While the millions of taxpayers who waited until the last minute struggled to add up dollars and cents to get their tax returns to the Internal Revenue Service in time, the agency was counting pennies itself. When the new IRS Oversight Board met last month, more generous funding for the agency was its top priority. The nine members of the board, who are nominated by the president and confirmed by the Senate, described the IRS as broken and declared that more funds than Mr. Bush has proposed will be needed to fix the agencys problems.
Congress created the board in 1998 after the Senate Finance Committee held public hearings, the first in twenty years, on IRS abuses. For days the committee heard testimony from angry taxpayers who recounted horror stories of overly aggressive revenue agents exercising seemingly boundless power. At the conclusion of the hearings the Finance Committee labeled the IRS a rogue agency, but took no direct responsibility for reining it in. Instead, Congress voted to delegate part of the job to an independent oversight board housed in the executive branch.
Does the IRS really need more oversight, or does the agency already suffer from too much political interference? Over the past twenty years Congresses and presidents have balked at fully funding the agencys budget requests. Not surprisingly, over the same period, the percentage of tax returns audited has also fallen every year. Dwindling appropriations have forced revenue agents to make hard choices when selecting tax returns to audit.
One perhaps unintended consequence of budgetary pressures is that the IRS appears to be disproportionately targeting low-income taxpayers who are eligible for the earned income tax credit (EITC), designed to help lighten the burden of regressive payroll taxes. The IRS defends these audits, reasoning that they are cheaper to administer than devoting resources to examining the returns of well-heeled taxpayers. The mind-numbing details involved in calculating the amount of credit that can lawfully be claimed mean that an auditor is likely to determine that the EITC filer in fact owes more tax. But is Congress really comfortable with the image that it is building budget surpluses on the backs of low-income taxpayers?
Tight IRS budgets may also produce some intended consequences. When the oversight committees in Congress exercise their budgetary authority over the IRS, the agency becomes beholden to the committee members wishes. Congressional control of the purse strings sends a clear message: meet our demands or see your budget cut even further. One possibility is that oversight committee members use their power self-interestedly to see that the IRS goes easy on their constituents, reallocating its law enforcement resources toward taxpayers not having the benefit of such representation.
In a study forthcoming in the July 2001 issue of Economics and Politics, we report evidence of that kind of political influence on the IRS. When the number of revenue agents, the amount of potentially unreported income, and the fraction of filers claiming the EITC are held constant, the percentage of tax returns audited for tax years 19921997 was significantly lower in the 33 IRS districts that have a congressional representative on one of several key IRS oversight committees.
Presidential politics likewise appears to help explain the widely varying rates at which tax returns are audited across districts. Other things being equal, audit rates (not including correspondence audits due to document mismatching or mathematical errors) were significantly lower in IRS districts that are both rich in electoral votes, and competitive in the popular vote for president. Consequently, presidents have more to gain politically by redirecting the agencys tax law compliance efforts elsewhere.
Given that the IRS already responds to presidential politicking, no one should be surprised if the new oversight board is no more effective in curbing abuses than the congressional oversight committees apparently have been. The oversight board is in fact a redundant political smokescreen.
Our evidence suggests that a bureaucracy run amok does not explain the well-documented behavior of IRS agents. The reason that its agents aggressively look ever more intrusively for additional tax revenue in places where there tends to be less of it is that the IRS is doing exactly what the president and Congress want it to do.
As a result, the vicious circle set in motion by the IRSs strategy of targeting poor taxpayers while remaining attuned to the wishes of presidents and influential members of Congress who benefit personally from less aggressive enforcement in selected districts and states will in all likelihood continue unabated.