For Lawmakers and IRS, Declarations of Dependence Are Long-Standing

In January, House Ways and Means Chairman Dave Camp came forward with a bold idea to change the way financial derivatives are taxed.

Under the Michigan Republican’s proposal, all derivatives used to make speculative bets would be subject to “mark to market” taxation, meaning their increase in value would be treated as ordinary income even if they weren’t sold. Meanwhile, derivatives purchased by businesses to hedge against risk would continue to be taxed as they had in the past.

The distinction would be worth huge sums of money, and the law would present a challenge for the IRS. The agency would have to sort derivatives into two categories, either as bets or hedges, based on the seemingly vague concept of the motivation of their owners.

Committee staffers argued that the IRS would be up to the job.

These days, such a confident assertion about the tax-collecting agency is hard to imagine, and it illustrates how lawmakers have relied on the IRS to sort out the critical details of tax legislation.

Now, of course, the IRS is at the center of major political controversy, having apologized for improperly screening conservative organizations applying for tax-exempt status. Far from trusting the IRS to handle difficult assignments, Republicans such as Camp are taking aim at the agency, portraying it as a symbol of government overreach and incompetence.

“This is a problem of the IRS being too large, too powerful, too intrusive and too abusive of honest, hardworking taxpayers,” Camp said at a May 17 committee hearing.

There is little doubt that IRS bashing is back in vogue on Capitol Hill. Less clear is where the outrage will lead. Ways and Means Republicans may make subtle adjustments to the tax overhaul legislation that they plan to finish by the end of the year. But, according to experts, there is only so much they can do to limit the power of the agency, which will always be needed to enforce and interpret laws in a complex economy.

As lawmakers look more closely at the IRS and, during calm moments, consider ways to improve it, some see a risk of overreaction.

“I think this institution is basically sound,” said Donald Korb, a former IRS chief counsel who now practices law at Sullivan & Cromwell LLP. “For the most part, they’re good at what they do.”

There is evidence to support that view.

Although precise comparisons are hard to make, the United States is generally considered to be a world leader in tax compliance. Last year, the IRS estimated that, in 2006, 85.5 percent of all taxes owed were collected, with the amount of uncollected revenue totaling $385 billion.

According to a 2010 study produced for the World Bank, the percentage of goods and services in the U.S. deliberately concealed from public authorities for any reason, including tax avoidance, is lower than it is for any other developed country. As much as average people might loathe the IRS, year after year, tax-filing seasons pass with little controversy. And when called on to handle special tasks, such as mailing out stimulus checks in 2008, the IRS has usually fulfilled its responsibilities without incident.

But even the IRS’ staunchest defenders acknowledge that it has significant room for improvement. And the inspector general’s report that charged the IRS with mistreating conservative nonprofit organizations amounts to a strong indictment of the agency’s management and internal systems.

According to the audit, low- to mid-level IRS employees at a Cincinnati office were poorly trained, had a tenuous grasp of the laws they were trying to enforce, had persistent difficulties getting guidance from their superiors in Washington and took actions on their own that were politically tone-deaf at best and a gross misuse of power at worst.

Veterans of the IRS Exempt Organizations Division have largely confirmed the report’s view of the agency’s inner workings. “The IRS is kind of a screwed-up agency,” said Paul Streckfus, a former IRS employee who edits the EO Tax Journal. “Pretty inefficient. Lots of work to be done, people coming and going.”

The IRS, former employees say, is mostly successful at assessing and collecting taxes from wage earners. But it struggles at more difficult jobs, such as collecting taxes from small businesses that operate in the cash economy and large corporations that shift profits among their foreign subsidiaries.

Areas of the agency not primarily concerned with raising revenue, such as the Exempt Organizations Division, are especially likely to have problems attracting talent and to be neglected by senior management.

There have been signs in recent years that the IRS is getting worse at even its most basic functions. Between fiscal 2000 and fiscal 2010, the amount of taxes assessed but not collected by the agency jumped from $11 billion to more than $46 billion. Satisfaction reported by taxpayers calling the IRS’ toll-free assistance line hovered above 80 percent in the mid-2000s but plunged to 53 percent in 2008, when the IRS was mailing out stimulus checks, and it has never fully recovered since then.

Experts attribute the IRS’ shortcomings to several factors.

There is, inevitably, the matter of funding. Although many argue IRS resources should keep pace with the growth of the economy, the IRS budget over the past three years has dropped from $12.1 billion to $11.2 billion.

As a result, some the IRS’ best employees “are leaving in droves and the agency is struggling to bring in new people,” said Jeff Trinca, a lobbyist for Van Scoyoc Associates who specializes in tax administration issues. And experienced workers who have stuck around are less productive because they need to train new hires, Trinca said.

Republican lawmakers say the IRS budget cuts are justified by the need to slash all forms of government spending to reduce the deficit; IRS officials argue they have a special case to make because dollars spent on enforcement tend to offer a return on investment in the form of new revenue.

The IRS Exempt Organizations Division’s budget could stand to be doubled or tripled, Streckfus said, even if not all of those funds would be spent efficiently. Because of strong union and civil-service protections that makes it difficult to fire people, “when you say there are 1,000 people working for the IRS, that’s the equivalent of 500 people working for a private corporation and probably equivalent to about 300 people working on the Hill, where the senators to work them to death,” he said.

Those workers are especially challenged administering a growing number of social programs — such as the earned income tax credit and elements of the 2010 health care overhaul — that are run through the tax code.

“If you get closer to their core job of assessing taxes and collecting those taxes, I’d put them up against anyone in the world,” Trinca said. “But when you start having them sort out whether some poor woman and her child has moved in with their mother for too many months in order to get them their EITC, that is an impossible job.”