Dealer’s Choice: The Debt Ceiling’s Tax Fallout

Tax Notes contributing editors Robert Goulder and Joseph J. Thorndike examine the looming debt ceiling crisis and its likely effect on the IRS’s budget, all in five minutes.

This transcript has been edited for length and clarity.

Robert Goulder: You’ve heard the news by now: The federal government is just weeks away from hitting the debt ceiling. If the alarm bells aren’t going off by now, they should be. Lawmakers could just voluntarily increase the debt ceiling as they did three times under the last administration, but nobody expects that to happen here without some concessions.

I’m Bob Goulder with Tax Notes. Today, we ask what the political crisis means to the IRS. Is it possible that President Joe Biden could sacrifice IRS funding for the sake of avoiding a larger economic crisis? My colleague, Joe Thorndike, a contributing editor with Tax Notes, thinks there’s a real possibility that that might happen.

So tell me, Joe, is Armageddon too strong a word here?

Joseph J. Thorndike: Yeah, well, maybe a little bit too strong. So let’s say we go with: total unmitigated financial catastrophe. What we have going on right now, these are negotiations.

I think the White House is still insisting that they are not negotiations about the debt limit since President Biden refuses to bargain on that point. He says he wants an increase in the limit that is free of conditions, but he’s willing to talk about ostensibly unrelated things like the amount of federal spending that’s going to be going on in the future, and maybe IRS funding in particular since that is a major GOP priority.

Robert Goulder: So the Republicans have some strong opinions about IRS funding. What a shocker!

Joseph J. Thorndike: Yes. Well, indeed they do. Last month, the House passed the Limit, Save, and Grow Act of 2023, which basically constitutes a GOP wish list — or maybe let’s call it a demand list — for GOP approval of a debt limit increase.

In exchange for raising the debt ceiling by $1.5 trillion, the bill would cut federal spending by $4.8 trillion over the next 10 years, and that includes a $71 billion cut slated for the IRS.

Robert Goulder: Ah, now, wait a minute, Joe. As I recall, that provision to defund the IRS, it’s actually scored as a revenue loser. That is, you take away some of their budgetary resources, and the national debt actually gets bigger. How is that?

Joseph J. Thorndike: Well, that’s right. Cutting the IRS budget in the name of deficit reduction is actually nonsense because it doesn’t actually save any money. When we cut the IRS budget, we impair the agency’s ability to collect taxes from the people who already owe them.

That means that the $71 billion we save in IRS funding will actually cost us — according to official estimates — about $180 billion in lost revenue. So what’s the net on that? We lose about $110 billion over 10 years. That’s the kind of math that got us a $31 trillion debt in the first place.

Robert Goulder: Yeah. OK. So that answers the question. But then what is the point of doing this if it’s not about debt reduction?

Joseph J. Thorndike: So the charitable answer to that, and taking the Republicans at their word, is that it’s about reining in a badly managed agency. And the IRS does have some long-standing management problems, especially around its information systems and technical modernization efforts. More recently, it’s suffered from serious customer service problems, and we’ve all heard about its plunging audit rates. But these problems especially, they’re the result of inadequate funding to a large extent.

Further cutting agency resources, they’re only going to make those problems worse. The real reason I think the IRS is taking it on the chin right now is that they are an easy target. They are the least popular agency in almost every poll. And attacking them, it’s an easy political win, but it is also shortsighted. It hurts anyone who ever has to deal with the IRS, and that’s pretty much everybody who pays taxes.

Robert Goulder: How do you think it’s going to resolve? Any predictions?

Joseph J. Thorndike: I think that there’s a decent chance that the Biden administration actually does decide to sacrifice the IRS for the sake of a deal, either now on the debt limit or later in the year on the budget.

The reason is because when they’re forced to sacrifice something, I think that Biden might look at the same polls that drive the GOP to attack the IRS. This is not a popular agency, so if you have to gut somebody’s budget, then the IRS budget may be the least bad choice, at least politically.

Robert Goulder: There you have it. That’s our take on the debt ceiling crisis and IRS funding. Thank you for watching.