Written by Peter Kennedy, Director, for The Delaware Business Times

If anyone thinks enforcement does not influence compliance significantly, you should spend a few hours observing traffic patterns on the border of Elsmere and Wilmington during rush hour. Elsmere has a reputation for strict enforcement of traffic regulations.  On a regular basis during my morning commute, I saw cars speed up after leaving Elsmere despite the fact that the speed limit drops from 35 to 25 at the Wilmington City line.

In 2015, the overall IRS tax audit frequency was 0.8% meaning that one return in 125 was selected for audit.  If a return reflected $75,000 to $100,000 of income, it was closer to one in 200.  If an average working career is 40 years, most working adults can reasonably expect not to be audited in their lifetimes.

A client once told me that the majority of what passes for honesty is actually lack of opportunity – hence the need for effective controls.  With people knowing the IRS was supposedly monitoring, the estimated “Tax Gap” (defined as the difference between what people owed in taxes and what was actually collected) in from 2008 – 2010 was estimated to be over $450 billion annually or 18.3% of total taxes owed.  As Alan Rappeport pointed out in a March 2 New York Times piece, the “Tax Gap” comes within shouting distance of the annual budget deficit.

In the aftermath of the Deepwater Horizon oil spill in the Gulf of Mexico, the Federal Government sought recompense for the many fishermen and others whose livelihood was impacted.  Individuals were told to submit their tax returns with their claims, but this was met significant resistance.  As it happens, the tax returns were a poor indicator of actual lost income for those folks, how about that?

So um, yeah, about all that effort organizations put into preparing the 1095 Forms….. The primary purpose of the 1095 Form was for the IRS to be able to match a taxpayer’s claimed insurance status with their employer’s records, catch those without insurance by choice, and force them to pay the penalty.  The penalty was designed to both fund the Affordable Care Act and “encourage” folks to sign up for insurance.   And the administration just announced it will not be enforced…..

The IRS is probably the most reviled of federal agencies, so the news that a preliminary federal budget was slashing its resources by 14% was greeted with joy in some circles.  You have to imagine that for President Trump (who has been audited nearly every year of his adult life) and other Republicans (still legitimately peeved over Lois Lerner and the unbalanced approach to right-leaning organizations seeking exempt status), it’s payback time.  But, the IRS serves a vital purpose.  Like those cars leaving Elsmere, the rate of noncompliance will accelerate as enforcement wanes and the rule followers feel like suckers while the rule breakers go zooming past. If the tax gap was 18.3% seven years ago, I’ll take the “over” on what it would be if measured today.  That means that legitimate taxpayers are either paying roughly 25% more than they would if everyone abided by the tax code, or they are being left with a tab for a bloated deficit depending on how you look at it.  Short-changing the IRS penalizes the rule-followers and rewards the dishonest.

“Tomorrow is Overrated” is the new marketing slogan for José Cuervo Tequila, but it might also apply to the section of the suggested Federal budget where the IRS funding is discussed.   Maybe it could be modified to “The Future is Overrated”.  Slashing the IRS budget 14% at this time is irresponsible bordering on lunacy.  Once noncompliance becomes implicitly accepted, the erosion of confidence on the part of an average taxpayer will make cheating more mainstream.  The hangover involved in getting that genie back in the bottle will be painful and lengthy.

Posted in