Choosing to rebuild state capacity - IRS edition

You should be rooting for the IRS modernization project

The Internal Revenue Service is the least popular federal agency according to surveys, viewed favorably by just 42% of Americans. That is not altogether surprising. Given its task, it will never be as popular as, say, the National Parks Service (84% approval rate). But it is still more popular than the “federal government” as a whole (40%) and other political institutions, such as Congress (30%).

Here’s the thing: you should be rooting for the IRS to succeed. Why?

1. Collecting revenue is a core state task. If a country doesn’t do it well, it can’t achieve it’s policy goals. So, we have a collective interest in a functioning revenue system, reducing the tax gap. Otherwise, we become a country where paying taxes is semi-voluntary.

2. As citizens, we have to interact with the tax system. Its one of those public services you can’t really opt out of. So we have an individual interest in making that service better.

3. The US has moved more and more of its safety net system through the tax system. Helping more vulnerable people while avoiding the administrative burdens of traditional welfare services is another reason to cheer for the IRS.

The evolving state of the IRS also offers a clue about how to fix state capacity. The issue of government capacity is becoming more important as a topic. A lot of people, who have no well-defined label beyond ‘Ezra Klein listeners’, are concerned that US government has become too sclerotic to take on big tasks, like transitioning to a green economy, or basic tasks, like building enough housing or infrastructure. There is a lot of value to those critiques, and if they generate new interest and ideas into how to rethink American state capacity, so much the better.

But I also think there are some cases where state capacity failures are a relatively straightforward outcome of the anti-statist tendencies of the right. A couple of years ago I pointed to the IRS as an example of where capacity problems were a matter of funding and constraints, which in turn was driven by political choices. Over time, the agency had fewer people to deal with more clients and more complex tasks. Give the IRS more money, and the freedom to do its job, and it would become more effective.

Since then, the IRS has gotten more money, about $80 billion over 10 years, via the Inflation Reduction Act.

So is it becoming more effective?

Yes!

Closing the tax gap by finding tax cheats

A recent analysis by the nonpartisan Congressional Budget Office looked at how new funding will matter to the ability of the IRS to close the tax gap, i.e. the amount of money lost due to tax evasion, estimated to be about $600 billion per year. The ability to address this problem is directly a function of state capacity. Between 2008 and 2021, the IRS lost 13% of employees, and one quarter of those employees worked in the enforcement area. Of the new $80 billion for the IRS, $46 billion is assigned to enforcement.

The IRS will collect an additional $180 billion in revenues from higher income tax evaders from 2022-2031 as a result of new spending according to the CBO. An IRS analysis predicts the gains to tax enforcements to be even higher, generating $561 billion between now and 2034.

The IRS estimate is higher partly because it is using a longer time frame, but it is also estimating the effect of what it calls “diversified revenue strategies” - which are expected to improve voluntary compliance, and better target resources to detect evasion. Whatever estimate you prefer, the basic value proposition is straightforward. Giving the IRS more money will a) pay for itself, b) reduce the deficit, and c) discourage tax evasion. The gains in revenue come from shifting resources away from auditing welfare recipients to targeting the wealthy because, as bank robber Willie Sutton once observed, that’s where the money is.

Better customer service

A lot of the IRS funding went on things other than enforcement, such as customer service. The result is:

• 5,000 new customer service workers hired to staff call centers

• 87% increase in phone calls answered, up from 18%

• phone wait times declined by 85% from 27 minutes to 4 minutes

• a backlog of millions of prior year claims have been processed

The IRS has also created a new customer experience office to institutionalize improved processes.

I asked Nina Olson about customer service. She is the Executive Director of the Center for Taxpayer Rights, and former National Taxpayer Advocate, part of the IRS that directly looks out for citizens rights and services. In other words, she knows in extraordinary depth the challenges the IRS has faced historically, while also being an unstinting advocate for fixing tangible problems that we face when we interact with the agency.

She emphasized that the IRS customer service improvements have been real, but have targeted the low-hanging fruit, like phone service. There are other areas, like resolving identity theft, that need more work. She also pointed out that new IRS employees are going to be less experienced, and that the agency, like much of government, faces a retirement crisis among long-standing staff. According the Olson:

The IRS has major strides in increasing staffing on the phones, and beginning to dig out of the correspondence backlog. It’s work on developing a strategy for multiple channels for taxpayers to get assistance and access to their account information is promising. Now the IRS needs to ensure its employees are well-trained and have access to the right systems so taxpayers can their issues resolved at the first point of contact.

Piloting new innovations

Catherine Rampell has written about improving government, but perhaps her most insightful piece was a photo essay. Visual images by Matthew Busch conveyed the reality of how overwhelmed the IRS looks from the view of its employees. Take a look at this IRS cafeteria for example (not a typo, this is a cafeteria).

Modernizing the IRS is not just about hiring new staff. The image makes clear how much the agency is still paper based, and relying on older technologies. Part of the modernization project is to better digitize files and correspondence. Part of the project make it easier for citizens to interact with the agency.

The most exciting new innovation is to make tax filing easier by piloting a free e-filing system. Without prospects of funding to do this in the past, IRS leaders entered into a disastrous public-private “partnership” with the tax preparation industry that generated a lousy product while companies like Intuit pushed clients into paid e-filing products like TurboTax.

Sometimes public-private partnerships work well. This one did not, because the goals of the IRS and the private tax preparation industry were simply too far apart. One wanted a free e-filing product, and the other wanted to monetize e-filing. The private actors achieved their goal at the expense of the public one.

Now the IRS is finally piloting it’s own free tax filing system in a dozen states. It will be available only to those with simpler tax situations. By taking a limited pilot approach, the agency hopes to learn from clients, improve the product and make the case for expansion, and further innovations like pre-filling tax forms. It is, predictably, being strongly opposed by the private tax preparation industry, who benefit from making the tax return process as onerous as possible. (This is the section where, if this was a regular media outlet, you would be reading a quote from an Intuit spokesperson about what a waste of money or how dangerous it is to let the IRS help taxpayers. But in this blog, we do not platform rent seekers).

Can we rebuild capacity when one party opposes it?

It is worth noting that the choice to make the IRS work better was an entirely partisan one. Not a single Republican voted for the Inflation Reduction Act. And unlike other aspects of the Act, such as infrastructure projects they are now happy to take credit for, Republicans continue to oppose funding the IRS. The first vote of the current GOP House majority was to rescind the IRS additional spending. As part of an agreement to avoid a government default, they clawed back $20 billion of additional spending. The phantom “87,000 armed IRS agents” looms large in GOP imagination. Republicans have also opposed the pilot of direct e-filing, preferring that citizens pay private tax preparers instead.

At an aggregate level, the choice to invest in competent government should be an easy one. This does not mean the tasks the IRS is taking on are simple. Success, even with more resources, requires leadership and concrete strategies to use that money effectively. Innovations like direct filing necessarily imply some risk of failure. But one upside of starving the IRS for a decade is that the needs became very clear: improved enforcement, customer service, and offering taxpayers real choices when it comes to e-filing. Stability is also a component of organizational success. For the IRS, its ongoing improvement also depends upon continuing to fund core services in addition to its modernization project. But can we expect stability in capacity improvements when one political party seeks to undermine or even abolish the agency?

There are certainly going to be cases where government capacity issues is more complex, reflecting unprecedented tasks, entrenched interests, and progressive proceduralism. This is not one of them. One party wants to do things that will save Americans money and provide them better service. The other does not.

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