The IRS just isn’t prepared for the Inflation Reduction Act


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With much fanfare, President Joe Biden has signed into law the Inflation Reduction Act.

Historians may one day say this legislation did more to complicate an already too complicated tax code than any tax bill in the past 50 years. It is now up to the Internal Revenue Service to administer this law, and even with increased funding, it is not ready for the task — and, if past is prologue, it may never be.

The law raises taxes by some $300 billion over the next decade, largely by creating two new taxes on corporations. The first is a 15% tax on a corporation’s book, or accounting, income if the tax liability they report to the IRS is zero. The law now requires firms to calculate their tax liability twice, as if doing it once was not burdensome enough.

The second corporate tax hike is a new excise tax on the repurchase of corporate stock. Excise taxes are special taxes on specific products, such as cigarettes. They are typically levied with the intent to discourage the consumption of those products or mitigate the harm of them.

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These new taxes will be extremely hard for the IRS to enforce, and they come at an economic cost.

The Tax Foundation estimates these new taxes will reduce the long-run size of the U.S. economy by 0.2%, eliminate 29,000 jobs and do nothing to tame inflation. Admittedly, these are milder effects than the original Build Back Better Act, but the impact of this bill’s complexity could be much greater and more difficult to measure.

These new taxes are used to pay for 26 new or expanded tax subsidies for various climate and energy industries at a cost of roughly $260 billion over the next decade.

Each of these expanded credits will come with its own complex rules and regulations dictating who is eligible and for how much.

IRS has failed to fix key issues for nearly 40 years

As the complexity of our tax code continues to grow exponentially, so too does the challenge of administering it. This begs the question: Is the IRS ready?

Lawmakers approved roughly $80 billion in new spending for the IRS. Ostensibly, the majority of these funds will be used to beef up enforcement activities. This will purportedly raise an additional $205 billion over the next decade, according to the Congressional Budget Office.

But will more money for enforcement be enough?

Let’s not forget that the IRS is the agency that had to rush to hire 5,000 new workers this year to manage the backlog of 23 million paper tax returns that had piled up over the past two filing seasons. A recent photo in The Washington Post showed the cafeteria in the IRS’ Austin, Texas, facility filled with paper tax returns waiting to be processed. The article points to this as justification for why the IRS needed $80 billion in new funding.

But these arguments ignore the fact that the IRS has failed to fix these issues for nearly 40 years.

In 1986, the IRS launched a multibillion-dollar effort to modernize its obsolete computer systems to reduce its dependence on manually inputting paper returns. Nearly a decade later, in 1995, the then General Accounting Office of Congress reported that the “IRS’s efforts to modernize tax processing are at serious risk due to remaining pervasive management and technical weaknesses that impede modernization efforts.”

By 2000, Treasury’s Inspector General for Tax Administration reported that the IRS, after spending more than $3 billion, was incapable of managing the modernization process and had to turn it over to a private contractor. Since 2000, the IRS has spent more than $4.8 billion, after adjusting for inflation, on technology and “business service” modernization.

Outdated technology remains a drag on the IRS

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To be sure, some of these investments have improved the ability of taxpayers to file electronically and the IRS to manage those returns and flag questionable entries. In 2000, just 16% of tax returns of all types — individual, business, employment, and excise taxes — were filed electronically. In 2021, 78% of all returns were filed electronically; 90% of individual returns are filed that way. Taxpayers using commercial software such as TurboTax are now doing the work for the IRS.

Yet, at a time when many taxpayers can file their tax return on a cell phone, the IRS still does not have the technology to scan paper returns and must enter them manually as done during the 1960s, ’70s and ’80s. As The Washington Post story noted, many IRS computers are still running on computer language written in the 1960s.

The IRS and its defenders say many of the problems are due to underfunding and staff attrition.

In fairness, the IRS budget hasn’t changed much over the past 20 years after adjusting for inflation. Its budget in 2021 is roughly the same as it was in 2001 in today’s dollars. Moreover, staffing has declined dramatically over the decades. In 1991, when the technology modernization program started in earnest, the IRS had more than 114,000 full-time employees. Today, it has roughly 75,000.

But, in the same way that ATMs have reduced staffing at banks and self-checkout has made buying groceries faster, e-filing and technology have made the IRS modestly more efficient. By the IRS’s own account, it cost 56 cents to raise $100 in tax revenues in 1991. Today, it takes 35 cents to raise $100.

Despite these modernization efforts, the IRS is still far behind the technology curve, and tax complexity compounds these problems. The Inflation Reduction Act doesn’t fix these issues; it greatly adds to them.

Under the weight of an increasingly complex tax system, the IRS is not an agency that can fix itself, and Congress throwing money at it for new technology and thousands of new auditors without structural reform will not get the job done.

— By Scott Hodge, president emeritus and senior policy advisor at the Tax Foundation



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