sam hammond is the director of poverty and welfare policy at the Niskanen Center in Washington. david koggan is a student at Carnegie Mellon University and recent Niskanen Center policy intern. This essay was adapted from a Niskanen Center report, “The IRS: A Broken Home in Need of Repair.”
illustrations by michael glenwood
Published January 24, 2022
If taxes are the “lifeblood of government,” as the Supreme Court has often reaffirmed, then the IRS is the heart that keeps the federal government’s blood pumping. Virtually every public function relies on the revenue collected by the IRS, including our capacity to underwrite a growing public debt without runaway inflation.
But, stretching the metaphor a bit further, the 68-year-old agency’s risk of cardiac arrest is clearly growing. Decades of workforce and budget cuts have left the IRS short of personnel and money: Congressional funding for tax enforcement and operations was 19 percent lower in 2021 than in 2010, giving the agency roughly the same inflation-adjusted budget it had 30 years ago. This, despite needing to process over 56 million more individual returns and twice the number of business tax returns annually, all while administering an increasingly complex tax code that saddles the agency with growing responsibilities in social welfare and regulatory policy that the agency was never designed to handle. And with nearly one in three IRS employees currently eligible to retire, the agency’s staffing crisis is set to grow much worse.
This mismatch of responsibilities and resources is not helped by the IRS’s floppy-disc technical infrastructure. The backend of the IRS is the all-important Individual Master File. Used to store and process tax submissions, the IMF is programmed in impenetrable assembly code that literally dates from the Kennedy administration. Translating the code into Java, a comparatively modern programming language, has been a long-term goal of the IRS — but one which has faced repeated and often embarrassing setbacks. And while the agency is formally committed to a broad-based modernization initiative, progress reports have been lacking.
As this is being written, the Biden administration is pressing for a considerable increase in the IRS’s enforcement budget. But with lawmakers delegating more and more responsibility to the IRS, it will take more than a boost to its enforcement muscle to bring the agency into the 21st century.
The agency was last restructured in 1998 — when we still feared the new millennium might cause a computer-induced apocalypse. Technology has advanced by leaps and bounds in the decades since, but the user experience in dealing with the nation’s tax and transfer system has in some ways regressed. This is partly because the IRS is drowning in mission creep, as Congress has found it convenient to expand the agency’s tasks far beyond the business of collecting taxes.
Congress’s response has almost always been myopic, punishing the IRS’s mistakes with austerity and subterfuge, which only begets further struggles to muddle through.
Want to know the rules for government programs ranging from opportunity zones to a Covid-19-inspired child allowance? Ask the IRS, although it may take a few years to get back to you. Administering complex tax expenditures and social programs has stretched the agency thin.
One way or another, the agency’s bloated mission needs to be devolved, with sufficient resources appropriated to give it a chance to do its core job well. However, achieving these reforms will be impossible without first fixing the broken funding and oversight mechanisms that have long exposed the IRS to politicization.
When Modernization Meets Vilification
Despite delegating to the IRS ever-greater responsibilities, Congress has tended to scorn it rather than nurture it. Of course, the IRS has made many mistakes over its history, building an unenviable record of cost overruns and project mismanagement. Yet Congress’s response has almost always been myopic, punishing the IRS’s mistakes with austerity and subterfuge, which only begets further struggles to muddle through.
Indeed, Congress has generally ignored the IRS’s requests to properly fund modernization of their information systems infrastructure. And this inclination to starve the beast has led to technological failures that contribute to a vicious cycle of visible dysfunction and angry constituents — souring lawmakers against the IRS all the more.
The mismanagement of past funding influxes has only added to Congress’s skepticism. When the IRS finally began receiving the money for the Tax Systems Modernization program in 1986, for example, it experienced a “famine-to-feast infusion of resources” that the agency was ill-prepared to absorb. As a General Accounting Office report noted in the early 1990s, the IRS lacked a clear explanation of its plan for TSM while failing to clarify the mission and scope of the program.
The IRS was unprepared for the TSM because its organizational culture and management structure was unsuited for technology mega-projects. Despite the agency’s lack of in-house technical skills, it was averse to working with outside contractors and even with newer employees at home in the digital age. As Barry Bozeman, a specialist in organizations, notes, given the political scapegoating of those at the IRS and negative portrayal of the service by news media, “it is not difficult to understand how such an environment can foment distrust and insularity.” Bozeman lamented that the plans the organization developed before funding was allocated thus gave “more attention to the wish list than to the specifications and functionality.”
The Tax Systems Modernization program included projects ranging from developing electronic tax filing to digitizing paper returns. All seem like no-brainers today, but certainly not 30 years ago. IRS management failed to recognize that even the latest technology at the time was incapable of meeting their lofty expectations, and so many of the initiatives were doomed to failure before the first dollar was spent.
TSM evolved from a modernization effort into an organizational learning experience. Following various reports from watchdog agencies criticizing the program, scrutiny of the TSM went into high gear while funding floundered. “It’s never too late to stop a hemorrhage,” said a GAO chief scientist before the Senate Governmental Affairs Committee in May 1996. A month later, Congress created the National Commission on Restructuring the Internal Revenue Service to evaluate the agency’s future in earnest.
In 1997, the Commission released its final report. With an air of optimism unjustified by recent history, the report called to “overhaul the IRS and transform it into an efficient, modern and responsive agency.” The commission identified three core issues with the agency: lack of management accountability, chronic short-sightedness and inadequate technical expertise. It recommended:
• Establishing an executive board of directors to fill the leadership vacuum at the agency.
• Setting the IRS commissioner’s term length to five years, and giving the commissioner more flexibility to see initiatives to completion.
• Creating a single congressional committee to coordinate oversight of the IRS and assess overall agency performance, rather than allowing piecemeal investigation and recriminations when chickens came home to roost.
Unfortunately, many of the recommendations went ignored in favor of the path of least political resistance: putting the IRS on a tighter leash. The 1994 Republican revolution signaling an enhanced distaste for government only added to the anti-IRS zeitgeist. While the commission was bipartisan, lawmakers increasingly saw the IRS’s woes as a political opportunity.
As Republican Senator Chuck Grassley put it at the time, restructuring the IRS was “in keeping with what many saw as the mandate given to the Congress in 1994 — moving power from government to the people.” With congressional probes into the tax bogeyman continuing into 1997, Republican pollster Frank Luntz reminded candidates that “nothing guarantees more applause and more support than the call to abolish the Internal Revenue Service.”
The IRS never managed to improve its public image — and Congress has never managed to resist the urge to score partisan points at the agency’s expense.
While a reform bill went through the House in the fall of 1997, the politics of the Newt Gingrich era significantly altered the reform’s purpose. In both chambers of Congress, committees held hearings detailing “horror stories” from taxpayers on alleged IRS abuses. Then-chair of the House Republican Conference, John Boehner, declared “This Halloween, the Republican Congress is unmasking the IRS for what it really is: a bureaucratic monster stalking the American taxpayer,” in tandem with the launch of a GOP website to solicit such claims.
Another opportunity for scoring political points surfaced with claims that the IRS was targeting conservative nonprofit organizations. In the year following passage of the IRS Restructuring and Reform Act of 1998, an investigation led by former FBI director William Webster found that the allegations of politically motivated targeting were unfounded and that the IRS had been operating within the law. As the Restructuring Commission noted in its initial report, there were “very few examples of IRS personnel abusing power.” Not that anyone (including the writers) paid much attention; the report argued that taxpayers needed greater protection from undue IRS enforcement nonetheless.
An effort that originally sought to improve the IRS’s ability to implement modernization projects quickly transformed into legislation that, as political scientist David C. Johnston puts it, “handcuffed the tax police.” Instead of passing laws to help the agency adequately administer the tax code, the IRS was tied down with even more bureaucratic red tape, and modernization efforts withered.
A Service Underserved
The perverse “reforms” in the late 1990s would go on to have drastic effects on the IRS’s ability to do its most basic function. Following their adoption, the agency faced dramatic pressure to defer action on improving tax collection. Individual income tax audit rates declined by two-thirds from 1996 to 2002, while the audits that did occur defaulted to inaction in a third of the cases. In fiscal year 1997, the IRS had performed 10,090 seizures in response to unpaid taxes. In 2017, the number was 323. Tax law professor Leandra Lederman identifies three key reasons:
• The IRS restructuring consumed organizational resources that had to be directed away from regular activities.
• Legal changes forced the agency to reallocate individual employees from enforcement to service responsibilities, such as helping taxpayers to navigate filings.
• The introduction of strict penalties for wrongful activity by IRS personnel, known as the 10 Deadly Sins, deterred aggressive efforts at collection because agents feared being fired.
Charles Rossotti, a Harvard MBA and veteran of Robert McNamera’s Defense Department, was named IRS commissioner by President Clinton in 1997 and tasked with breaking the gridlock. Drawing from the Restructuring Commission’s original report, Rossotti initiated a top-to-bottom overhaul, converting regionally based operations to four centralized divisions that served different classes of taxpayers — the basic structure that remains to this day.
Commissioner Rossotti understood the magnitude of the modernization challenge facing the IRS, at one point describing the agency’s information systems capabilities as “like being a bank and not knowing how much money is in your customers’ accounts.” The one-time Boston Consulting Group analyst chose to partner with the private sector to bring more expertise into the effort. But progress proved elusive: in 2004, Congressional testimony suggested that the efforts still faced “significant delays and cost over-runs.”
Meanwhile, the IRS never managed to improve its public image — and Congress has never managed to resist the urge to score partisan points at the agency’s expense. For example, in 2013, a report from a watchdog agency accused the IRS of targeting a conservative 501(c)(4) nonprofit organization. Congressional Republicans piled on.
Yet investigations by multiple institutions later concluded that this was in all likelihood a result of bureaucratic mismanagement of a markedly complex tax code. Indeed, far from engaging in overzealous enforcement, the IRS has adopted a defensive culture of risk aversion, with employees afraid to carry out normal enforcement activities in fear of regulatory violations that would end their careers. As Commissioner Rossotti put it in 2002, “We live in a fishbowl. It is difficult to make even a small mistake because it immediately gets magnified.”
The attacks levied against the IRS have also worn down employee morale. Commissioner John Koskinen testified in June 2014 that “when [IRS employees] are subject to depositions and recorded interviews, it sends … a deleterious effect on morale because they thought they were actually doing what they were asked to do.” In response to the aforementioned brouhaha over conservative nonprofits, Koskinen estimated that 250 IRS employees were forced to dedicate approximately 120,000 hours of work toward meeting congressional demands.
Koskinen apparently moved few minds or hearts in the GOP. In 2015, Congress turned the screws a bit more with the Protecting Americans from Tax Hikes (PATH) Act. A component of the legislation explicitly sought to deepen IRS personnel’s fear of punishment by affirming that “performing, delaying or failing to perform … any official action (including any audit) with respect to a taxpayer for purpose of extracting personal gain or benefit or for a political purpose” will result in an employee’s termination. The same year this legislation passed, IRS funding levels adjusted for inflation fell to 1998 levels.
Social Policy by Other Means
Despite never missing an opportunity to decry the IRS’s alleged inclination to overreach, Congress has increasingly delegated regulatory and social welfare tasks to the service. Indeed, a bitterly divided Congress’s growing reliance on the byzantine process of budget reconciliation to pass major legislation has only accelerated what sociologist Joshua McCabe calls “the fiscalization of social policy.” The reconciliation route allows a narrow majority to bypass the threat of filibuster — but only if the legislation can be construed under the Senate’s rules as budgetrelated. This has resulted in a proliferation of tax credits and regulations (managed by guess who) where on-budget spending and policy programs often make more sense.
The past 18 months have made the problems with this approach all too apparent, with the IRS struggling to quickly implement a host of Covid-19 relief programs ranging from tax credits for paid sick leave to economic impact payments for businesses and other enterprises. As a result, the IRS has been forced to take on the responsibilities of a Health and Human Services agency with the administrative capacities of a toll booth.
Despite never missing an opportunity to decry the IRS’s alleged inclination to overreach, Congress has increasingly delegated regulatory and social welfare tasks to the service
And — again, no surprise — combining tax enforcement with benefit administration has allowed vilification of the former to affect implementation of the latter. Passage of the Affordable Care Act (aka Obamacare), for example, gave the IRS responsibilities in administering a variety of health care provisions, including the premium tax credits that underwrite the individual insurance exchanges. As a consequence, the Republican House majority that emerged out of the 2010 midterms repeatedly pushed to slash the IRS’s budget.
As the Republican chair of the House Appropriations Committee stated in a 2013 hearing, any significant increase in IRS funding “was going to be a challenge for some very basic reasons. There are a lot of objections to the Affordable Health Care Act, a lot of objections to Obamacare.” The IRS Advisory Council would warn a year later that the agency was “in the midst of an existential funding crisis.”
Ironically, a 2015 report from the Parisbased Organization for Economic Cooperation and Development found that the IRS was one of the most efficient tax administrations in the developed world, yielding among the lowest costs of tax collection ratios. Whether this statistic is worth celebrating is another question — the easiest way to lower the cost-to-collection ratio is to ignore more complicated forms of tax evasion. Following budget cuts throughout the early 2010s, IRS Commissioner John Korskinen reported that, “We continue to find efficiencies wherever we can and are presently saving $200 million a year. … But we have reached the point of having to make very critical performance tradeoffs.”
With a shrinking scope for finding bona fide efficiencies, 75 percent of cuts instead went to reduced personnel and staff training. Over half of employment cuts have been in enforcement positions, causing the number of revenue agents to dip below 10,000 for the first time since 1953 when U.S. GDP was oneseventh as large as today. From 2010 to 2019, the audit rate for individuals declined by almost two-thirds and the rate for businesses fell by half.
Indeed, as the IRS’s resources have been gutted, the “core tax-collection mission” that Senator Grassley cited for the agency in the 1990s is ironically the area that has suffered the most. The impact is obvious: from 2011 to 2013, the CBO estimates that over $100 billion in business income and $60 billion in non-business income was underreported.
Public Austerity, Private Burden
Cost ratios notwithstanding, the IRS’s claims of efficiency are based on an illusion, as the true costs of administering the tax code have simply been offloaded to the public. In lieu of robust in-house IRS services to help house-holds and businesses, taxpayers are instead forced to turn to a professional-industrial complex of tax lawyers, accountants and tax preparers. In 2019, tax preparation services alone generated $11.3 billion in revenue. Meanwhile, the IRS’s 2019 budget was just under $12 billion.
The burden of the IRS’s inefficiency hits low-income Americans the hardest. For wealthy households, tax compliance represents a small fixed cost relative to their tax liability, to say nothing of the potential savings they can gain from savvy avoidance strategies and impaired IRS vigilance for evasion. Meanwhile, fees to tax preparers routinely reduce net refunds to low-wage recipients of the Earned Income Tax Credit by 13 to 22 percent.
While other countries provide pre-populated tax returns and free filing services that reduce the burden of tax compliance for all but the most complex returns, efforts to do the same in the U.S. have been successfully blocked by the tax preparation industry. The ironically named Taxpayer-First Act of 2019, for example, went so far as to bar the IRS from creating its own, in-house tax preparation service. And while the IRS does have a “Free File” program that theoretically allows most Americans to file a return for free, the system is outsourced to private companies within the so-called “Free File Alliance.”
The main website for free filing is a clunky, Web 1.0 form designed by tax prep behemoth Intuit TurboTax. And just to make matters worse, Intuit is abandoning ship. The company recently announced it is leaving the alliance, throwing the viability of the IRS’s new non-filer portal into (further) question.
The tax preparation industry benefits from tax complexity, and has even taken steps to hide free alternatives from its customers. Yet this ugly political economy likely wouldn’t survive without the backing of ideological actors on both the right and left. For instance, when David Boaz of the libertarian Cato Institute was asked what one law he’d abolish if he could wave a magic wand, he answered, “End tax withholding. There is no way the government could collect half of what it does if people had to write a check at the end of the year.”
But why stop there? If paying taxes should be painful, why not require that they be filed weekly, on papyrus, while doing push-ups? Taken to its logical conclusion, a strategy to promote limited government based on public sector inefficiency transforms an indirect subsidy for lawyers and accountants into a strange kind of anti-tax masochism.
On the left, meanwhile, many progressive advocacy organizations have all but bent the knee to tax prep giants like H&R Block, which spend millions a year lobbying while making strategic donations to think tanks and other nonprofits that promote refundable tax credits. At this very moment, centerleft groups are mounting a push to give the IRS the authority to regulate and license tax preparers. This may even be a good idea, given the high error rates derived from independent and fly-by-night preparers. Nonetheless, the motives of the advocates are a touch suspicious: the tax-prep industry’s biggest players clearly appreciate the prospect of putting their small competitors out of business, while reforms that would obviate the need for tax prep services in the first place remain off the table.
The IRS’s lack of personnel has induced a growing reliance on automated processes for tax audits. Yet automated methods for auditing wealthy individuals’ tax filings are at best problematic given their length and complexity. Like the drunk who looks for their lost keys under the lamp post because that’s where the light is, the IRS increasingly subjects lower-income populations to unprofitable scrutiny merely because they file the types of returns the IRS can quickly and automatically screen for audit.
Indeed, the agency’s Automated Correspondence Exam software application is specifically tailored to assess EITC cases. As a result, in 2018, over one-third of individual tax returns selected for examination were related to EITC refunds. Not only is this a questionable use of scarce government resources, there is also solid evidence that it has discouraged eligible households from taking advantage of EITC benefits. A 2019 NBER working paper found that taxpayers were less likely to claim the EITC in subsequent years if they were audited, despite the fact that only a small share of audited households were ultimately determined to be cheaters.
If Congress is going to respond to scandals by “punishing” the IRS, mandatory funding would at least push lawmakers toward reforms that address weak management structures rather than just squeezing funding.
It doesn’t take a weatherperson to tell which way the wind has blown. With resource cuts this deep, the IRS can’t even do automation — the one potential route left for getting the job done with fewer people and less money — very well these days. The share of cases involving software-detected underreporting declined between 2010 and 2018 as the IRS’s Automated Underreporting program experienced a 40 percent cut to its workforce. Blaming high audit rates on untrained tax preparers only confuses the issue. While certified tax preparers really do make fewer errors, this is a case of an industry selling an antidote to its own poison.
If at First (Second, Third) You Don’t Succeed ...
The IRS’s 2019 Modernization Business Plan outlined numerous ambitious goals for overhauling their systems, including:
• Modernizing the IRS Individual Master File.
• Developing web applications for assisting taxpayer issues.
• Replacing batch processing with a realtime tax processing program.
• Improving automation of business tax returns.
• Transferring workloads to cloud-based platforms and digitizing data.
• Protecting taxpayer data through a combination of enhanced cyber analytics and threat management.
The 2018 legislation mandating this modernization initiative was followed in 2019 by the aforementioned Taxpayer First Act, which called for reorganizing the IRS’s leadership structure to address the agency’s repeated failure to bring the agency into the digital age. But don’t hold your breath. As recently as August 2020, a report found that “specific or long-term plans have not been developed to address updating, replacing or retiring most legacy systems” — due primarily to underfunding.
Enough Is Enough
The administrative capacity of the IRS has been crumbling for decades. The time has come for a major reinvestment in the agency’s staffing, training and technology. But in addition to more funding, a well-designed reform would:
Differentiate the IRS’s Roles in Tax Enforcement and Benefit Administration
In recent years, the IRS has increased its outreach to low-income communities in order to increase program participation. Yet one is rarely excited to open a letter from the tax man. This is one of many reasons to explicitly separate the agency’s tax enforcement mission from its role as benefit administrator. For example, the Wage and Investment Division, which administers tax laws governing individual wage earners, could be reorganized to distinguish between the division’s compliance and enforcement activities and its role in benefit outreach and customer service.
Establishing mandatory appropriations for the service would thus help the agency modernize while being resilient to scandals, real or perceived.
A benefits-only administrator could be supplemented with the authority needed to streamline and automate benefit delivery. This could include a richer data-sharing agreement with the Social Security Administration, collaboration with states to identify non-filers within their SNAP (food stamp) and Medicaid programs, and the authority to test variants of application forms for clarity and ease of use without running afoul of the Paperwork Reduction Act.
Ideally, Congress would return the IRS to a single mission while delegating its non-revenue responsibilities elsewhere. Spinning out new organizations by mission has more than enough precedent. The Immigration and Naturalization Service, for instance, struggled to build a culture around immigration enforcement while also being charged with attracting new immigrants to the United States. This led to a reorganization that separated U.S. Citizenship and Immigration Services from the investigatory activities of the U.S. Immigration and Customs Enforcement.
Make Congressional Appropriations to the IRS Mandatory
As IRS Commissioner Charles Retting testified in April 2021, “mandatory, consistent, adequate multi-year funding allows us to plan appropriately.” While this is no doubt true of every government agency, stable funding is particularly vital for an agency that raises the cash to pay for almost everything else the federal government does. Adequate, reliable funding is all the more important as the IRS takes on programs like the expanded Child Tax Credit, which has the structure of a program that the Social Security Administration would normally oversee but with none of the budget protections that enable the SSA to manage tens of billions in monthly pension payments on time.
Commissioner Retting cites the IRS’s unstable annual appropriations as a major reason for the IRS’s hiring struggles. Establishing mandatory appropriations for the service would thus help the agency modernize while being resilient to scandals, real or perceived. If Congress is going to respond to scandals by “punishing” the IRS, mandatory funding would at least push lawmakers toward reforms that address weak management structures rather than just squeezing funding.
Create a Joint Congressional Committee to Oversee the IRS’s Broader Missions
The original IRS Restructuring Commission recommended creation of a joint Congressional IRS oversight committee. But decades have passed, and the recommendation has gone unheeded. Establishing a specific committee for oversight would enable Congress to better understand the extent of the problems facing the IRS, while allowing agency staff members to focus on their work.
Expand the IRS’s Project Management Capabilities With Clear Implementation Frameworks
The IRS still doesn’t seem to have adequate plans for implementing major IT projects — if and when the agency received the resources to go beyond the planning stage. If the Biden administration’s plan to fund a large portion of its social agenda by reducing tax evasion is to have any chance of success, the IRS needs to have a detailed framework in place.
Replace the Free File Program With Inhouse Filing Software on the IRS Website
As discussed above, the IRS contracts with private tax prep companies to provide a free online filing option — an application that users have generally found wanting. With Intuit’s exit, the time is right for Congress to kick the tax prep industry to the curb and allow the IRS to build its own in-house filing software. This would not require the reinvention of the wheel. The IRS has all the information it needs to calculate most people’s taxes, send out a pre-populated return and let individuals decide whether to pay the bill or to file an alternative.
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If you’ve read this far, you already know that modernizing the IRS is as close a thing to the proverbial free lunch as can be found in government. But you also know that simply pouring money into the IRS’s moribund structure isn’t enough. While there are risks involved with any major restructuring, the potential upside is enormous.