Tax Refund

What policymakers give, policymakers can take away. Nine months after Congress enacted President Biden’s proposal to boost the Internal Revenue Service’s 10-year budget by $80 billion, the president and House Speaker Kevin McCarthy (R-CA) have agreed to cut the IRS’s budget by up to $21.4 billion over the next three years as part of a deal to raise the debt ceiling.

The bipartisan agreement’s cutbacks just nine months after the enactment of the Inflation Reduction Act (IRA) point to the fragility of the IRS budget. A reduction of this magnitude may not only have direct impacts on IRS operations, but it could also have negative indirect effects on how the agency spends the remaining IRA funds.

What does the agreement say?

Some of the agreement is clear as to the negotiators’ intent toward the IRS, but other parts are ambiguous.

Start with the bill language. Nearly $1.4 billion would be taken back immediately from unobligated funds provided by IRA. But monies for taxpayer services and modernization would not be cut. That’s not too surprising. Ensuring the phones are answered and refunds are paid quickly are priorities for voters and the people who represent them.

Moreover, Congress already zeroed out funding for business systems modernization in the fiscal year (FY) 2023 appropriations, arguing that the agency could rely on leftover funds from COVID relief legislation, as well as the IRA funds. Additional cutbacks would slow progress in technological improvements at the agency.

However, the bill leaves it to the discretion of the Biden administration as to where the $1.4 billion of cuts would occur, with the choices being the other IRS accounts (tax enforcement, operations support, and the 2024 pilot for direct e-filing), several Treasury offices, or the US Tax Court.

Even without more details, the Congressional Budget Office (CBO) estimates that the $1.4 billion reduction will result in a reduction in federal revenues, leading to a net increase in the deficit of $900 million over the next ten years.

For FY2024 and FY2025, the fate of the IRS effectively hinges on a handshake between Biden and McCarthy. Nothing is specified in the actual bill. According to a White House briefing and press reports, the agreement would “repurpose” $10 billion in the FY2024 appropriations process and reallocate another $10 billion in FY2025 to other non-defense priorities.

Why the distinction between 2024 and 2025?  Here’s one (hopeful?) theory. In its recent strategic operating plan, the IRS warns that IRA’s $3.2 billion allocation for taxpayer services would be exhausted in four years if the regular annual appropriations were frozen. Does “repurposing” the 2024 funding open the door to shifting some of the $46 billion in IRA for enforcement to taxpayer services?

Whatever the reasons, there is one strong advantage to the vague language in the agreement for the negotiators. There’s probably not enough specificity for CBO to estimate the offsetting revenue loss due to the hefty reduction in the IRS’s funding in 2024 and 2025. So, on paper, the reduction in tax collections we could expect from cutting back on IRS resources won’t show up in the final numbers.

What are the worst-case scenarios?

Since IRA’s funding covered an entire decade, one possibility is that the IRS would accelerate spending—either hoping Congress would restore funding after 2025 or fearing Congress would cut more after 2025.

But unless the IRS rushes out to buy lots of laptops and pens, there is a limit to how much faster the agency can spend. Accelerating spending could also undermine the goals of IRS strategic operating plan. It takes time to recruit and hire the accountants and lawyers with the skills and experience to tackle the complicated tax returns of the wealthy and big businesses. And even if masses of mid-career tax professionals were rushing to apply for jobs at the IRS, there are limits to how fast the agency could absorb thousands of new hires.

Moreover, the strategic operating plan lays out a careful, incremental strategy for investing in technology. Former Commissioner Charles Rossotti warns the IRS should not race to hire lots of enforcement agents until it figures out how to use data and technology to improve audit selection.

On the flip side, some may view the cuts as a signal that neither Congress nor the Administration is fully committed to the IRA funding. If those at IRS charged with implementing IRA lose confidence in the willingness of lawmakers to sustain funding increases, they may be reluctant to commit to years-long investments in staff and technology.

What is the best-case scenario?

At least for the time being, the IRS still retains most of the IRA funding boost. Rather than accelerating spending or slowing investments, the IRS could stay the course and cautiously test out approaches that could improve the efficiency and fairness of tax administration and then provide Congress with the evidence to evaluate the agency’s spending needs. If Congress were to act on that evidence, the Biden-McCarthy deal could yield a good outcome for the IRS and the vast majority of taxpayers.

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