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Well, with the change of
administrations in the White
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House also comes a change in
policy path. One area where the
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current administration may have
an impact is around the IRS and
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the number of audits that the
agency conducts or doesn't
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conduct. That number, already low,
may even go further lower. Ben
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Sprung-Keyser is an Assistant
Professor of Business Economics
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and Public Policy here at the
Wharton School, and he has
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looked deeper into this and
joins us right now. Ben,
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pleasure to have you with us
today. Thanks for your time.
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Great to be here.
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I guess we
need to start with where we kind
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of are in the— the level of
audits we are seeing, which, as
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from a historic perspective, has
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been going down over the last
few decades. Yeah,
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Yeah. So that— that's exactly right. I
think you can think of sort of
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audit rates as being on a real
roller coaster over the last 15
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years or so. They hit a high
water mark in about 2010 or so,
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fell pretty precipitously in the
five years afterward, and
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declined until around 2020 or
so. Then there was— as part of
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the Inflation Reduction Act
signed by President Biden, there
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was a substantial increase in
funding allocated to the IRS, in
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part to try to recover audit
rates to where they had been
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previously. And a big topic of
conversation right now, of
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course, is whether that will be
sort of allowed to proceed, or
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whether those audit— those new
IRS employees, for example, will
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will not end up conducting the
audits
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that they were once
expected to conduct.
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So the research that you were a
part of looks at how an audit
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can impact an individual
depending on the wealth level
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that they are at, correct?
- Yeah,
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that's right. So— so the question we
were thinking about in our work
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is, what is the return to an IRS
audit? So if you think about it,
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the IRS is going to spend sort
of one more dollar auditing an
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individual. How much revenue
does the IRS get back? And the
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sort of old adage is clear in
this case, that you got to spend
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money to make money in the
context of IRS audits. And the
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thing we were interested in is,
well, how does that differ
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across the income distribution?
There's a limited quantity of
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resources that the IRS can think
about allocating to think about
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who might be subject to an
audit, which is obviously going
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to be determined based on an
assessment of who may not have
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paid their tax obligations. We
know as a sort of pre-
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established fact that those tax—
unpaid tax obligations are
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heavily concentrated at the high
end of the income distribution,
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so about 60% of all of the
dollars that you might think of
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as being owed to the federal
government but are unpaid
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appear to come from the top 10%
of taxpayers. Now, that doesn't
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necessarily tell you how the IRS
should think about sort of
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allocating resources from the
perspective of audits, because
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it may also be, for example,
that that money is particularly
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difficult for the IRS to
collect. That high-income
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taxpayers have complicated
returns. They have complicated
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business structures, or whatever
that may be that may make it
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difficult for the IRS to collect
revenue there. And so the
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question we asked is, well, if
the IRS is going to spend money
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conducting audits, what does it
get back from those audits, and
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how does that differ across the
income distribution?
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And obviously that is something that
an agency like the— like the
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IRS wants to make sure that
they maximize. The dollars that
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they spend are obviously going
in a in an area or a focus that
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can return the most on that
investment.
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So that's exactly right. The
consideration— one of the
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considerations for the IRS, of
course— or at least, you know, I
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think a reasonable consideration
might be, how do you think about
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the return on your individual
dollars here? And so in the
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context of our research, what we
find is that the return on IRS
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spending is higher when auditing
high-income taxpayers as
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compared to low-income
taxpayers. And so the estimates
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here, for example, suggest that
the IRS may return about $12 for
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each individual dollar it spends
auditing when it focuses on
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taxpayers in the sort of top 10%
of the income distribution. That
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number is sort of less than half
when it comes to
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lower-income taxpayers.
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Does this suggest any potential
policy changes that an agency
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like the IRS should probably
consider, then, moving forward, in
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order to be able to maximize the
revenues that they— that they
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have from the federal
government?
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So I think— I wouldn't say that our
research comes with a specific
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recommendation of doing policy X
or policy Y. But the idea, at
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least our hope, is that it
should inform how folks who are
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thinking about constructing
those policies might look. So,
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just to give one example, when
it came to the funding under the
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Inflation Reduction Act, there
was then clarification that came
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back from the IRS Commissioner
after that was passed,
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suggesting that that revenue
would be— or that, the funding
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would be exclusively used to
audit taxpayers above $400,000
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in earnings. And certainly, I
think our evidence suggests that
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that focus on those high-income
taxpayers is a good way to think
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about prioritizing where those
dollars should be spent.
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But if we're talking about a time
where maybe the IRS is going to
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have a lower number of potential
audits, then you're talking
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about that revenue number having
a direct impact down the road as well.
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So that's certainly right. It's
certainly the case that, for
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example, a reduction in IRS
spending means a reduction in
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revenue, in this case, as it
comes from that. And if that
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reduction is concentrated
amongst high-income taxpayers,
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that may be particularly costly
for the IRS when it comes to
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doing this. Now, this is not to
say, by the way, that one should
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generalize these results to say
one should do exclusively
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auditing of taxpayer group X
versus group Y. I should note,
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for example, that there are
complicated questions regarding,
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you know, deterrence
considerations. So if you knew
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with 100% certainty you were not
going to be audited, that might
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change your calculation about
how likely you were to, you
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know, underpay your tax
obligations, things of that
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sort. When the IRS is making its
decisions, I suspect it is
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calculating and considering a
very wide range of other
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factors, for example, with that
in regard. And similarly, for
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example, the IRS is— I think
rightfully so— very focused on
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only auditing taxpayers who they
suspect of unpaid tax liability,
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right? So you wouldn't want to
sort of just throw darts at a
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dartboard when choosing the
process of choosing what
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taxpayer to audit, because we
also care about the hassle
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burden imposed by the audit, and
we want to try to make sure that
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one minimizes that.
- So
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having done this research, what
do you think is the takeaway
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that people should truly
understand about the process and
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maybe what we will see in the
future?
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So I think the takeaway here is,
I don't know what the future
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will bring, right? I think the
takeaway is that when you think
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about sort of the efficient use
of government funds, that, at
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least from our perspective, we
seem to believe that the return
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to auditing higher-income
taxpayers is substantially
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higher than the return to
auditing lower-income taxpayers,
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and to reduce that spending is,
in fact, a cost government
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revenue. Right? That it brings in
more money than it costs. So
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in the respect of sort of reducing
overall deficit, for example,
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IRS audits can be a quite
effective way of doing that. I
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think that's the kind of clear
takeaway that comes from the
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paper. I think the other sort of
clear takeaway that comes from
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the work is that one of the
reasons why IRS audits can be so
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effective in generating
government revenue is that they
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can change behavior in a sort of
consistent and durable way. So
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one of the things we think about
in the paper is if someone is
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faced with an IRS audit in a
given year and they're deemed to
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have unpaid tax liability, how
does that change what they pay
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back to the government in the
future years? And the evidence
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seems to suggest that it
produces a sort of durable
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effect on those individual
taxpayers. Think about it, if
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you're not allowed to deduct
your home office, because it
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turns out it's not a home
office, you're probably not
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going to go ahead and try to do
that again in the next year as
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well. And so that's one of the
clear things that we see in the
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results, and it gives an
intuition for why it could be so
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cost effective for the IRS to
sort of conduct audits of— of
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those folks that it believes are
particularly non-compliant taxpayers.
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And certainly people, once they get
audited— audited the first time,
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they want to try and avoid going
down that road a second time.
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I think that's absolutely right.
Right— rightfully so.
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Ben, great to meet you. Thanks
very much for your time today.
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Great to be here. Thanks so much.
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Thank you. Ben Sprung-Keyser, Assistant
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Professor of Business, Economics
and Public Policy here at the
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Wharton School.
