxpayer Advocate Nina Olson stated in a webinar of her new organization, the Center for Taxpayer Rights:
“Equating the entire tax gap to ‘tax evasion’ is just so disingenuous. And it’s also wrong; it’s incorrect. Evasion has a technical meaning under the law, and generally it requires mens rea, a criminal intent. So much of it is error, or inadvertent...there are a bunch of different types of noncompliance. And if you say [it’s all tax evasion] - and that’s what the Washington Post called it, that’s what the New York times called it - then that creates distrust among the taxpayers of the tax agencies. [They’re asking], ‘why am I paying if you’re letting all these people off the hook?’”
IRS Internal Issues Mean Funding Boost Is Not A Guaranteed Revenue Generator
While CBO generally does great work at informing Congress, it is important to note that the budget impacts of an unprecedented boost to IRS funding are ultimately subject to a wide range of potential outcomes. There is no purely linear relationship between IRS funding and revenues. Estimates must be built on assumptions. As NTU pointed out in a statement on Monday, “The Internal Revenue Service’s (IRS) massive Inflation Reduction Act budget boost has yet to be properly managed, overseen, and directed to the agency’s most urgent service and modernization priorities…”
CBO itself noted several points of uncertainty in its original estimate of the new tax revenues that might be gained through the funding provided for enforcement:
“The change in revenues resulting from the proposed increase in the IRS’s funding could be different from CBO’s estimate. It would depend on a number of factors, including the IRS’s ability to hire the appropriate personnel, the composition and productivity of the additional audits and other enforcement actions undertaken by the IRS, changes in taxpayers’ behavior in response to greater IRS enforcement, and the effect of increased IRS spending in areas other than enforcement (such as technology).”
Given inflationary pressures and a shortage of accountants, the IRS may have a hard time hiring as many highly-skilled investigators as anticipated. Additionally, the success of an audit by the IRS is not guaranteed. Recent reviews of IRS audits within sections focusing on high-income businesses and partnerships have noted a high-rate of “no change” in the amount owed from the audited taxpayer's initial position.
The IRA windfall was so enormous compared to past IRS funding levels that it’s still unclear whether or not the Service could even make full use of these additional funds. The IRS released its plan for the $80 billion in increased funding late, and the final release by Treasury Secretary Janet Yellen was extremely sparse on details. Unlike in a budget justification, the plan did not deliver specific, annual funding levels for the components of the plan, and did not indicate the levels of full-time employees for each area.
Conclusion
If congressional spenders have had a change of heart and are now truly concerned about the federal deficit, then they should consider further cuts to annual appropriations and to the Biden administration’s energy industry subsidies, which will continue to balloon past CBO’s initial estimates. And if they legitimately fear wealthy taxpayers ducking taxes, then they should dig into the details of the tax gap. This will show that increasing enforcement at an inefficient agency does not guarantee return on investment, and that increased audit activity will hurt lower income households far more than wealthier ones.
Finally, if Members of Congress and the media are genuinely worried about the federal deficit and are not trying to simply score political points, then there should continue to be offsets for emergency spending, further frugality from Congress, and a renewed sense of commitment to America’s financial future.