The poorly named Inflation Reduction Act has little to do with fighting inflation. It has more to do with tax policy, and more importantly, tax policy enforcement. Indeed, the Internal Revenue Service (IRS) has been given a great deal of extra resources to conduct audits and investigations of potential tax evaders.
The response by many is that more enforcement of tax policy is a desirable thing. Citing numerous studies, notably a famous one in the American Economic Review authored by Gabriel Zucman and two of his colleagues, defenders of greater enforcement point out that most tax evasion is done by wealthy individuals in the top 0.01 percent of the income or wealth distribution. Because of their vast wealth and high incomes, the richest can cheat governments more easily. As a result, the richest in society evade 25 percent of their taxes compared with less than 5 percent for people down the income ladder. Such proportions make it easy to then jump to “enforcement” in order to argue that more audits will allow governments to collect more revenues and close the deficit.
There is, however, one major problem with this: It does not consider that everyone cheats the government in one way or another.
Take the aforementioned famous paper by Zucman and his colleagues. That paper estimates tax avoidance by relying heavily on movements of wealth to foreign countries to avoid tax liabilities. This “offshoring” is costly to do, and only the richest can afford it – ergo the great degree of cheating frequently highlighted in the media.
However, people with lower incomes cheat differently. Because of their modest means, they can more easily cheat governments by working illegally. For example, self-employed workers can “omit” certain cash payments they received in the course of fully legal work. Others can simply work an illegal job and not report anything.
True, random audits ensure that enforcement could eventually catch these individuals. The problem is that these types of cheating are harder to detect because they are small relative to the economy’s size. For example, an undergraduate student who worked during the summer for a moving company for cash payment for three or four days (a classic occurrence in my home city of Montreal), could earn a few hundred dollars that tax authorities could hardly detect. This is why Zucman and his colleagues argue that random audits “are likely to miss some forms of tax evasion in the bottom and the middle of the distribution.”