Tax authorities target the poor: When it’s too expensive to tax the rich

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  Quantumrun Foresight
• October 26, 2023

Insight summary

Tax agencies worldwide often focus more on auditing low-income taxpayers due to funding constraints and the complex nature of auditing the wealthy. Easier and quicker audits are conducted on lower-income individuals, while resources-intensive audits for wealthy taxpayers often end in out-of-court settlements. The focus on lower-income taxpayers raises questions about fairness and contributes to declining public trust in government agencies. The wealthy, meanwhile, use various means like offshore accounts and legal loopholes to protect their income. 

Tax authorities target the poor context

The IRS said that it is generally easier to audit poor taxpayers. This is because the agency uses lower-seniority employees to audit returns for taxpayers who claim the earned income tax credit. The audits are done by mail, account for 39 percent of total audits done by the agency, and take minimal time to complete. Conversely, auditing the rich is complex, requiring labor from several senior auditors, often because the ultrawealthy have the resources to hire the best team to execute sophisticated tax strategies. In addition, the attrition rate among senior-level staff is high. As a result, most of these disputes with wealthy taxpayers end up settled out of court.

According to a recent study by the White House economists, the 400 wealthiest families had an average income tax rate of just 8.2 percent from 2010 to 2018. In comparison, couples with median-wage jobs and no children pay a total personal tax rate of 12.3 percent. There are a few reasons for this disparity. First, the rich generate more income from capital gains and dividends, which are taxed at a lower rate than wages and salaries. Second, they benefit from various tax breaks and loopholes that are not available to most taxpayers. In addition, tax evasion has become a normal occurrence among large corporations. Between 1996 and 2004, according to a study in 2017, fraud by America’s major corporations cost Americans up to USD $360 billion each year. That’s equivalent to two decades’ worth of street crime every year.

Disruptive impact

The IRS is traditionally viewed as a fearsome agency capable of sniffing out tax evasion schemes. However, even they are powerless when faced with the extensive machinery and resources of the ultrawealthy. In the early 2000s, IRS realized they were not properly taxing the 1 percent. Even if someone is a multimillionaire, they may not have an obvious source of income. They frequently use trusts, foundations, limited liability corporations, complex partnerships, and foreign branches to lower their tax liabilities. When IRS investigators examined their finances, they generally scrutinized narrowly. They might focus on one return for one entity, for example, and look at a year’s donations or earnings. 

In 2009, the agency formed a new group called the Global High Wealth Industry Group to focus on auditing wealthy individuals. However, the process of declaring income for the rich became too complex, resulting in pages and pages of questionnaires and forms. The lawyers for these individuals pushed back, saying the process has become almost like an interrogation. As a result, the IRS backed down. In 2010, they were auditing 32,000 millionaires. By 2018, that number fell to 16,000. In 2022, an analysis of public IRS data by Transactional Records Access Clearinghouse (TRAC) at Syracuse University discovered that the agency audited earners with less than USD $25,000 annually five times more than those who earned above USD $25,000.

Wider implications of tax authorities targeting the poor

Possible implications of tax authorities targeting the poor may include:  

• Tax agencies expanding their focus on low-wage earners more than ever to make up for the loss of income caused by tax evasion by the wealthy.
• The contribution to a societal reduction in institutional trust of government agencies.
• The eventual application of advanced AI systems to automate increasingly complex audits and conduct intrica
• The wealthy continuing to build offshore accounts, taking advantage of loopholes, and hiring the best lawyers and accountants to protect their income.
• Auditors leaving public service and choosing to work for the ultrawealthy and large corporations.
• High-profile tax evasion cases settling off-court because of privacy protection laws.
• Lingering effects of the pandemic layoffs and The Great Resignation resulting in more average taxpayers not being able to fully pay their taxes over the next few years.
• Gridlock in the Senate and Congress over revising taxation laws to increase rates for the 1 percent and funding the IRS to hire more staff.

Questions to comment on

• Do you agree that the rich should be taxed more?
• How can the government address these tax disparities?