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Beyond BLS

Beyond BLS briefly summarizes articles, reports, working papers, and other works published outside BLS on broad topics of interest to MLR readers.

July 2023

Costs and benefits of tax audits

Summary written by: Jonas Trostle

A common saying is that life only has two certainties: death and taxes. Unlike death, which only happens once, taxes usually occur annually, with Americans filing theirs to the Internal Revenue Service (IRS) every April. Not all taxpayers, however, always fill out their tax forms correctly, and if the IRS suspects that the tax information is incorrect, it will audit their returns.

In “A welfare analysis of tax audits across the income distribution” (National Bureau of Economic Research, Working Paper 31376, June 2023), William C. Boning, Nathaniel Hendren, Ben Sprung-Keyser, and Ellen Stuart investigate how much value the public gets for paying a dollar toward funding in-person audits. Beyond calculating the direct costs and revenue collected, the authors also calculate the indirect costs and benefits, some of which are delivered over a 14-year span.

To determine the marginal cost of one additional audit, the authors calculate how much fixed costs affect the total cost of conducting an audit. They also compare years of high and low rates of auditing to discern how quickly returns diminish as the IRS increases its number of audits. The authors find no substantial decrease in the revenue collected per audit as the number of audits increases. Breaking down the marginal costs and marginal revenue by income, they find that the marginal return among the taxpayers earning less than the median income is around $1 but that the marginal return for audits on taxpayers in the 90th–99th and the 99.9th percentile rises to about $3 and nearly $9, respectively.

The researchers also find that audited taxpayers pay higher taxes for at least the next 14 years. This effect, called “specific deterrence,” increases the revenue collected, and when discounted over the 14 years to account for the future value of money, this revenue is around 3 times the tax revenue collected from the audit originally.

Finally, Bonning, Hendren, Sprung-Keyser, and Stuart quantify the welfare impact of audits. Using a marginal value of public funds framework, they find that the welfare cost per dollar collected is higher for lower income audits and lower for higher income audits. The authors note that the federal government prefers to collect income from high-income taxpayers and prefers to collect audit revenue from low-income taxpayers. The authors say that “it is hard to envision a set of preferences that result in such an outcome” and that it matches no traditional social preference model.