IRS Set to Receive Substantial Funding Boost

Congress is preparing to substantially increase the enforcement resources of the Internal Revenue Service (IRS) in the FY 2010 Financial Services appropriations bill, representing a reversal in the lethargic funding approved during the Bush administration. This much-needed increase in resources is only a first step in improving the enforcement of the tax code, however, as observers say the IRS also needs to improve how it uses its limited resources.

On July 9, the Senate Appropriations Committee near-unanimously approved its version of the FY 2010 Financial Services bill, which sets funding for the IRS, among other agencies, at $12.2 billon. That is an increase of $549.8 million over FY 2009 levels and $26.4 million more than requested by the Obama administration.

The majority of the funding increase was directed to the enforcement budget of the IRS, which grew to $5.5 billion, an increase of $386.7 million over FY 2009 levels and equal to the president's request. When the House and Senate begin conference negotiations over the differences between their Financial Services bills, these funding levels could change somewhat before the final bill is passed. The House allocated $22.4 million less to the total IRS budget than the Senate did, but regardless of the final compromise, enforcement activities are sure to receive a significant increase in funding over FY 2009 levels since both the House and Senate included the president's requested increase.

The enforcement division of the IRS oversees activities including the examination of both domestic and international tax returns; the settlement of taxpayer appeals of examination findings; the detection and investigation of criminal violations of tax laws; and the collection of unpaid accounts. According to the Senate Committee on Appropriations' report [1] on the bill, the IRS will work to strengthen these activities while also "launch[ing] a robust package of six enforcement initiatives."

Five of these six initiatives represent priorities of President Obama in his attempt to reduce the tax gap, the perennial $300 billion-plus disparity between what all taxpayers owe in taxes and what they actually pay into the system. These initiatives, which focus on international tax issues and primarily seek to address abuse of the tax system by multinational corporations and wealthy individuals, include:

• Improving identification and coverage of complex international financial transactions
• Increasing coverage of smaller international businesses and individuals
• Increasing reporting compliance of domestic taxpayers with offshore activity by doubling the number of criminal investigation attachés in foreign ports of duty
• Expanding IRS's international presence in the tax-exempt and government sectors, including investigation of offshore tax shelters used by pension plans

Of course, money is not the sole solution to the problems contributing to the tax gap. As OMB Watch noted in Bridging the Tax Gap: The Case for Increasing the IRS Budget [2], it is both the quantity and quality of enforcement activities performed by the IRS that matter. For example, face-to-face audits – the most effective type conducted by the IRS – produce the highest return-on-investment, yet they have dwindled in number and in duration, particularly for corporations. The IRS has managed to gradually increase the overall audit rate, shifting toward the less effective correspondence audit, yet these levels are still at historic lows and do not adequately enforce existing tax laws.

While high-income individuals receive too little attention, the IRS also wastes significant resources over-auditing low-income filers claiming the Earned Income Tax Credit (EITC). Audits of EITC filers constituted about 40 percent of all audits performed on individual tax returns in FY 2006, even though EITC errors account for only three percent of the tax gap.

The key will be for IRS Commissioner Douglas Shulman to use the increased resources provided by Congress to start to correct some of the problems with IRS enforcement practices.