I’m not sure what you do during long car rides, but in my family, we debate the nuances of the US tax system. It started somewhere between our daughter’s college town of Madison and our hometown near Detroit last weekend.
My mother-in-law asked whether we’d filed our taxes. Of course we will, and you shouldn’t take advice suggesting otherwise. Filing is required of most US citizens and permanent residents.
But we hadn’t filed yet, and my husband wondered how many Americans might be “aggressive” when filing this year by claiming as many deductions as possible to reduce their taxable income.
He thought many would, given the news of deep staffing cuts at the IRS. If they did, I noted it would be another sign that our voluntary tax system is under strain. My family didn’t buy it. “You have to file a return,” they argued. “How is that voluntary?”
They weren’t entirely wrong. But what makes our system “voluntary” is what happens before you file your return. Individuals self-report everything.
That means we willingly (and ideally, accurately) calculate and disclose our income, expenses, and other relevant tax data. The US tax system is built on mutual trust, basic understanding of filing requirements, some occasionally complicated forms, and data management.
My husband countered, “But see, the IRS already has the information. They match what we report to the forms they get. They know if we don’t report enough.”
True, but for individual filers, that matching process only goes so far. Most people behave pretty well when their income is reported by a third party. But when it’s not—like for income from sole proprietorships, pass-through businesses, or even rental and farm income—things can get tricky.
Consider the tax gap—the difference between what taxpayers owe and what they actually pay on time. The IRS projects about 85 percent of taxes owed are paid “voluntarily and timely.”
But it recently projected that for Tax Year 2022, the gross tax gap reached $696 billion. That’s the amount of true tax liability that wasn’t paid voluntarily and on time. After expected enforcement and late payments, the net tax gap, or the portion the IRS expects never to collect, still totaled $606 billion.
That’s a lot of money left on the table.
Most of the tax gap, about $539 billion, comes from underreporting. That includes income people don’t disclose (or misrepresent) on timely filed returns. Another $94 billion comes from taxpayers who file by the deadline but don’t pay on time, and $63 billion is attributed to people who don’t file at all when they should.
The individual income tax is the largest source of federal revenue, so unsurprisingly, most of the underreporting—over $500 billion—occurs in individual income tax returns. The rest comes from employment taxes, corporate taxes, and a small share from estate taxes.
This offers a reminder that “voluntary” doesn’t mean “optional.” Our tax system depends on us being honest and understanding at least the basics of filing requirements, especially when the IRS can’t easily double-check our returns.
Which brings us to audits, or, these days, the lack of them. (I brought that up somewhere near Ann Arbor.) I asked my family to guess the IRS audit rate of all individual tax filers. My husband answered.
“One in 100.”
He was close. The audit rate of individual income tax returns was just shy of 1 percent of 2011 tax returns. By 2018 it had dropped to 0.3 percent.
The audit rate has been different for different groups of filers. For example, the audit rate of those with “positive income” (the sum of income before losses and deductions) of $500,000 or less dropped from 0.7 percent to 0.3 percent. That includes audits of filers claiming the Earned Income Tax Credit—their rate dropped from 1.8 percent to 0.9 percent. And for those making over $1 million, audit rates dropped from 7.2 percent to 1.6 percent.
The declines were largely due to budget cuts and a shrinking IRS workforce.
To address this, Congress passed the Inflation Reduction Act in 2022 (IRA), which gave the IRS a major funding boost—about $80 billion over 10 years. The goal was to improve enforcement, especially for high-income taxpayers, partnerships, and large corporations. Then-Treasury Secretary Janet Yellen directed the IRS to avoid increased scrutiny of those earning under $400,000.
However, that funding was later slashed by nearly $42 billion, and the IRS’s annual appropriations remain frozen at 2022 levels. Recently, about 11,000 IRS employees took a buyout or were laid off (though in compliance with court orders, 7,000 were reinstated and invited to return by April 14), and modernization efforts have now paused.
So, where does that leave us? Maybe there are opportunities for efficiency gains that the architects and implementers of IRA haven’t yet reaped. But filing taxes is a lot like driving: If there are too few police or traffic cameras to catch you, you might be more likely to speed or run a red light.
These are the very questions my colleagues will explore on Tax Day. The TPC event, “How Will Large Reductions in the IRS’s Funding and Staffing Affect Taxpayers?” on April 15 is part of the Donald C. Lubick Symposium Series. It will feature expert panels on the real-world impacts of these funding cuts. That includes delayed taxpayer services, reduced (but still present) enforcement, and growing inequities in who gets audited and who doesn’t.
Whether you’re a tax nerd like me or just trying to survive a car ride with one, the discussion promises real insight into how our tax system functions and what a well-functioning IRS should look like.
So join us. It’s a virtual event: No seatbelt required.
The Tax Hound helps make sense of tax policy for those outside the tax world by connecting tax issues to everyday concerns. Have a question or an idea? Send Renu an email.
