IRS Data Web Snares Mostly Low- and Middle-Income Taxpayers

Agency expands its robo-audits to get more personal data, but has so far only netted small change.

Izmir, Turkey - March 29, 2011: Close up of Internal Revenue Service (IRS) main page on the web browser. IRS is a United States government agency tasked with collecting yearly state and income tax from working residents and businesses.
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The IRS has become more proactive in targeting banks and financial institutions that aid in illegal tax dodges using offshore accounts. But its technological push is largely focused on domestic filers. Meanwhile, a report by former McKinsey & Co. economist James Henry estimates that 100,000 super-rich individuals worldwide have $9.8 trillion stashed in offshore accounts.

That means a large portion of the $15 trillion of U.S. investment in the global economy generates income that is increasingly out of the reach of U.S. tax authorities, said Inspector General George in his testimony. Private estimates suggest there may be as much as $125 billion in tax evasion, he said. That's on top of the IRS's $400 billion "tax gap," which is estimated largely by auditing and following up on existing tax returns and checking the validity of audits, but not touching "unreported" or hidden income. George told Congress that global tax dodges are not targeted because "identifying hidden income in international activity is very difficult and time-consuming."

The expansion of IRS technology was heralded for its potential to bring more tax cheats to justice. But Toder says, "It's unlikely they can move that number very much." The likeliest group to be caught, Toder says, will be small businesses, filers of Schedule C "side business" expenses and independent contractors whose income is not backed up by a W2 wage report. This group is believed to make up the largest portion of the so-called "tax gap."

Avoiding controversy, IRS stealth strategy. Going forward, many more people will feel the intrusive pinch of IRS robo-audits and personal data mining—although they may not know for sure what personal data is being used. Legal and privacy experts, as well as the IRS National Taxpayer Advocate, have called on the agency to share detail on what documents it examines in audits. By working in collaboration with taxpayers, it will be more likely win cooperation and compliance, they argue. The IRS has told Congress such disclosures might hamstring its efforts. The agency prefers a "stealth" approach of not informing taxpayers about what information is used, which Acting IRS Commissioner Steven T. Miller told Congress is "less intrusive."

The IRS is following the philosophy of former Obama regulatory czar, Cass Sunstein, who advocates using technology tools and behavioral science policies to "nudge" people to do the right thing. In the case of the IRS, that policy so far has fallen most heavily on lower-income taxpayers and has done little to collect substantially more tax revenue.

Ultimately, the agency's legacy could be measured in lost privacy, says Harry Surden, a University of Colorado—Boulder Law School associate professor and former fellow at Stanford's Center for Computers and Law, who has done in-depth studies on the use of technology by government. He has found that data mining and new technology make possible a level of government intrusion into personal lives that few realize is possible. At a hearing this month, Iowa Republican Senator Charles Grassley said IRS Acting Commissioner Miller has not done enough to explain the agency's stance on "abusive intrusion of privacy," adding that "the IRS has to take this issue seriously, and a casual explanation is inadequate." He called to "clarify the true policy in writing" on how and why it uses private electronic communication in tax work.

[Read: Good News, Bad News for Tax Refunds.]

"You could get the tax gap down close to zero, but it would certainly not be a good policy to spend that much," says Michigan policy expert Slemrod. "Nor is it advisable in the same way that it is not good policy to put someone on every corner of every street to eradicate street crime."

Technology and law experts say that for such major expansions of government into people's lives, simply doing what is legal could have unintended effects that could be detrimental to a system that requires cooperation from taxpayers and the legal community.