Despite the fact that the United States is losing an estimated $600 billion per year in unpaid taxes, IRS funding has fallen precipitously over the last decade, forcing the agency to shed a large share of its workforce, including 35 percent of revenue agents responsible for examining complex tax returns and conducting audits. Largely because of this steep drop in funding, the agency has dramatically reduced the audits that it conducts on high-income individuals and large corporations. Those trends have meant that a greater share of audits are of lower-income taxpayers, especially the low-wage workers who claim the Earned Income Tax Credit (EITC). These trends have had negative implications on communities of color, as a disproportionate share of EITC claimants are Black and Hispanic. In particular, some of the most heavily audited places in the country are predominantly Black communities.
For these reasons, many organizations dedicated to social, racial, and gender justice have demanded that the IRS dramatically refocus its audit priorities and that Congress provide it the tools to hold high-income and corporate tax dodgers accountable. President Joe Biden has outlined a plan to do so in his American Families Plan as well as in his budget proposal to Congress. The plan would provide substantial additional resources—about $80 billion over the next decade—to rebuild the IRS’ ability to enforce the tax laws; upgrade its computer systems; and provide better taxpayer service. The enforcement resources will be directed toward high-income individuals and corporations, with audit rates not increasing above the level of recent years for those with incomes under $400,000. By directing enforcement resources toward high-income people, business entities, trusts and estates, and large corporations, the Biden plan would take an important step in the direction of tax fairness and racial equity when it comes to tax enforcement.
Investments in IRS enforcement of the rich and corporations can help reverse audit disparities
The audit rates for the rich have fallen so steeply over the last decade that, in recent years, the agency has audited low-income filers who claim the EITC at close to the same rate as it audits the top 1 percent. This is despite the fact that EITC noncompliance or errors represent only a small share of the “tax gap,” while the top 1 percent is responsible for an estimated 36 percent of the individual tax gap, or $175 billion per year. The IRS has said bluntly that its recent audit priorities reflect that audits of low-income filers are cheaper and easier for the agency to conduct. Auditing low-income filers requires fewer resources and manpower than audits of wealthy individuals, who are able to employ batteries of tax lawyers and accountants to contest audits and litigate against the government. The IRS also has much more visibility into the incomes of wage earners, whose earnings employers report to the government on W-2 forms. Wealthy individuals, on the other hand, have much more complex tax returns and, often, opaque source of income. They are also able to employ sophisticated tax evasion schemes. In order to properly examine these returns, audits of the ultrawealthy require skilled agents with several years of training. The IRS has shed a very large share of these workers over the past decade due to funding cuts, a recent hiring freeze, and retirements.
The special focus on EITC recipients has created stark disparities in who gets audited. A 2019 study from former Senior IRS Economist Kim Bloomquist found that because of the IRS’ focus on the EITC, audit rates tend to be highest in low-income communities of color. And the 10 counties in the country with the highest audit rates were all predominantly African American. The manner of EITC audits also burdens low-income communities of color. Audits of EITC recipients are most often done by mail through correspondence examinations. Such audits are inexpensive for the IRS to conduct but burdensome on low-income taxpayers who often face obstacles in responding to them, including the inability to reach points of contact at the IRS; lack of professional representation; and language barriers. The National Taxpayer Advocate has emphasized that correspondence audits are not effective in improving future compliance, yet families are less likely to claim the EITC after being audited. Together, these problems disproportionately burden communities of color and undermine the anti-poverty goals of the EITC.
Investments in the IRS can provide the agency with the resources to better serve regular taxpayers—and more thoroughly, and more often, audit wealthy taxpayers, the business entities they own, and large corporations. The Biden administration has proposed an additional $80 billion in funding for the IRS over the next decade for enforcement and technology modernization. Crucially, the administration has stated that it will:
… ensur[e] that the additional resources go toward enforcement against those with the highest incomes, rather than Americans with actual income less than $400,000. Additional resources would focus on large corporations, businesses, and estates, and higher-income individuals.
Furthermore, the Department of the Treasury has said that “[a]udit rates will not rise relative to recent years for those with less than $400,000 in actual income.” These shifts in priorities would mean a smaller share of overall audits would be of low-income filers, who are disproportionately filers of color, and refocus the agency’s efforts on high income individuals—who are disproportionately white—as well as corporations.
In 2019, just 4.9 percent of Black households and 5.3 percent of Hispanic households had more than $200,000 of income, compared to 11.8 percent of non-Hispanic white households. Nine in 10 of the wealthiest 1 percent of households are white. Business owners are also disproportionately white. Among all private employers with 100 or more employees (or federal contractors with 50 or more employees) in 2018, just 3.3 percent of executives or senior officials were Black and just 4.5 percent were Hispanic. Meanwhile, 84.5 percent were white.
Corporations are also disproportionately owned and run by white Americans. The median retirement account value for white households is more than twice that for Black and Hispanic households. Outside of those accounts, white households own three times as much in corporate stock as Black and Hispanic households, on average. More than 90 percent of Fortune 500 chief executive officers are white, while 3.4 percent are Hispanic—and only 1 percent are Black. Over the last decade, the audit rate for large corporations has dropped in half, likely exacerbating the corporate tax gap and the related problem of corporate profit shifting, which costs the United States tens of billions of dollars a year. Biden’s plan would invest substantial resources so that the IRS is not wholly overmatched in audits and litigation with large corporations.
The Biden tax enforcement plan will reduce disparities, but the United States also needs better tools to measure progress
On his first day in office, President Biden established an Equitable Data Working Group as part of a broader executive order on advancing racial equity. Currently, not all federal government data is broken down by race and ethnicity, gender, or disability—and tax data provides no information on race. This effort focuses on how federal agencies can better collect data by demographic groups and better inform how the federal government can enact equitable policies. The working group includes the Department of the Treasury, represented by the assistant secretary for tax policy. The Treasury Department recently said that it is “currently undertaking research to study the relationship between the tax code and racial inequities,” with “close engagement between federal agencies and those in the research and advocacy communities.” That research must ascertain the extent of racial disparities in enforcement, including whether auditing and enforcement actions are disproportionate within income groups.
One challenge is how to collect the necessary data. Asking for racial information on tax forms carries risks, such as deterring people from filing. However, current proposals do not include adding a race question to 1040 tax forms. For example, tax professor Jeremy Bearer-Friend proposes conducting follow-up surveys that include race and ethnicity questions. This survey would be done by the IRS’ research division instead of tax administrators. This method would reduce the possibility of tax administrators misusing race and ethnicity data. The Biden administration and Congress must also ensure that enforcement practices are not racially biased. Though shifting enforcement resources toward wealthy Americans and corporations and lowering the share of enforcement resources directed at EITC recipients will reduce disparities, it is incumbent on the IRS to develop metrics to track progress.
More will need to be done to address inequities in the tax code
Appropriately funding the IRS would help reverse some of the inequities in the tax system, but fundamentally changing substantive aspects of the tax code will be needed to address the current disparities. Overall, the United States federal tax code is progressive, but many of its features compound the concentration of wealth in ways that exacerbate the racial wealth gap.
These include the tax expenditures such as qualified retirement accounts and the mortgage interest deduction that are intended to encourage wealth building but are structured to favor those who already have wealth. They also include the favorable rates for capital gains—which benefits those who derive income from wealth—and the giant loophole known as stepped-up basis that allows people to amass wealth and never pay income taxes on those gains. In comparison, people who derive income from work pay income taxes every year on their wages, with taxes withheld directly from each paycheck. These features of the tax code worsen the racial wealth gap because they favor those with existing wealth, and Black Americans systematically have less wealth than white Americans. For example, on average, white college dropouts have more wealth than Black college graduates. Tax law professor Dorothy Brown discusses these and other problematic aspects of the tax code in her new book, The Whiteness of Wealth.
The revenue proposals in President Biden’s American Families Plan would address several of these problems and, thereby, advance racial equity. His plan would equalize the top tax rates on capital gains and ordinary income while closing the stepped-up basis loophole, addressing the problem that some of the wealthiest people in the country can get away with paying virtually no income taxes for their entire lives and providing more equity between those who derive income from wealth and those who derive income from work. His plan also reforms and expands tax credits that will greatly benefit Black and Hispanic families. For example, before this year, the families of 27 million children did not receive the full benefit of the Child Tax Credit (CTC). Of those children, 9.9 million of were Hispanic and 5.7 million were Black. President Biden’s American Rescue Plan Act extended the full credit to families regardless of income while expanding it significantly. His American Families Plan would extend these reforms for four additional years and make a linchpin of them—full refundability—permanent. In a recent brief, the Center for American Progress argued for full permanence for the expanded CTC.
While more must be done, rebuilding the IRS and reprioritizing the agency’s focus on wealthy tax cheats is a fundamental step towards creating a more fair and equitable tax code and an important step in the direction of racial equity. Congress now has the chance to seize this opportunity by implementing the changes outlined in President Biden’s FY 2022 budget—providing the IRS with a substantial multiyear funding stream and additional information reporting—allowing the agency to crack down on high-income tax evasion as well as corporate tax dodging. Combined with the other important tax reforms laid out in the budget, Congress can raise substantial revenues to help address our nation’s most pressing needs while dramatically improving tax fairness.
Lorena Roque is a senior policy analyst for Race and Ethnicity Policy at the Center for American Progress. Galen Hendricks is a research associate of Economic Policy at the Center.