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CBO Estimates Huge Deadweight Loss from Increased IRS Budget

Summary:
On September 2, the Congressional Budget Office published an estimate of the amount of additional tax revenues the Internal Revenue Service would reap if its budget were increased by a total of billion over a 10-year period. The answer? 0 billion. I was stunned by how low that number is. Think about what that means for the deadweight loss. We normally estimate DWL by looking at how the tax distorts the economy, causing a mix of producer surplus loss and consumer surplus loss. A standard number for the DWL from many taxes is 30 percent of the revenue raised. But the CBO analysis doesn’t even touch this; it’s just about auditing and collection costs. So if the standard 30 percent applies, this amounts to an overall DWL of 70 percent of the amount of revenue

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CBO Estimates Huge Deadweight Loss from Increased IRS Budget

On September 2, the Congressional Budget Office published an estimate of the amount of additional tax revenues the Internal Revenue Service would reap if its budget were increased by a total of $80 billion over a 10-year period.

The answer? $200 billion.

I was stunned by how low that number is.

Think about what that means for the deadweight loss. We normally estimate DWL by looking at how the tax distorts the economy, causing a mix of producer surplus loss and consumer surplus loss. A standard number for the DWL from many taxes is 30 percent of the revenue raised. But the CBO analysis doesn’t even touch this; it’s just about auditing and collection costs.

So if the standard 30 percent applies, this amounts to an overall DWL of 70 percent of the amount of revenue raised. That’s one inefficient way to raise tax revenue.

Is there any factor that could make the 30 percent number be lower? Yes. To the extent people anticipate more scrutiny by the IRS, some might actually reduce their avoidance. They might, for example, declare income that they would have otherwise hid. It takes real resources to do that kind of avoidance, which is really evasion, the illegal part of avoidance. It takes good lawyers and lots of time, for example, to set up a bank account in Grand Cayman. So some people might actually engage in less avoidance and evasion.

Interestingly, though, Phill Swagel, the director of the Congressional Budget Office, goes the other way. He writes:

Second, CBO expects taxpayers to adapt to the IRS’s enforcement activities and adopt new ways of evading detection, so an enforcement activity may have a lower return in later years.

David Henderson
David R. Henderson (born November 21, 1950) is a Canadian-born American economist and author who moved to the United States in 1972 and became a U.S. citizen in 1986, serving on President Ronald Reagan's Council of Economic Advisers from 1982 to 1984.[1] A research fellow at Stanford University's Hoover Institution[2] since 1990, he took a teaching position with the Naval Postgraduate School in Monterey, California in 1984, and is now a full professor of economics.[3]

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