Congressional under-funding of IRS costs the government $385 billion

The Internal Revenue Service released a report on how much revenue the government misses out on due to illegally unpaid taxes. According to their estimates, the figure for 2006 was around $450 billion, with 17 percent of taxes going unpaid. Around $65 billion of the unpaid taxes are recovered through enforcement, leaving a net tax gap of $385 billion. As Salvatore Babones points out, it is the wealthy who are primarily to blame for these unpaid taxes and the deficits they help cause. After all, normal workers have their earnings reported to the IRS by their employers and have their taxes withheld, making tax avoidance very difficult.

Even though withholding and reporting has been shown to reduce tax avoidance, Congress has been reluctant to require either for the kinds of income wealthier Americans generally collect. When Congress passed a law to withhold interest income, they repealed it almost immediately as the investor class cried out in horror. Congress might also reduce tax avoidance through increasing IRS enforcement; instead, Congress continues to cut the IRS enforcement budget. In 2012, they cut the enforcement budget by $193 million, and the overall IRS budget by 2.5 percent. In real terms, Congress has cut IRS staffing by one-third since 1990. All these cuts have taken place despite the fact that the IRS estimates every dollar spent on enforcement delivers $4 to $5 more in extra revenue, and delivers even more savings when spent on other things like modernization improvements (e.g. moving more and more taxes online).

The amount lost from lack of enforcement is not small either. To put it in context, the debt-ceiling debacle last summer that nearly shut down the government ultimately resulted in a deficit-reduction plan that cut spending by $2.1 trillion over the next decade. If the annual tax gap remains at the 2006 number of $385 billion per year, that is equivalent to $3.85 trillion of foregone revenue over the course of a decade. As the IRS undergoes more cuts however, that number will likely increase. If we recovered only half of those illegally unpaid taxes, we would reduce the deficit by about as much as the deficit reduction deal that nearly brought the country to a halt.

So the important question becomes why doesn’t the Congress do so? What serious arguments could be mounted against beefing up enforcement, which increases compliance with tax laws and reduces the deficit? Unless you think that the IRS numbers on the payoff of increased enforcement are fake, there are no legitimate reasons someone would oppose increasing enforcement, and in fact support decreasing enforcement through cuts as the Congress has. I suspect — as their track record indicates — those on the right do not care if the wealthy avoid paying taxes. They spend almost all their legislative effort trying to reduce the taxes of the rich; so it makes perfect sense that they would pursue that aim in ways other than statutory changes.

Just remember that the next time a deficit discussion fires up. Like commentators have rightly pointed out time and time again, conservatives in the United States are not actually interested in reducing the deficit per se. Their movement is after all the one of the starve the beast strategy. Even their pretend allegiance to rule of law — the one they are so adamant about when it comes to illegal immigration — is not enough to overwhelm their hatred of tax collection. Legally or illegally, conservatives seem pretty singularly focused on collecting as little revenue from the wealthy as possible, and lax tax enforcement is one of the ways they are succeeding in doing so.

Effective corporate tax rates are not that high

I somehow summoned the energy necessary to watch the New Hampshire Republican debate on Saturday. Like the seemingly dozens of GOP primary debates held so far, the usual trainwreck transpired. Jon Huntsman spoke in Chinese briefly to try to show how much he knew about China, not realizing that the nationalists in the Republican party are not very receptive to that kind of thing. Ron Paul tried once again to distance from the disgusting decade he spent publishing a racist, homophobic, and conspiratorial newsletter by claiming he loved Martin Luther King, Jr. Newt Gingrich complained about almost every question that was asked. Rick Perry strangely promised to re-invade Iraq, not realizing I guess that even Republican voters do not seem to keen on that these days.

Rick Santorum managed to say a few weird things as well, including the bizarre claim that he worked in the coal fields against Cap & Trade, whatever that means. One issue Santorum raised which was not obviously bizarre — but ultimately wrong — was about the corporate tax rate. Like many of the other GOP candidates, Santorum claimed that the 35% corporate tax rate hurts the ability of the US to attract capital investment. The problem with this common refrain is that it ignores the fact that the tax rate corporations actually pay is not anywhere near the 35% statutory rate.

The corporate tax code in the United States is actually progressive, despite the way pundits usually talk about it. There are four marginal rates, the lowest at 15% and the highest at 35%. Only corporate income in excess of $10 million per year is actually subject to the highest 35% tax rate. This includes most corporate income, but small corporations can and do have significantly lower statutory tax rates.

Even if we focus only on the large corporations that pull down most of their income in the top tax bracket, the amount of deductions and loopholes in the tax code is so vast that almost no corporations actually pay the corresponding 35% tax rate. How much each company actually pays varies widely, and some even have negative tax rates. One study which analyzed the tax records of 280 Fortune 500 companies found that the average effective tax rate of the companies was 18.5%, but the effective tax rates ranged from as low as -57.6% (yes negative) to over 30%. Given that enormous range of effective tax rates, the idea that the 35% statutory tax rate gives us any indication of the tax burden of corporations in the United States is absurd.

Thus when we compare corporate taxes in the United States internationally, comparing only statutory tax rates is inadequate. Instead, it makes more sense to compare corporate tax revenues as a share of GDP. The Citizens for Tax Justice put together such a comparison using OECD data for 2009. Except Iceland, the United States has the lowest ratio of corporate tax revenues to GDP in the entire 34-country OECD.

Even though the hysteria about corporate over-taxation is unfounded, that does not mean there is nothing to improve about the corporate tax code. The deductions and exemptions that cause absurd outcomes like one company having a -57.6% tax rate are problematic. They create enormous distortions that lead to inefficient allocation of resources, and other sub-optimal outcomes. But Rick Santorum did not propose to eliminate any of these exemptions and deductions; instead, he proposed introducing a new one to reduce the corporate tax rate to 0% for manufacturers.

So not only is Santorum being misleading by citing the 35% statutory tax rate, his proposed solution to the non-existent competitiveness problem would actually create even more distortions, making the corporate tax situation even worse. Santorum’s misstep on corporate taxes is not as circus-like and hilarious as some of the other candidates’ missteps — nothing will ever top Perry’s desire to re-invade Iraq — but it is still something that needs to be pointed out and understood. Despite all their pretensions to the contrary, the GOP and the right-wing in general either know very little about fiscal, monetary, and economic issues or put a lot of effort into actively misleading people about those issues. The corporate tax nonsense is just one instance of that.