Of Public Interest

Volume 4, Number 4
February, 2002

The Internal Revenue Service has stated its intent to subject 54,000 taxpayers to intensive audits, starting September 2002. These audits are described as a National Research Program (NRP), the purpose of which is to allow the IRS to develop an up-to-date base of information about taxpayer compliance with IRS provisions. This information will be used to refine the methods the IRS uses to select which taxpayers to audit in future years.

So long as we have an income tax, there is nothing wrong in principle with the IRS researching how to organize its compliance activities. At the same time, most people rightfully cringe at the prospect of being audited by the IRS. Sen. Charles Grassley (R., Iowa) once described an IRS audit as "performing an accountant’s version of root canal on honest taxpayers." The eyewitness reports of the experience of being subjected to IRS audits give good reason for this kind of reaction. The thought of being subjected to yet a new onslaught of IRS audits will understandably inspire more such reaction.

Audits might not be too bad if there were some black-and-white truth out there to guide auditors and taxpayers. In this case, taxpayers would have nothing to fear from the arbitrary judgments of IRS auditors, because there would be no room for such arbitrariness. Unfortunately for audited taxpayers, IRS auditors are not bound by any kind of black-and-white truth.

For many years, Money magazine asked CPAs and IRS officials to calculate the tax liability from a moderately complex return. The difference in answers given by these experts was enormous, with the high answer generally being about double that of the low answer. The IRS experts don’t know what tax liability truly should be; different experts give different answers. These differences would be ok if taxpayers were presumed innocent when they face IRS auditors. If so, any supportable claim that can be found across the gamut of expert opinion would absolve the audited taxpayer of IRS claims for additional money. But this is not how it works with the IRS.

Despite these deep problems with the inherent arbitrariness of IRS enforcement, some form of auditing will be necessary as long as we have an income tax. The audits envisioned by NRP may well provide the IRS with information that will allow it to improve its audit procedures. If improvement means greater accuracy in final outcomes, NRP may have a value that outweighs its cost. The concern, of course, is that improvement would simply mean an increase in the amount of money collected, while doing nothing about the considerable inaccuracy in IRS claims about the tax implications of different commercial transactions.

The cost of NRP raises a troubling problem in its own right. Who rightfully should bear the cost of these audits? As it stands, it is the taxpayers who will be audited who will bear those costs. If you are selected for audit and your participation requires 100 hours of your time, this is a special tax that you have to pay to generate information for the IRS. For someone who earns $30 per hour ($60,000 per year), this tax would be $3,000.

Private businesses sometimes solicit information from customers through such devices as surveys. Such customer participation is voluntary. When that participation requires more than a few moments of time, businesses will often compensate people for their participation. This compensation makes sense. The information has value to the business, but providing it is also costly for customers to provide that information. Customers are compensated for what is, after all, a service they provide to the business. When paying for information, businesses are more likely to limit the amount of information they seek.

It is easy to imagine a world where businesses could compel the participation of customers in their information audits. In such a world, customers would not be pleased to be chosen because they would bear a burden without compensation. Furthermore, businesses would have no incentive to economize on the amount of information they solicit from customers.

The same principle applies to the IRS and its search for information. The forthcoming audits place the cost on the selected taxpayers. This is a form of tax that is collected only from those particular taxpayers. Furthermore, the IRS has no incentive to economize on the burden it imposes on those it selects because it can obtain taxpayer time free of charge. To the extent these audits would genuinely improve the accuracy with which the IRS performs its duties, NRP would provide a general gain for all taxpayers. If so, it is only reasonable that all taxpayers fund this gain, rather than a selected few. Voluntary participation through compensation will do this; conscription will not.

A Publication of:
Public Interest Institute at Iowa Wesleyan College
600 North Jackson Street
Mt. Pleasant, Iowa 52641-1328
Phone: 319-385-3462 Fax: 319-385-3799
E-Mail: public.interest.institute@limitedgovernment.org Web Site: www.limitedgovernment.org