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IRS Losing Battle with Tax Cheaters

Note from editor: This article from the New York Times focuses on problems with the Federal tax system. But the situation it describes often occurs at the state level as well. Not only do legislatures tend to give generous tax breaks to corporations, they often underfund tax enforcement and look the other way when corporate tax avoidance becomes rampant.

When it comes to lower income taxpayers however, Congress isn’t so forgiving. The IRS has been under pressure from Congress to scrutinize lower income taxpayers who apply for the Earned Income Tax Credit. As a result, in the year 2000, tax returns filed by low income taxpayers making less than $25,000 were more likely to be audited than returns from taxpayers earning more than $100,000. Since 1998, audits for the poor have increased by a third while audits for the wealthiest Americans fell by 90%.

New York Times
November 5, 2002

IRS leader: U.S. losing to cheaters

Departing Commissioner Urges More Enforcement

By David Cay Johnston

Preparing to step down Wednesday after five years, the commissioner of the Internal Revenue Service, Charles O. Rossotti, says the agency is steadily losing the war with tax cheats, especially the wealthiest and most sophisticated among them.

The Bush administration, which has yet to name a replacement for Rossotti, recognizes that tax cheating is widespread but says the IRS is getting the right amount of money in its budget. And the administration stopped Rossotti from speaking his mind to Congress, according to three senior IRS officials.

The officials said the oversight subcommittee of the House Ways and Means Committee was to have held its first hearing on sophisticated tax cheats Oct. 1. But the hearing was called off at the request of Rossotti, who the officials said had been ordered by the Bush administration not to testify about his views that the IRS cannot adequately enforce the law without annual budget increases that keep pace with the growing number of tax returns and the increasing sophistication of tax cheats.

Asked whether he had been muzzled, Rossotti, who had won wide praise in tax circles for bringing a culture of candor to the IRS, declined to comment. Asked why, he said, “I am still a member of this administration.”

But Rossotti expressed his concerns in an interview. “The tax system continues to grow in complexity, while the resource base of the IRS is not growing and in real terms is shrinking,” he said. “Basically, demands and resources are going in the opposite direction.”

“This is systematically undermining one of the most important foundations of the American economy,” he said.

        Tax avoidance

David Hariton, a corporate tax lawyer at Sullivan & Cromwell, said tax avoidance has become so sophisticated that “the government needs to devote 10 times as many resources as it does now if it wants to tax capital effectively.”

He said the additional spending would bring in many tens of dollars of tax for each dollar spent on law enforcement.

Because most IRS resources are devoted to routine work like processing tax returns, the 10 percent reduction has meant a 28 percent decline in money for audits, investigations and collections, Rossotti wrote to the board.

“The IRS is simply outnumbered,” he wrote.

He said the IRS needs to work 13.3 million cases in which documents, primarily from partnerships and similar entities that are used mostly by wealthy investors, do not match up with reports on individual tax returns. But the agency has the resources to pursue only a fifth of these cases.

In his report to the oversight board, Rossotti put the tax loss from that area alone at $7 billion annually. But in earlier reports to Congress, the IRS has used figures that could put the tax loss as high as $64 billion. Rossotti has said that every fifth dollar of partnership income is not showing up on tax returns.

     Offshore accounts

He said the IRS had also identified 82,100 taxpayers who used offshore accounts to evade taxes, but could pursue only 17,000 of them. He estimated the annual tax loss at $447 million, or less than $7,000 for each taxpayer, a modest figure when compared with his previous estimates of multibillion-dollar losses. Jack Blum, an IRS consultant, has estimated that offshore evasion alone costs the government $70 billion annually.

To close the law-enforcement gap this year, Rossotti said, the IRS needs $1.9 billion — an increase of 51 percent for its enforcement budget — and authority to hire 29,306 more people, on top of the 48,000 it already has.

In addition, he wrote, at a bare minimum the agency needs a 2 percent increase, above inflation, each year just to keep pace with growth in the tax system.

News reports about what Rossotti wrote to the oversight board infuriated officials in the Office of Management and Budget, who insisted he make no other public comments contrary to the administration’s view that the IRS budget is adequate and that he say nothing about future budgets, according to senior IRS officials.

The IRS is getting a 4.8 percent increase in its law-enforcement budget, to $3.7 billion, this year, Mitchell B. Daniels Jr., director of the Office of Management and Budget, wrote last month to Sen. Max Baucus, D-Mont., who is chairman of the Senate Finance Committee. Baucus had written Daniels in September asking whether the IRS had enough money to enforce the law.

     Reforms studied

Daniels wrote: “I am confident that these resources,” together with tax simplification and other reforms being studied by the Treasury Department, “will allow the IRS to effectively attack the serious non-compliance problems Treasury has identified.”

Former commissioners, retired IRS executives and others who work closely with the agency say it needs a large infusion of money for law enforcement to reverse the wave of tax cheating, which, they warn, will only grow, especially among corporations and high-income individuals, as long as law enforcement is weak.

One recently retired IRS senior executive, who said his new employer would not allow him to be identified in an article, said “the IRS does not need another $100 million, it needs 2 or 3 billion more.”

Dennis Crawford, who retired this fall as acting chief of criminal investigation, agreed that the agency was letting too many tax cheats get away for lack of resources to pursue them, but he said a sudden and huge budget increase would be wasted.

“The IRS doesn’t have the capacity to handle a $2 billion budget increase,” he said. Rather, he said, it needs steady and significant increases to build its capacity until it is sufficient to deter tax cheats.


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