Fighting tax evasion by the wealthy can raise revenue and restore the integrity of the U.S. tax system
Recent estimates suggest that as much as $36 billion a year in taxes are unpaid by Americans hiding wealth abroad, and more than $50 billion more is lost due to corporations shifting taxable profits offshore. To tackle this thorny problem, the Inflation Reduction Act of 2022 provides about $80 billion to the IRS for greater tax enforcement, expressly targeting the top “1 percent” of high-income, high-wealth individuals.
Now, however, the incoming Republican-led majority in the U.S. House of Representatives wants to rescind that IRS funding, either outright or by reducing the annual appropriations level for the IRS, when the new 118th Congress convenes early next year. The most charitable explanation is that the House Republicans are resigned to letting billions of taxes go unpaid because cracking down on these abuses would be too intrusive or resource-intensive.
Our new paper, “Different From You and Me: Tax Enforcement and Sophisticated Tax Evasion by the Wealthy,” reviews recent research showing that tax evasion and legally dubious forms of tax avoidance by wealthy individuals and large corporations represent an important and pressing challenge for the IRS, which needs more funding, not less, to tackle this problem. The research shows that the wealthy are adept at using sophisticated tactics to reduce their tax bills, but we argue that the IRS has tools at its disposal to combat this problem. Investing in tax enforcement targeting the high-wealth population could make taxes in the United States more progressive, raise revenues to fund vital public programs, and restore public confidence in the U.S. tax system.
Tax enforcement policy is a multistage process. Congress writes the tax code that defines tax liabilities and penalties for evasion, and the U.S. Department of the Treasury writes regulations to refine these rules. Then, the IRS collects information with which to assess these liabilities, and it conducts audits. The audit process itself consists of multiple steps, from selection of whom to audit, examination of tax returns, assessment of any additional taxes and penalties due, resolution of disputes in case of disagreements, and, finally, collection of additional taxes due.
Weaknesses at any step of this enforcement process can lead to the loss of substantial tax revenue. Poorly written regulations, for example, can create legal gray areas that make audits more difficult and disputes more likely. Likewise, a lack of resources for disputes can embolden taxpayers to take aggressive positions that reduce their taxes.
Wealthy actors are particularly well-equipped to exploit weaknesses at any stage of the enforcement process because they have access to legal and financial intermediaries who can devise sophisticated schemes to reduce their tax burdens. Our new working paper documents how so many high-income and high-wealth taxpayers take actions to make their evasion more difficult to detect—for example, by masking evasion within complex business entities and/or offshore structures. They also have the resources to scan the tax code for gray areas and legal avoidance opportunities, and to fight back and undertake lengthy, costly legal battles were the IRS to dispute the legality of their tax positions.
We review the research on the tax enforcement process in the paper, and we present two illustrative examples. First, offshore tax evasion is perhaps the most widely publicized method used by the wealthy to evade taxes. To tackle offshore evasion, governments over the past 15 years have enacted new international cooperation policies, soliciting information from offshore financial institutions. Based on the evidence we review, these efforts have made some progress in mitigating offshore tax evasion, but some wealthy taxpayers can dodge these new policies by restructuring their portfolios and reallocating wealth across jurisdictions.
Our second example involves gray area avoidance—exploiting ambiguities in tax law, such as the case of “syndicated conservation easements.” The law around conservation easements allows landowners to donate development rights on their land for conservation purposes and then, to claim an income tax deduction equal to “fair market value” of their donation. But because the legal standard for a fair market value in this domain is weak, many landowners claim income tax deductions far out of proportion to real fair market values.
Such gray area avoidance can be fought case by case, by disallowing abusive deductions and litigating the resulting disputes, or by reforming the law to shut down abusive schemes more directly. Unable to make major changes to the rules themselves, the IRS has so far mainly taken the first approach, resulting in a grueling series of court battles.
With this new understanding of sophisticated strategies used by the wealthy to dodge taxes, we suggest six ways to conduct tax enforcement targeting high-income, high-wealth taxpayers and the businesses they own. This multipronged approach includes:
- Facilitating robust information sharing, especially sharing information on all types of assets and capital income of the wealthy across national borders
- Investing fiscal resources in deep, thorough tax audits of these individuals
- Allocating additional fiscal resources toward litigating tax disputes
- Pursuing substantial penalties for the most egregious tax evaders
- Monitoring aggressive tax sheltering schemes and undertaking frequent legal reforms to shut them down
- Promoting whistleblower disclosures to identify “blind spots”—types of evasion of which authorities might not yet know or be aware
A multipronged approach such as this is essential to limiting tax evasion and dubious tax avoidance by the wealthy. But the IRS cannot implement such an approach without the funds provided by the Inflation Reduction Act.
The next wave of tax enforcement research should further evaluate these types of policy interventions. We acknowledge in our working paper that the task outlined above might seem daunting. Yet we also document that high-quality enforcement policy targeting high-income, high-wealth individuals can raise substantial tax revenue, in turn providing fiscal resources the federal government could invest in policy to promote more equitable U.S. economic growth.