By Leonard E. Burman and Joel Slemrod
The IRS is under withering scrutiny for allegedly using partisan political criteria to evaluate applications for nonprofit 501(c)(4) status. All sides agree that, if true, this would constitute an unacceptable abuse of power and that it raises serious questions about the adequacy of IRS governance.
But the economic consequences have gone unexamined amidst all of the political fallout. To be specific, will the publicity about the IRS actions, and any accompanying decline in taxpayer trust in the IRS’s procedures, affect tax compliance? This is no trivial matter. Taxpayers already skirt an estimated $400 billion in tax liability—a figure that looms especially large given the $600 billion annual deficit. If noncompliance were to grow significantly, it would exacerbate our already daunting fiscal challenges.
The best available evidence suggests that the answer is probably no, unless the scandal undermines the IRS’s ability to effectively monitor and punish noncompliance. Economists posit a simple model of tax evasion: taxpayers decide whether, and how much, to cheat by comparing the expected tax saving from successful tax evasion to the costs, including penalties, of being caught. The extent of tax evasion depends on people’s perceptions of the chance of getting caught, the perceived penalty of detected evasion, and taxpayer risk aversion toward the gamble that is tax evasion. It is hard to see how the scandal, by itself, would affect any of these factors.
Some social scientists have argued that this framework misses important elements of the tax evasion decision. For example, some people may comply with their legal obligation because of a sense of civic duty, not fear of punishment. But government actions can affect citizens’ sense of obligation. Tom Tyler of Yale University argues that citizens are more likely to be law-abiding if they view legal authorities as legitimate. Margaret Levi of the University of Washington argues that some taxpayers’ behavior depends on the behavior, motivations, and intentions of the government. When citizens believe that the government will act in their interests, that its procedures are fair, and that their trust of the state and others is reciprocated, then people are more likely to become “contingent consenters” who cooperate in paying taxes even when their short-term material interest would make evasion the better option.
Though plausible, no evidence compellingly suggests that these factors have much of an effect on tax evasion. In particular, direct written appeals to taxpayer duty have no apparent effect on compliance behavior. In contrast, abundant evidence supports the theory that a higher chance of detection deters evasion significantly. Strikingly, for wages and salaries, where employer information reports and IRS computer matching make successful evasion unlikely, the noncompliance rate is just 1%; for self-employment income, where no such information reports exist, the noncompliance rate is more than 50%.
If, as the evidence suggests, evasion is constrained mostly by the threat of detection and penalty, then the IRS scandal will cause the tax gap to grow only if the uproar about the IRS results in a cutback in their ability to enforce the law effectively. If, for example, Congress slashes the IRS budget in retaliation or otherwise handcuffs the tax authorities, that could have significant, and lasting, fiscal implications.
Leonard E. Burman and Joel Slemrod are the author of Taxes in America: What Everyone Needs to Know. Leonard E. Burman is Daniel Patrick Moynihan Professor of Public Affairs at Maxwell School of Syracuse University. Joel Slemrod is Professor of Economics in the Department of Economics and the Paul W. McCracken Collegiate Professor of Business Economics and Public Policy in the Stephen M. Ross School of Business, at the University of Michigan.