The Political Economy of the IRS

Abstract

This paper tests a multiple principal–agent model of the Internal Revenue Service. Using data for 33 IRS districts over six tax years, 1992–1997, we report evidence that the fraction of individual income tax returns audited is significantly lower in districts that are important to the president electorally and that have representation on key congressional committees. These findings suggest that the IRS is not a rogue government agency, but rather is an effective bureaucratic agent of its political sponsors. “Reforming” the IRS by subjecting it to an independent oversight board appointed by the president would therefore seem to be redundant.

Government Preferences and SEC Enforcement

“…For instance, Grier et al (1995) find that the president's decision to veto a bill can be predicted by the votes of senators from electorally important states. Young et al (2001) find that the fraction of individual 16 income tax returns audited is lower in districts that are important to the president electorally. Mebane and Wawro (1993) also show that the president specifically targets spending toward areas that are important for his reelection.…”

“…A large literature on political business cycles, starting with Nordhaus (1975), has highlighted that the incumbent government is indeed willing to induce pressure on regulatory agencies to enhance the current employment conditions or avoid negative news with regard to these conditions. For instance, Hunter and Nelson (1995) and Young et al (2001) Such increased political pressure on the SEC or efforts by the SEC in election years are, however, not necessarily constant across states. In fact, prior research has argued and found that during presidential elections the political influence is directed to electoral-vote rich states that are tightly contested to enhance the presidential reelection prospects (or those of the president's party) (Grier, McDonald, and Tollison 1995;McCarty 2000;Young et al 2001).…”

“…For instance, Hunter and Nelson (1995) and Young et al (2001) Such increased political pressure on the SEC or efforts by the SEC in election years are, however, not necessarily constant across states. In fact, prior research has argued and found that during presidential elections the political influence is directed to electoral-vote rich states that are tightly contested to enhance the presidential reelection prospects (or those of the president's party) (Grier, McDonald, and Tollison 1995;McCarty 2000;Young et al 2001). For instance, Grier et al (1995) find that the president's decision to veto a bill can be predicted by the votes of senators from electorally important states.…”

Is There a Connection Between the Tax Administration and the Political Power?

“…This technique disentangles both effects. Thus, we aim to identify which factors explain the distance of each decision unit to the frontier (what is known as the inefficiency effects model) by applying the methodology developed by Battese and Coelli (1995) to a panel of 3 Among other studies that have tested the importance of the marginal "electoral productivity" by district in the design of public policies, see Wallis (1996), for the distribution of federal grants to the US states; Case (2001), who tests the political criteria that guide the allocation of block grants from federal to sub-federal layers of government in Albania;Castells and Solé-Ollé (2002), for the allocation of national investment across Spanish regions; Garrett and Sobel (2002), who test the presidential influence on the rate of disaster declaration and the allocation of emergency funds across US states; Besley and Burgess (2002), Besley and Case (2002), or Besley and Preston (2002), all of whom show that the responsiveness of government is greater the greater the electoral competition; or Young et al (2001) -already cited in the main text -who test whether the tax audit probability by district depends on the electoral importance of that district to the president. Certainly, all these studies show the importance of electoral motives for the design of public policies, though the measurement of "electoral competition" differs in each case according to the way in which regional representatives are elected to the national assembly.…”

Political Connection and the Demand for Industry Specialist Auditors

“…For instance, Correia (2014) provides evidence that political connected firms are less likely to be subject to SEC enforcement actions. Under a tax-related setting, some studies suggest that political connection can generate tax benefits (Brown, Drake, & Wellman (2015), diminishes the audit rates by IRS (Hunter & Nelson, 1995, Young, Reksulak, & Shughart, 2001) and reduces the political costs of being tax aggressive (e.g., Mills et al, 2013), hence leading to higher tax aggressiveness activities (Kim & Zhang, 2015). Further, D'Aveni (1990) suggest that firms with political and director connections are less likely to be associated with bankruptcy, suggesting that political connection increases client firms' prestige.…”