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Bugs in Space and Tax Cheats

America’s affluent are misreporting their incomes big-time — and annually costing the federal treasury hundreds of billions in the process.

Blogging Our Great Divide
May 18, 2016

by Sam Pizzigati

The folks working for the federal government can do some incredible things. Over at NASA, for instance, they’re now putting the finishing touches on the new James Webb Space Telescope, an instrument powerful enough “to capture the heat signature of a bumblebee on the moon.”

Amazing. We can now spot a bug in space.

So how come we can’t spot people who cheat on their taxes right here on terra firma in the US of A?

A great many people, the IRS has just acknowledged in a new report, are stiffing Uncle Sam. Our federal “tax gap” — the disconnect between what taxpayers owe and what they eventually pay — is now averaging $406 billion a year.

This eye-opening figure comes from an IRS “tax gap” study that covers the years 2008 through 2010. Just under 17 percent of the nation’s taxpayers, the report details, are misreporting their income and underpaying their income tax due.

The other side of the coin: Just over 83 percent of Americans are paying their taxes, in full and on time.

If you make a typical American income, you almost definitely fall within this 83.1 percent. Actually, you don’t have much choice. All wage and salary income — the overwhelming bulk of the income average Americans receive — gets automatically reported to the IRS and faces paycheck withholding.

Thanks to this automatic reporting and withholding, notes the new IRS study, only 1 percent of overall paycheck income goes under- or unreported.

But some Americans — the nation’s most affluent — don’t get the bulk of their income from wages and salaries. They get the bulk of their income instead from business profits and rents and the money they make buying and selling assets.

Most of these income dollars don’t get automatically reported. Few of these dollars ever face any withholding at all.

Now this absence of automatic reporting and withholding might not matter all that much if the IRS had plenty of agents out in the field doing in-depth audits. But the IRS has been losing staff. The tax agency had 50,400 full-time-equivalent enforcement staff available in 2010. The 2016 figure: only 38,800.

With fewer watchdogs on the job, 19 percent of the individual tax due on capital gains and “partnership” income is going uncollected. An even higher share of rents and royalties and “proprietor” income — 63 percent — is escaping taxes.

How much of this tax cheating involves big-time business people and how much involves mom-and-pop business operators? The IRS doesn’t say. The agency doesn’t break down the new tax evasion data by taxpayer income class. But eight years ago, economists Andrew Johns and Joel Slemrod went through earlier IRS raw data and did just that.

Americans who make between $500,000 and $1 million a year, these two researchers found, misreport their income at triple the rate of taxpayers making between $30,000 and $50,000 and well over double the rate of taxpayers making $50,000 to $100,000.

One key point to keep in mind here: We’re not talking about loopholes in the tax code when we talk about the “tax gap.” Loopholes let the deep-pocket set legally sidestep what otherwise would be a significantly higher tax bill. The IRS tax gap numbers only apply to outright illegal tax cheating.

The rich engaging in this cheating do sometimes get nabbed. The latest example: Earlier this month, a federal judge found that Texas tycoon Sam Wyly engaged in “deceptive and fraudulent actions” to avoid taxes on over $1 billion of his assets.

But the Sam Wylys remain outliers. Most high-income tax cheats don’t get caught. And that won’t change until Congress start subjecting the incomes of the awesomely affluent to the same reporting and withholding standards that apply to the incomes of average Americans.

Sam Pizzigati, an Institute for Policy Studies associate fellow, co-edits His latest book: The Rich Don’t Always Win: The Forgotten Triumph over Plutocracy that Created the American Middle Class, 1900-1970

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