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Senate Budget Committee Hearing: Fairness and Fiscal Responsibility: Cracking Down on Wealthy Tax Cheats

Senate Committee on the Budget

Fairness and Fiscal Responsibility: Cracking Down on Wealthy Tax Cheats

Wednesday, November 8, 2023

 

Topline

  • Democrats discussed the benefits of the increased funding for the IRS in the Inflation Reduction Act and argued that better tax enforcement would reduce the deficit.
  • Republicans called for simplifying the tax code and argued that reducing one’s tax liabilities is different than tax evasion.

 

Witnesses

  • Dr. Natasha Sarin, Professor of Law & Finance, Yale Law School & Yale School of Management
  • Dr. Nathaniel Hendren, Professor of Economics & Co-Founder of Policy Impacts, Massachusetts Institute of Technology
  • Chris Edwards, Kilts Family Chair in Fiscal Studies, Cato Institute

 

Opening Statements

Chair Sheldon Whitehouse (D-R.I.)

In his opening statement, Whitehouse discussed how the wealthiest Americans play by different rules and are empowered by a tax code that is rigged in their favor. He noted the super wealthy are responsible for a large share of tax evasion and cost the American people hundreds of billions of dollars each year. Whitehouse said that years of budget costs hobbled the IRS, shrinking the audit rate for millionaires by 80% and cutting the audit rate for corporations in half. He lamented that there is tax amnesty for the rich and tax enforcement for the poor. Whitehouse cited the CBO’s estimate that the money Democrats provided for the IRS in the Inflation Reduction Act would result in $180 billion in additional revenue and criticized House MAGA Republicans for turning their Israel funding supplemental into a scheme to reward wealthy donors by slashing funding for tax enforcement. He concluded that the tax gap is nearly half the size of the deficit and said auditing the wealthy delivers the biggest bang for the enforcement buck.

 

Ranking Member Chuck Grassley (R-Iowa)

In his opening statement, Grassley criticized the so-called Inflation Reduction Act for abandoning the bipartisan focus on IRS-reform. He noted that the enforcement of the Inflation Reduction Act (IRA) will come at tremendous cost to small business owners and said Democrats don’t seem to care about the costs to small businesses because they are bewitched by the idea that the IRA created a magic money machine that will only extract dollars from the wealthy and large corporations. Grassley criticized the IRS’ statement that the $400,000 threshold will be based on total positive income, which he decried as an extremely broad definition of income that will capture many unsuspecting small businesses.

 

Testimony

Dr. Natasha Sarin, Professor of Law & Finance, Yale Law School & Yale School of Management

In her testimony, Sarin discussed the remarkable changes in the first year of the IRA’s enactment, citing the IRS achieving an 87% level of service and serving 100,000 more taxpayers in person as examples. She noted the IRS is gearing up for a direct file option which would save Americans money on tax preparation and explained that the IRS is prioritizing high-end enforcement efforts. Sarin affirmed that adequately funding the IRS is critical to our fiscal sustainability, as more than $600 billion in owed taxes are uncollected each year. She noted that one year’s worth of uncollected taxes would shrink our annual budget deficits by nearly half, and discussed how the IRS is making progress in large corporate tax evasion, citing the agency’s recent finding that Microsoft owes nearly $30 billion in back taxes. Sarin concluded that adequately funding the IRS is critical to creating a fairer economy and said the IRA has meaningfully improved our fiscal future.

 

Dr. Nathaniel Hendren, Professor of Economics & Co-Founder of Policy Impacts, Massachusetts Institute of Technology

In his testimony, Hendren said that while the CBO suggested that expanded IRS enforcement from the IRA would deliver roughly $180 billion in revenue, his team’s results suggest that the true return on the IRA’s investment would be three times higher. He explained their different findings stem from the fact that the CBO has been reluctant to include estimates of deterrence effects in their forecasts. Hendren said his estimates, which address the effects of deterrence, suggest net revenues closer to the $500 billion range. He concluded that increasing audit enforcement is an efficient way of increasing revenue.

 

Chris Edwards, Kilts Family Chair in Fiscal Studies, Cato Institute

In his testimony, Edwards affirmed that all new spending should be offset by cuts and explained that reducing the President’s increased IRS enforcement does not work as an offset because enforcement may modestly increase revenues. He noted that he still supports rescinding the increased IRS enforcement budget because there are much better ways to boost tax compliance, including simplifying the tax code. Edwards decried enforcement as a blunt and inaccurate tool. He noted that taxpayer errors and cheating have not increased as a share of the economy and said the U.S. tax gap as a percentage of GDP is the same size or smaller as tax gaps in Europe. Edwards concluded by discussing three better ways to boost tax compliance: Keeping tax rates low, improving IRS customer services, and simplifying the tax code.

 

Question & Answer

Tax Enforcement & Evasion

Whitehouse asked Sarin about a statistic she quoted earlier saying that the IRS went from an 18% level of service in 2022 to an 87% level of service today. Sarin explained that that statistic refers to the number of phone calls that are answered and said that in the two years leading up to the Inflation Reduction Act the IRS had received 500 million phone calls, with only 13% ever being answered. Sarin noted the improvement of 13% to 87% in answered phone calls as well as reduced wait times in the short period since the IRA’s passage.

 

Whitehouse asked which tax evasion devices are unaccounted for in the IRS’ $688 billion tax gap estimate that makes the actual number larger. Sarin said the challenge is the IRS can only measure what it can see. She said the IRS does a good job measuring the individual income tax gap, but they have no capacity to measure the corporate income tax gap, the digital assets tax gap, or the partnership tax gap.

 

Whitehouse asked if auditing a complex partnership will cause more headaches for the firms that have created them. Sarin said pass-throughs are taxed at the individual level, and auditors need to peel back partnerships to find the individual income tax liability. Sarin explained that in the past, a single IRS agent would be given the task of going through complex structures with hundreds of entities and that to find all income owed to the IRS by these complexly structured firms would require a team of experts. Whitehouse finished by asking Hendren if his argument is that when a complex entity is correctly audited that the revenue correction would persist through time. Hendren said yes and said that he has found that when you audit an individual or business, you typically pick up three additional dollars to the initial dollar you picked up.

 

Grassley asked Edwards if the lopsided nature of IRS funding would create a taxpayer services cliff with customer service money running dry before enforcement funding. Edwards said that with a need for technology upgrades at the IRS, there should be a bipartisan compromise to move some of the extra enforcement money back to customer service and IT upgrades. Grassley said liberal pundits claim that anyone who is not a tax cheat has nothing to worry about with increased IRS enforcement. He asked Edwards to discuss the cost and burden an IRS audit imposes on innocent taxpayers. Edwards said IRS audits cause businesses to go bankrupt after they are audited and noted audits cause collateral damage and that the IRS loses nearly half the time in tax court.

 

Grassley then asked Edwards if the frequently quoted $688 billion tax gap could be overstated due to incorrect methodology. Edwards said that while the study being referenced is interesting, he believes that the IRS’s methodology is generally accurate and has shown the tax gap to be a similar percentage share of GDP as it was in previous years.

 

Sen. Chris Van Hollen (D-Md.) asked if the witnesses agree that better tax enforcement will reduce the deficit. Sarin and Hendren said yes, while Edwards said slightly. Van Hollen then asked if the witnesses agree that the cuts by the House would harm revenues and again, Sarin and Hendren said yes while Edwards said slightly yes.

 

Van Hollen asked how large the witnesses think the current tax gap is, and how targeting wealthy taxpayers who are not paying what they owe can reduce the deficit. Hendren said it’s hard to measure what you don’t see. He noted that for every dollar you spend on an audit, you get back $12, and those estimates only increase as you go up in income distribution. Van Hollen replied that Democrats are not talking about increasing tax rates and are just talking about collecting money that is already owed. He said it amazes him that Republicans want to prevent the IRS from doing that.

 

Sen. Romney (R-Utah) said corporations are not trying to cheat but are trying to follow every legal avenue to keep their taxes as low as possible. He also called for more audits and said it’s insane to believe that getting rid of auditors would save money.

 

Sen. Jeff Merkley (D-Ore.) said his colleagues across the aisle want to let the richest Americans cheat and asked if that is good for America. Sandrin said the U.S. is losing 3% of its GDP annually from tax evasion and that it is a matter of fairness where the wealthiest have the tools to evade taxes while lower income Americans foot the bill.

 

Merkley said it’s a privilege that the wealthiest Americans earn the type of income where their taxes are not collected in advance. He called for an eruption of integrity and bipartisan support to ensure the richest Americans do not cheat and undermine our social contract.

 

Sen. Mike Lee (R-Utah) noted that tax evasion is illegal and said his Democratic colleagues conflate tax evasion and legal measures to reduce tax liability. He criticized those in the Biden Administration who have called for unconstitutional proposals, including a wealth tax, or complex proposals that tax unrealized gains.

 

Sen. Mike Braun (R-Ind.) said increased IRS enforcement would only save $10 billion a year, and asked if the witnesses had any other ideas for how to get the budget in order. Sarin said adequately funding the IRS would generate $500 billion, but Braun pushed back that estimate is contrary to the CBO estimate. Edwards called for large spending cuts, cutting Social Security for wealthy individuals, and getting the federal government out of K-12 education.

 

Tax Code

Romney noted that raising taxes on people slows the growth of our economy, but asked if there are places where we could generate more money or revenue from our tax code without slowing growth. Edwards cited the energy tax subsidies in the IRA, which he said are more expensive than the Administration let on and will cost about one trillion dollars. He also called for cutting back on the municipal bond tax exemption, which he said mainly goes to upper class individuals and distorts investment. Hendren added that audits are a particularly great way to raise revenue.

 

Sen. Ron Johnson (R-Wisc.) said the solution to tax evasion is simplifying and rationalizing the tax code. He explained that our tax code is complex and difficult to comply with and said income should be based on cash generation. Edwards added that the confusion and grayness of the tax code is what in part encourages companies to push the limits of the tax code through complex structures designed to save on taxes.

 

Israel Security Supplemental Appropriations Act, 2024

Whitehouse opened by asking if any witnesses disagreed with the statement that House IRS enforcement cuts would not reduce the deficit. No witnesses disagreed with the statement.

 

Sen. John Kennedy (R-La.) asked Sarin if she tweeted that the House Republican’s Israel proposal would make it easier for wealthy Americans to cheat on their taxes. Sarin confirmed that she did. Kennedy criticized her for tweeting that without speaking with any Republican House members, and Sarin explained that her tweet reflects what’s in their legislation. She noted that all three witnesses, who fall across the ideological spectrum, agree that defunding the IRS will increase the budget.

 

Kennedy argued that House Republicans might have voted for the bill because they believe the IRS is a model for inefficiency. Sarin explained that the IRS was inefficient because it was underfunded. She added that defunding the IRS makes deficits worse, not better.

 

Van Hollen asked if the witnesses agreed that House Republicans’ Israel aid bill would increase the deficit by cutting funding for the IRS. Sarin and Hendren said yes, while Edwards said slightly. Van Hollen said the bill would cost the American taxpayer $90 billion. He blasted the Republicans’ claim that the cuts to the IRS would offset the cost of the bill as misleading at best and dishonest at worst.

 

 

For more information on this meeting, please click here.

For an archive of past SIFMA hearing coverage, please click here.