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The IRS should do more to nab wealthy tax dodgers

The Internal Revenue Service (IRS) building in Washington,

The Internal Revenue Service (IRS) building in Washington, D.C. Wealthy taxpayers who stash money in complex structures shortchange the IRS by about $175 billion per year. Credit: Bloomberg/Andrew Harrer

President Joe Biden has big, ambitious plans that will continue to ring up unwieldy bills for the federal government. His administration will have to fund a significant — but still undetermined — portion of those bills by raising taxes on affluent Americans. And that won't go well unless Biden's team can get ahead of well-heeled taxpayers who are inclined to outfox the system.

The Internal Revenue Service has spent years underestimating how much income those artful dodgers have masked to avoid paying taxes. The money has been stashed in complex structures, often offshore bank accounts or private business partnerships, shortchanging Uncle Sam by about $175 billion a year.

The data revealing this come from a National Bureau of Economic Research study that looked at audits of individual income tax returns from 2006 to 2013. The researchers zeroed in on the top 1%, top .1% and top .01% of U.S. taxpayers. In 2013, you qualified as a one-percenter if your adjusted gross income was $428,713 or more. You were in the .1% if you reported income of about $1.9 million or more, and the .01% if you reported $9.5 million or more.

The feds lean heavily on individual taxpayers to fill their coffers. In fiscal year 2019, the IRS collected about $1.9 trillion from more than 154 million income tax returns — which was about 54% of the $3.5 trillion it collected before it paid refunds that year. So even if the IRS now raises its game and taxes the money that affluent Americans shelter, it may increase the government's overall haul just 10%. More meaningful increases will come only with a significant hike in tax rates.

Nevertheless, $175 billion is found money, and the IRS can do a better job of policing wealthy taxpayers' shell games. The researchers discovered that most offshore tax evasion goes undetected and that an under-resourced IRS is easily outmaneuvered. The study acknowledges that many wealthy taxpayers operate in "the gray area between avoidance and evasion" - meaning that identifying any transgressions and then collecting what's owed can be a thorny affair.

Buried inside the NBER data are revelations about human nature. Individual taxpayers' propensity to embrace greed, possible fraud and risk is boiled down to mathematical equations that measure how likely they are to take a "binary concealment action." The analysts found that affluent people were more likely to evade taxes if they could find ways to shelter a lot of money inexpensively. If they couldn't save a lot of money, they'd pass. If it was expensive to shelter money, they'd pass.

But not many are passing, apparently. The top 1% underreport 20% to 25% of their annual income. The top .1% and .01% underreport about 15% of what they make. All of this is happening during a modern gilded age in which the top 1% control the lion's share of America's individual wealth.

One of the many perverse outcomes has been that the IRS, whose budget has been persistently gutted in recent years, has developed a preference for auditing poorer taxpayers — because their transgressions are easier to detect. "Increased concealment effort by high-income taxpayers can actually cause the tax authority to substitute toward auditing more low-income taxpayers," the NBER study notes.

Plenty of real-world reporting backs this up. In 2009, as ProPublica has pointed out, the IRS formed a SWAT team of sorts to uncover and derail the complex tax dodges of ultrawealthy Americans. "Such taxpayers tend not to steamroll tax laws; they employ complex, highly refined strategies that seek to stretch the tax code to their advantage," noted the site's reporters. "It can take years for IRS investigators just to understand a transaction and deem it to be a violation."

The IRS team found itself routinely outnumbered by well-paid accountants and lawyers representing the wealthy taxpayers and further upended by congressional Republicans who kept draining resources from the agency. The SWAT team's work was "dead on arrival," according to ProPublica. The IRS told Congress in 2019 that it now audits the poor more often than the rich because it's easier and more cost effective.

There's clearly a better way. Boosting the IRS's resources would be a start. Closing loopholes around the treatment of income from business partnerships and reducing the availability and abuse of havens such as offshore bank accounts would also help.

If you're one of the fortunate folks making several million dollars a year and this column makes you flinch, think how hard it will be for billionaires who might come under the same microscope. After all, the COVID-19 pandemic was particularly good for their finances. As the Institute for Policy Studies observed, the combined wealth of the 657 billionaires in the U.S. has jumped by almost 45%, or $1.3 trillion, since lockdowns began. During the same period, 80 million Americans lost their jobs.

Bill Gates, the founder of Microsoft Corp., saw his personal wealth grow 29% during the pandemic, to $126.5 billion from $98 billion, according to IPS. Gates has repeatedly said that he considers the current income tax system inequitable and that he's willing to pay billions more in taxes — which would still leave him mind-bogglingly wealthy.

If billionaires are comfortable with the idea of forking over much more, millionaires can get comfortable with it, too. If they can't, the IRS should help enlighten them.

Timothy L. O'Brien is a senior columnist for Bloomberg Opinion.