Bloomberg Tax
Aug. 15, 2023, 8:45 AM

Connecticut Should Hire More Auditors Rather Than Study Tax Gap

Richard D. Pomp
Richard D. Pomp
UConn School of Law

The Connecticut legislature has required the Department of Revenue Services to “estimate the state tax gap and develop an overall strategy to promote compliance and discourage tax avoidance.”

Superficially, only a curmudgeon could object to such a study. But those of us who have labored in the weeds on behalf of tax justice could save the DRS time and money because the answer to the tax gap is simple: Hire more auditors.

It’s a perfect time to do so. Many sophisticated IRS auditors have left the government in droves, fed up with out-of-date computers and a steady decrease in resources. President Joe Biden’s $21 billion clawback from his budget for the IRS in response to Republican demands can only accelerate these retirements.

Why should the DRS spend time and money on estimating the tax gap, otherwise known as the underground economy or black market? The underground economy is diverse and includes unreported cash transactions, fraud, smuggling, prostitution and human trafficking, bribery, counterfeiting, ransomware, cryptocurrency, and activities yet to emerge, perhaps facilitated by artificial intelligence. This diversity demonstrates the difficulty in quantifying the extent of the problem.

Federal revenue estimates of the gap vary widely—it’s called the “underground” economy for a reason. And these disparate estimates are done by sophisticated, experienced economists and statisticians, with more resources at their disposal than now exist within the DRS. Any money or diversion of resources to deal with estimating Connecticut’s gap is better spent on hiring more auditors.

Federal IRS data shows that for every additional dollar spent auditing people in the top decile of the income distribution, the federal government can expect to get back 12 times that amount. Because the state income tax is based on federal definitions and concepts, we can expect a similar return for the DRS.

The “12 times” figure actually understates the real revenue at stake because an audit impacts subsequent taxpayer behavior. Data suggests that post-audit revenue is three times the revenue raised from the initial audit as taxpayers start to toe the line going forward. The payoff is even greater if high-income taxpayers and the largest corporations are targeted.

Increasing the number of auditors is a realistic alternative to fighting about raising tax rates on the very wealthy and the mega-corporations. Attractive politics to be sure, but what is accomplished by raising rates on taxpayers who aren’t paying their fair share in the first place due to tax minimization strategies that will continue to immunize them against higher rates?

Spending money on estimating the tax gap is unlikely to tell us in Connecticut anything that we don’t already know from the federal, albeit disparate, estimates. We also know the various federal strategies that taxpayers use to minimize their taxes, and these can be the object of special DRS projects, just the way they are for the IRS. We’re unlikely to stumble on tax chicanery that has eluded the IRS auditors.

The only exception is the sales tax, which the federal government doesn’t use. Luckily, robust literature and experience on sales tax avoidance exist, especially after the US Supreme Court broadened the powers of the states in 2018.

Connecticut had one of the first landmark cases on sales tax evasion 30 years ago when Stew Leonard Sr. went to prison after pleading guilty to tax fraud. Leonard had used customized computer programs to eliminate any record of sales. Today, thumb drives known as “zappers” plug into a USB port on an electronic cash register and wipe out sales—a modern embodiment of Leonard’s algorithms.

The DRS auditors are well aware of zappers, a standard audit target. If Congress ever adopts a national sales tax, DRS auditors would be a font of wisdom for the IRS.

Perhaps the motivation for a report documenting what we already know—that an underground economy exists, whatever the size of it may be—is to marshal political support for hiring more auditors. But that case can easily be made today, so we needn’t waste time and spend resources that could be better spent on audits today.

The former IRS auditors who have left the government are too young to stop working, and many have no desire to do so. They’re happy to bolster their federal pensions with state employment. Other states are grabbing them, and we should too—the sooner the better.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Richard D. Pomp is the Alva P. Loiselle and Board of Trustees Distinguished Professor at the University of Connecticut Law School. He is a member of the American College of Tax Counsel.

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