Tax Enforcement Going Forward: Resources, Cheating, and Perceptions of Fairness

IRSAs we head into the New Year and look back on 2015, this blog reflects on one facet of the future of tax enforcement, at least in the near term. The trend in decreasing resources devoted to tax enforcement may erode widespread respect, and therefore compliance, with the tax code. One reason for this is because if people don’t believe that the tax code is fairly and uniformly enforced against tax cheats, they themselves will be more inclined to cheat.

Although this is presumably an obvious or intuitive point, the psychology behind it is perhaps more complex than simply observing that people are more inclined to cheat if they believe that they can get away with it. That is true, but people also are more inclined to cheat if they believe that they themselves have been treated unfairly. This observation has implications in the tax arena, because perceptions of systemic unfairness – such as a perception that cheaters will be rewarded and non-cheaters will carry the burden – primes the population for more widespread cheating. Although it is very difficult to draw direct causal links between the amount of enforcement personnel and something as complicated as general compliance with the tax code, the need to sustain a collective perception of fairness in tax enforcement is something to consider as less and less resources are spent on ensuring that every citizen holds up their end of the tax bargain.

The Internal Revenue Service Criminal Investigation (“IRS CI”) released its Fiscal Year 2015 Annual Report (“the Report”) on December 3, 2015. The Report confirms what has been widely acknowledged for some time – that the ranks of IRS CI have been thinning considerably.

Here is a chart from the Report which lays out the attrition among IRS Special Agents.

IRS Chart 1

Although the above chart is clear, it is even more dramatic when one considers that the current population of the United States is approximately 320 million; however, in 1995, it was approximately 262 million. So, although the country’s population has increased by over 20 percent since the high water mark of employment of IRS CI Special Agents, there has been a reduction in the amount of agents by over 30 percent. The tax code has not simplified since 1995, either.

The results of this attrition – and likely aging – of the ranks of IRS CI are likely predictable. Here is another chart from the Report. The key metric is the first row – the number of investigations initiated, which reflects how many potentially future cases are in the pipeline.

IRS Chart 2

What the above chart does not reflect is that, traditionally, the cases pursued by IRS-CI have broken down (very) roughly into three approximately equal groups: “legal income” cases, which are traditional “pure” tax cases involving professionals, business people, and companies; “illegal income” cases, which typically involve tax charges that are secondary to the primary, non-tax charge of fraud, public corruption, etc.; and cases involving money laundering and narcotics. In the latter two categories, IRS CI is often in the role of assisting a primary law enforcement agency, such as the FBI or the DEA.

Thus, the amount of criminal tax cases which focus purely on the enforcement of the tax code are considerably lower than the totals reflected above. Moreover, IRS CI has been compelled for years to devote much of its resources on pursuing hundreds of identity theft cases, because the IRS has a major problem involving the practice of criminals using stolen identities to file false tax returns to obtain bogus refunds. Although these cases are certainly important, they essentially equate to “street crime” cases that do not fit into the traditional historical mission of IRS CI pursuing tax-cheating professionals and businesses.

What are some of the possible effects of all this over time? Although some government officials may suggest otherwise, less resources means less enforcement, and less enforcement means that more people who cheat will not get punished. If a point is reached in which it becomes generally understood – correctly or not – that tax cheats will not be pursued, then general tax compliance will drop amongst those otherwise predisposed to comply – even amongst those who otherwise would comply if they believed that they would not get caught if they cheated. Whether they are right or wrong, widespread perceptions of unfairness in the tax system tend to produce a greater incidence of cheating across the general population. Simply put, if people believe that they themselves have been left holding the short end of the stick, they are more inclined to cheat.

A study entitled “Fairness and Cheating,” presented in 2011 at the Royal Economic Society annual conference in London and based on an experiment run by professors from George Mason University and the University of Munich, sets forth how such cheating can occur in any context. This study found that people who feel that they have been treated unfairly are much more likely to cheat in turn, well beyond just retaliating against an unfair person. This study suggested that, beyond the expected motivation of obtaining an advantage at the expense of another, the roots of cheating can be complex. Sometimes, people cheat – whether they realize it or not – in order to compensate for a feeling of having been treated unfairly. This general principle certainly applies to the specific area of tax compliance. An analysis of decades of survey data by Professor Amitai Etzioni of George Washington University indicated that the incidence of tax evasion increased when the percentage of Americans who considered the tax system to be fair declined.

People often do things for reasons they don’t always understand. As the studies noted above suggest, as enforcement declines, we can expect cheating to increase – and not just because people are more inclined to think that they can get away with it.

This is not intended to be an argument for a blunderbuss approach to tax enforcement, and the fact remains that enforcement tactics and prosecutions can be inappropriate in individual cases. Regardless of whether the government attains the goal of appropriate tax enforcement in each individual case, the systemic need to fund tax enforcement appropriately rests in part on a basic observation about human nature: if people think that a system is unfair, then cheating bothers them less.