How much should we fund the IRS?

Abstract

Tax enforcement not only detects tax evasion (the direct effect) but also enforces voluntary compliance (the indirect effect). This paper explores implications of the indirect effect for the optimal size of the budget allocated to the Internal Revenue Service (IRS). The conventional wisdom prescribes that the size of the budget allocated to the IRS should always fall short of the level where an additional dollar allocated would return just an additional dollar of revenue. In a model where taxpayers are subject to a small amount of incomplete information, we show that after taking into consideration the indirect effect of tax enforcement, it is possible that the optimal prescription is opposite to the conventional wisdom. | INTRODUCTIONAs far as the collection of tax revenue is concerned, the true function of the Internal Revenue Service's (IRS) enforcement may not lie in detecting tax evasion (the direct effect) but in preventing tax evasion or enforcing voluntary compliance (the indirect effect). This view is clearly expressed by the National Taxpayer Advocate (2004, II-4):The IRS estimates that the annual net tax gap is about $255 billion. … Studies show that examinations [audits] reduce the tax gap primarily through an indirect effect on voluntary compliance rather than direct collection from the taxpayer under audit.

When is duplication of effort a good thing in law enforcement?

“…This assumption can be commonly found in the literature on law enforcement-for instance, see Jung et al (2022) and Friehe and Mungan (2021), in which the law enforcers are the Internal Revenue Service (IRS) auditors and police officers, respectively.…”