Professor, Loyola University Chicago School of Law
Periodically, the IRS estimates the tax gap (that is, the difference between taxes due and taxes owed). For the years 2008 through 2010, the IRS estimates the annual tax gap was about $458 billion. After including late payments and amounts collected through IRS enforcement efforts, the annual tax gap diminished by $52 billion a year, leaving a $406 billion tax gap in each of those three years.
The $406 billion tax gap is equivalent to just over 16 percent of taxes due. And the IRS is unlikely to significantly close this gap going forward. While the has proven remarkably efficient at collecting revenue—in fiscal year 2015, it collected $3.3 trillion on a budget of just under $11 billion—Congress has been cutting the IRS budget for the last decade or more, while, at the same time, assigning the IRS more responsibilities. In spite of its efficiency, the IRS must do more with less, and its ability to find taxpayers who do not pay their taxes is thus bound to suffer.
These constraints are reflected in the data about IRS enforcement activities: in 2015, the IRS audited about 0.8 percent of individual tax returns and 1.3 percent of corporate income tax returns. Not only does the IRS audit very few returns, but the number has been falling: in 2010, the IRS audited about 1.1 percent of all individual returns.
There is no easy solution to the tax gap, or to the audit rate. Increasing IRS funding, or decreasing its non-revenue-raising responsibilities, would perhaps be the most effective fix, but that currently appears unrealistic. In a 2015 Pew survey, 48 percent of Americans had an unfavorable view of the IRS, up from 40 percent five years earlier. And Republicans—who will control both the Executive and the Legislative branches of the federal government—score significant political points campaigning against the IRS. So properly funding the IRS appears unlikely in the near future.
An alternative solution, then, would be to reduce the costs to the IRS of enforcement. One way to reduce those costs? Crowdsource enforcement.
A Brief History of Tax Return Disclosure
Crowdsourcing tax enforcement is an old, albeit out-of-favor, idea. In fact, it was not until 1976 that Congress definitively ended more than a century’s experimentation with deputizing the public to help enforce the tax law. Beginning in 1861, the Civil War income tax law provided for public access to tax returns. To ensure that public access (and titillate their readers), newspapers published the returns of prominent citizens. This public disclosure ended when the income tax was allowed to expire, but Congress experimented anew with it in each successive iteration of the federal income tax.
Congress had one principal goal in publicizing tax returns: ensuring that taxpayers paid their taxes. Essentially, public access to taxpayers’ returns allowed the government to crowdsource enforcement—people would notice, for example, that their neighbor had paid suspiciously little in taxes. Knowing that the Panopticon was watching their returns, taxpayers would have every incentive to pay their full tax liabilities.
Not everybody appreciated this mandatory disclosure of tax returns, of course. From the start, public disclosure faced significant opposition. Every time Congress reintroduced public disclosure of tax returns, opponents of disclosure argued that such forced disclosure was both un-American and intrusive. According to critics, the publicity not only violated taxpayers’ privacy, but it might actually endanger taxpayers, exposing their wealth and addresses to criminals and kidnappers. Even without danger, the benefits, according to critics, were limited to individuals’ indulging their idle curiosity.
Moving to Privacy
By 1976, the public disclosure of tax returns had been severely curtailed. In spite of being “public records,” they were no longer generally available to newspapers or the public at large; rather, they were open to inspection by the general public under regulations approved by the president or pursuant to presidential order.
Federal agencies had more access to tax returns than the general public, but even federal agencies could only see them on a case-by-case basis, after providing a written request. In the 1970s, though, in the wake of Watergate and fears about the “proliferation of computerized data banks,” the government began to strengthen citizens’ privacy rights. The 1976 Tax Reform Act cemented those privacy rights, broadly forbidding government employees from disclosing taxpayers’ returns or return information.
Over the next two decades, privacy became such a central principle of American society that, in 1993, Professor Richard Pomp wrote that it was “unthinkable for proposals” for public disclosure of tax returns to be “taken seriously.” Less than a decade later, though, in the wake of Enron’s collapse, legislators, academics, policymakers, and the media were seriously discussing the implications of making corporate tax returns public.
A Post-Privacy World?
A decade and a half after Enron’s collapse, the table appears perfectly set for returning to public disclosure of tax returns. Earlier privacy concerns seem irrelevant, if not quaint, in today’s world. For many individuals, the public already has access to information about their salaries. At least half of the states maintain public databases of state employee salaries.[fn1] Securities and Exchange Commission rules require publicly-traded corporations to disclose the compensation of its five most highly-paid employees. And Forbes lists the income of the most highly-paid musicians, actors, and athletes, as well as its estimates of the net worth of the world’s wealthiest individuals.
Beyond this broad array of information already available, today’s privacy situation is almost the polar opposite of the post-Watergate world. While exponentially more personal information is stored on computer servers today than 40 years ago, Americans have largely put that information online voluntarily. Technology entrepreneurs argue that social norms have moved away from privacy. And while the entrepreneurs may have financial motivations for arguing that the norms have changed, they are not alone in that view. Many experts believe that within another decade, much of what we consider private today will no longer be considered private.
It may not even require movement with social norms to arrive at a post-privacy world with respect to tax returns. The IRS, tax, and accounting firms have, until now, done an admirable job keeping returns private. In contravention of decades of precedent, president-elect Donald Trump refused to release his tax returns. In spite of the pressure, only three pages of (state) tax returns were ever leaked. But the fact that he faced no leaked returns does not mean that they will not, in the future, be leaked: the extensive Panama Papers leaks suggest that no data—even private law firm data—is necessarily safe from public scrutiny. In fact, hackers may have accessed information on more than 700,000 taxpayers in an IRS data breach.
Of course, the fact that taxpayer information could be compromised, and that notions of privacy may change significantly in the future, do not present an affirmative case for requiring all taxpayers to disclose their tax returns.
Consequences of Crowdsourcing Enforcement
Requiring the public disclosure of tax returns has at least two beneficial results, from a tax compliance perspective. At the ex ante level, it forces taxpayers to think about how aggressive they want to be. When tax returns are private, only the taxpayer, her advisors, and maybe the IRS (if hers is one of the 0.8 percent of returns it audits) will know how she structured her tax life. She can thus maintain a public image as a tax-compliant citizen, even while pushing the boundaries. If, however, she knows that her tax returns will be available to the public, she is forced to internalize the non-monetary costs of her tax planning. Perhaps saving money by paying less in taxes is more important to her than being seen by her peers as complying with the tax law, in which case she may continue to take aggressive positions. To the extent there is a social norm of tax compliance, however, knowing that her peers will have access to her tax returns may cause a taxpayer to be more conservative.
At the ex post level, requiring taxpayers to publicly disclose their tax returns reduces the IRS’s search costs as it enforces the tax law. It would, of course, continue to use its matching system and other techniques for determining which returns to audit, but it would also have hundreds or thousands of additional eyes scrutinizing tax returns. Friends, neighbors, competitors, and former spouses may all have some interest in seeing tax returns, and potentially in reporting bad behavior.
This ex post crowdsourced auditing does have potential problems, of course. It would increase the noise, as presumably some percentage of tips would be false positives. And if it turns out that significant numbers of taxpayers are taking aggressive tax positions, it may encourage other similarly-situated taxpayers to take similarly aggressive positions. In both cases, though, the sheer quantity of data may correct for the problem. The IRS may not want to act on every tip, but if it sees a pattern of behavior from a number of taxpayers, it may decide to look closely at returns that engage in that behavior. And if the IRS were to strategically target aggressive positions taken by a number of taxpayers, that could discourage other taxpayers from following suit.
Two Final Thoughts
Administratively, requiring disclosure would be tremendously easy. In 2015, almost 88 percent of individual returns were filed electronically. With electronically-filed returns, the IRS could automatically redact certain sensitive information (for example, social security numbers and, perhaps, names of dependents) and instantly make the returns available online. The 12 percent of returns filed on paper would take more work to redact, but the IRS could require taxpayers who filed on paper to file an unredacted and a redacted version of their returns.
But culturally, it would be hard. Although we may be approaching a post-privacy world, we are not there yet. Although people freely post all kinds of personal information to the internet, few people voluntarily publicize their tax returns, and mandatory disclosure could still face significant pushback.
As an intermediate step toward full publicity, then, perhaps the tax law should make such disclosure option, but offer a carrot to those who opt in. For example, such a program could provide that those who disclose their tax returns will be protected from penalties for a certain number of years.
[fn] I didn’t do an exhaustive search, but even a quick Google search found me databases for these states: Arkansas; California; Connecticut; Florida; Illinois; Indiana; Iowa; Kentucky; Maryland; Massachusetts; Minnesota; Missouri; Montana; New York; North Carolina; Ohio; Oklahoma; Pennsylvania; South Carolina; Tennessee; Texas; Utah; Virginia; Washington; Wisconsin.