What makes capable states? As proximate factors, I can think of five requirements to running a capable administrative system - the enabling institutional framework, the numbers of personnel required, their professional competence and capabilities, the infrastructure and other resources required, and the account (the institutional pride) that the administrators hold about themselves and their work as a collective.
This post will about two of them, requisite personnel and their capabilities. The post has been triggered by this Bloomberg long read about the challenges facing the US Internal Revenue Service (IRS). The article talked to several ex-employees and finds it a "dysfunctional agency gutted by budget cuts, staff departures and lousy tech, leaving it incapable of enforcing the nation’s tax laws fully and fairly."
Politics aside, the IRS has undergone a long period of institutional weakening
Across the past few decades, the IRS has been decimated by cuts, to the point that by most measures it’s the worst-funded major federal department. It’s down to 84,000 (almost all unarmed) workers, a loss of 10,000 employees since 2010 and about the same as in 1974, when the US had 120 million fewer people and an economy a quarter of its current size. The IRS’s most experienced revenue agents have departed at an even higher rate than other employees, leaving 99.9% of the most complex and opaque type of business returns unexamined and millionaires’ and billionaires’ audit rates tumbling by 80% to 90%... Once in office, Reagan slashed tax rates, but the IRS didn’t actually start shrinking until the 1990s, when Republicans won the House for the first time in almost 50 years. As the agency came under sustained criticism in hearings spotlighting examples of overzealous enforcement, its budgets declined and its workforce began an epic 38% slide, losing 45,700 full-time staff from a 1991 peak to a 2018 nadir.
As the IRS was squeezed, the agency resisted laying off staff, but almost everything else was fair game. Training budgets were whittled away. Support staff disappeared. Major tech upgrades were out of the question. The IRS also cut back on the budget for outside expert witnesses such as appraisers, whose testimony is crucial for competing against well-heeled taxpayers in court. In the past decade alone, even as the number and complexity of tax filings have steadily risen, the agency’s inflation-adjusted budget has plunged 15%, from $12.2 billion in 2010 to $10.3 billion last year. The number of revenue agents—auditors who handle more complex returns—fell almost 40%, from about 14,500 to 8,500 over the same dozen years.
The impact in terms of effectiveness of IRS has been serious,
To get basic taxpayer information, auditors must still log in to a pre-Windows system with a black-and-green screen. Computers could take a half-hour to boot up in the morning or would crash if trying to run a web browser and word processing program at the same time. “You would spend a lot of time just trying to navigate the software,” says Katz, who’s now a CPA at Eide Bailly LLP. The IRS’s legacy systems also have trouble merging datasets, making basic financial analyses impossible. When agents couldn’t access taxpayer histories digitally, they would find themselves in the awkward position of asking people for copies of old returns... The audits that are being done are taking much longer to complete, a function of the increasing complexity of returns filed by the wealthy and the attrition of the experienced staff capable of parsing them. The average audit for those earning more than $10 million took 982 days last year, 40% more than in fiscal 2019, according to the National Taxpayer Advocate, an independent watchdog at the IRS...
Kim, who went on to co-found a law firm, says he has clients being audited by agents who “are not correctly applying the law.” He’s confident he’ll win any disputes when he appeals to higher levels of the agency, if at added cost to his clients. “The lack of agent training has a direct consequence on taxpayers,” he says... The IRS has said it now has fewer experienced examiners, the sort who can spot a sophisticated tax dodge in the field, than at any time since World War II.
The headline fiscal loss has been massive,
The agency’s latest estimate pegs the annual gap between taxes owed and paid at nearly $500 billion—almost an eighth of the $4 trillion a year it brings in. And academic studies suggest that the rich have hidden away far more than that offshore and in business activity the IRS can’t easily track. Nor does the estimate account for the impact of new vehicles for tax evasion such as cryptocurrencies.
Amidst this trend of weakening, the article points to glimpses of factors which make the IRS a professionally competent and capable agency,
Politics never enters into the job, ex-employees insist, a rule emphasized in annual training. Only two IRS employees are political appointees, the commissioner and chief counsel. Both must be confirmed by the Senate, with the commissioner serving a fixed five-year term. “In 27 years, I never had anything that came on my desk that had a political tint,” Kim says. Former agents say they were nothing like the pro-tax zealots depicted in conservative media as trying to soak the rich and squeeze everyone else. If pressure came from managers, they say, it was usually to close cases more quickly, not to rack up huge settlements. “There was never a vibe with anyone I worked with that ‘We really need to nail these guys,’ that we have to put the screws to the taxpayer,” one lawyer says...Former employees stick up for the agency. Many say their jobs were the best they’ve had in their careers. It’s a union shop, with excellent retirement benefits, sane hours and an often collegial culture. Those who faced discrimination at other employers—everyone including ethnic minorities, older workers and graduates of less-than-prestigious schools—report finding the IRS unusually welcoming and meritocratic. The latest figures show that almost two-thirds of the IRS workforce are women and almost 29% are Black—levels far exceeding those of the federal workforce as a whole.
Like with most economic, policy and social trends, this too has a Mathew Effect dimension
The chance that an American reporting income of $5 million or more gets audited fell from 16% in 2010 to 2.35% nine years later... A Stanford University study released in January found the agency over-audits Black Americans, perhaps a consequence of a strategy of pursuing cheaper audits against the poor instead of resource-intensive investigations of the wealthy. And almost no one is checking on vast segments of the economy, especially the 4.7 million returns filed each year for partnerships that hold much of the top 0.1%’s wealth. Only 3,155 partnership audits were initiated last year, one-third the number in 2018... Meanwhile, Americans with simple finances find it virtually impossible to cheat. Employers automatically report worker income to the IRS, which uses basic matching software to spot any discrepancies on returns.
Some observations of relevance to tax administration in India:
1. While part of the weakening has been a concerted political project of "shrinking the beast", the dominant broad-brush narrative that paints governments as ineffective and wasting public resources too has played its part. This is more an Anglo-Saxon trend (the Thatcher-Reagan axis) and less a factor in continental Europe. Unfortunately, this has been a trend that the opinion makers and commentators in the English speaking ex-colonies like India have adopted with some vigour.
2. While talking about state capability, we should make the distinction between the regulatory, promotional (economic growth creating), and developmental (welfare and basic public goods) states. It's less a matter of dispute that the state is responsible for defence, law and order, contract enforcement, statutory functions, tax assessment and collection etc and should be capable enough to do these effectively. This aspect is lost in the ideological efforts to tar governments in general as being inefficient and wasteful. These regulatory roles (and not the regulations themselves) should not be subjected to the new public management approach of costs-benefits assessment.
3. This article has strong resonance in the Indian context, especially in tax administration. For example, state indirect tax units are bottom-heavy, deficient in assessment and adjudication officials, chronically weak in capabilities like proficiency in tax laws and examination of business accounts, poor quality of work-flow automation, do limited systematic data analytics (as against opportunistic and adhoc analytics), and are pervasively corrupt and politicised.
4. As the economy becomes more complex and globally integrated, tax administration becomes ever more specialised. For example, on the direct taxes side there is the practice of tax "avoidance" by using professional tax firms to minimise individual and corporate tax payouts by the largest taxpayers. On the indirect taxes side, there is the trend of expanding share of services whose production and consumption are increasingly difficult to localise. There is a need to go beyond traditional bureaucratic hiring and personnel management approaches and adopt innovative and practical approaches to address this asymmetry in capabilities.
5. Complicating matters, the taxpayers are advised by professionals whose expertise in these issues is far greater than those of all but a handful of tax administrators. Worse still, after their retirement, the most capable tax administrators end up defending the other side. This also means that the Departments invariably end up on the losing side in tax litigations, most often due to a combination of bad assessment and adjudication, wilful negligence, and poor court representation.
6. For a country like India which is grappling with low share of tax to GDP ratio, a low-hanging fruit is to enhance the numbers of assessment and adjudication officers, and the general professionalism of tax administration so as to arrest leakages and thereby increase its tax revenues.
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