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Tax audits bring in 3x more money in subsequent years

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The United States avoided defaulting on its debt, thanks to last-minute deal reached by President Joe Biden and House Speaker Kevin McCarthy and grudgingly agreed to earlier this month by Congress.

Park of the package was a $21.4 billion cut to money the Internal Revenue Service was supposed to use for tax enforcement. The agreement called for an immediate $1.4 billion reduction, plus the loss of $20 billion over the next two years, most of that coming from the nearly $80 billion in extra funding the IRS was given as part of the Inflation Reduction Act.

Critics of the hit to IRS audit efforts say the cut will dramatically hamper the tax agency's ability to collect all the revenue it is owed, particularly by wealthy tax evaders.

They point to the Congressional Budget Office (CBO) analysis that the immediate $1.4 billion reduction in IRS funds will mean a revenue loss of $2.3 billion loss over the next decade, which in turn will increase the federal deficit by $900 million over those 10 years.

Hmmm. If I remember correctly, McCarthy's party wanted a deal that would move Uncle Sam's debt in the other direction.

Collection shouldn't suffer too much: Despite the loss of funding and dire debt projections, the IRS says it expects its tax compliance plans for the next five years to stay roughly the same.

How? The White House plans to repurpose funds during the fiscal 2024 appropriations process to cover the cuts to IRS compliance efforts.

Plus, the IRS always can fall back on a system with which it's way too familiar. "It might be the case in five, six, seven years there might be a need to ask for more IRS funding," said a Biden Administration official.

Audits pay off for years: All this talk of IRS money granted then revoked and its effect on efforts to audit tax evaders brings me to this weekend's Saturday Shout Out.

Even taxpayers who are confident that their filings are correct hate audits. That attitude is why, say a group of Harvard University economists, the IRS examinations are so effective.

Taxpayers who get audited tend to pay more in taxes for years to come, presumably because they don't want it to happen again.

"Getting audited tends to scare taxpayers straight and increase the amount they pay in taxes, voluntarily, for roughly a decade-and-a-half," writes Sam Becker in his Fast Company article Harvard economists have a surprisingly convincing argument in favor of IRS tax audits.

3 times the money going forward: This multiplier effect is roughly an additional $3 more in taxes in years after an audit for every $1 the taxpayer ends up owing after answering IRS questions.

Nathaniel Hendren, professor of economics at Harvard and one of the paper's authors, elaborated on the tax collection multiplier scenario in a Twitter thread.

Becker does a nice job putting all the academic economic speak into plain English. However, feel free to also check out the original source, the Hendren et al 77-page PDF paper titled "A Welfare Analysis of Tax Audits Across the Income Distribution."

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