CBS News is out with a great interview that highlights the growing concerns of small business owners as they grapple with rising inflation, worker shortages, supply chain disruptions, and the looming threat of an economic recession.
Here’s how Jessica Johnson-Cope, the owner of a small business that provides security and protection services, summed up the current environment:
With inflation, we’re getting less for more. We have an armored car business, so fuel costs are more expensive. Our largest armored car contract is with the federal government and we forecast those rates out for five years at a time, so we weren’t expecting as significant of an increase this year. That’s one area where our costs are up but we aren’t making more money…We don’t have opportunities to bake these increased costs into our rates unless we’re getting new business, because many of our contracts are long contracts.

Unfortunately for the small business community, Johnson-Cope’s experience is hardly unique. A recent survey conducted by NIFB showed that confidence among business owners continues to deteriorate, resulting in sharp declines in new investment and hiring:

Later in the interview, Johnson-Cope commented on the ongoing labor crunch, stating: “We definitely compete with larger terms for talent, and it’s a challenge.” We’ve been sounding the alarm over this trend for months now, but it bears repeating. While larger firms continue to grow, the small business sector – historically the primary driver of economic expansion – is shedding jobs at an alarming pace:

And while the White House and others quibble over whether we’re “technically” in a recession, it’s clear the small business sector is already there. Asked whether concerns over a broader economic slowdown make it hard to plan ahead, Johnson-Cope responded:
It’s already challenging enough to come up with financial projections. In the current financial climate, it’s even harder to project what’s going to happen from my vantage point. Last week we were securing a construction project, and our client said we would have to reduce coverage because one reason they needed security was to monitor equipment. But because of supply-chain delays, they didn’t even have the equipment they needed.
How does this all relate to federal tax policy? The Inflation Reduction Act currently under consideration by the Senate does nothing to address the concerns raised by Johnson-Cope or other small business owners. It’s unlikely to have any meaningful impact on inflation or help stave off a broader economic slowdown, as a recent statement from the Main Street Employers Coalition observes:
Recent NFIB member surveys make clear that inflation is the number one concern for Main Street businesses right now. With the CPI and PPI indexes measuring forty-year highs, businesses are struggling to balance rising prices with the need to accommodate their customers. A recent analysis from Penn-Wharton, however, finds the Inflation Reduction Act would increase prices in the short term and do little to bring them down in the long term.
Small businesses need relief from rising prices today, not years from now.
Furthermore, the legislation provides the IRS with over $80 billion to hire 87,000 new auditors, so they can target the Main Street community with 1.2 million additional audits over the next decade. Proponents claim these efforts will just target the rich and tax cheats, but that’s not accurate. Here’s what Summers, Rossotti, and Sarin recommended in the paper that forms the basis for this effort:
Early on in a new administration, a supplementary appropriation can increase enforcement resources allocated to examinations of noncompliant high-income taxpayers and the businesses they own.
Or, as the Tax Policy Center put it:
About $264 billion of that underreporting tax gap is from individual income taxes, and nearly half of that amount—about $125 billion—comes from underreporting by pass-through business filers such as sole proprietors, farmers, and those earning rental, royalty, partnership, and S-corporation income. They are prime targets for stepped-up enforcement.
So give the IRS $80 billion and use most of that money to target Main Street. As the countless small business owners still waiting on refunds know all too well, the IRS is in desperate need of additional resources. The solution, however, is not to hand the agency a blank check, which is what the IRA does.
This is a topic we’ve been engaged in for nearly two decades, and the basic premise remains the same. Some policymakers view the tax gap as “free money!” that they can spend without harming law-abiding taxpayers, but that’s not how it works. Much of the actual tax gap is made up of taxes owed that can never be collected, because the taxpayer that owes them is broke. Another portion is with business owners where the amount owed is in dispute – review the Tax Court decisions in Law360 and Tax Notes; the IRS loses as many cases as it wins. Still more is paid, just not on time.
You get the idea – it’s a mixed bag. What the tax gap is not is some huge pool of money just waiting for an intrepid IRS auditor to discover. Here’s the Tax Policy Center’s “Briefing Book”:
The Internal Revenue Service (IRS) estimates that over the past 30 years, the tax gap has fluctuated in a narrow range—15 to 18 percent of total tax liability. Some view the tax gap as a possible major revenue source that could be used to close the federal budget deficit without raising taxes. In practice, though, the potential revenue gains from proposals to improve enforcement are quite limited. (Emphasis added.)
More from the Tax Policy Center:
The IRS’s measure of the tax gap includes unpaid federal income, payroll, excise, and estate taxes. In its most recent study of noncompliance, the agency estimated the gross annual tax gap was $441 billion for tax years 2011-2013. Late payments and enforcement revenue reduced the gap by $60 billion each year.
But the IRS estimate does not distinguish between taxpayer mistakes and intentional evasion. For example, it includes the honest errors made by taxpayers trying to comply with ever-changing and often-opaque laws. The IRS also includes the liabilities of well-intentioned taxpayers who acknowledge what they owe but are unable to pay.
Moreover, the IRS may be overstating or understating the true tax gap. The agency uses a statistical method called “detection controlled estimation” (DCE) to account for noncompliance missed in audits of individual income tax returns. But that approach is being reconsidered or already has been rejected by other countries out of concern for its accuracy. Some researchers have found DCE effectively triples the estimate of the individual income tax underreporting gap…
Then there are those shades of gray where taxpayers, IRS examiners and appeals officers, the courts, and Congress may disagree over what is legal. For example, the IRS bases its tax gap estimates on the post-audit recommendations of examiners, even if they are reversed on administrative appeal or by court challenge. As a result, the IRS may include taxpayer behavior that failed to pass muster with auditors but ultimately was found by IRS appeals officers or the courts to be legal avoidance that should not be included in the tax gap.
Here’s OMB from the FY 2008 Budget:
Requiring third-party reporting of all income would likely raise compliance levels. However, this is not possible in all cases and even where it is possible it might require burden-some new reporting requirements for individuals and businesses. For example, individuals paying a contractor or purchasing a car might be required to file reports to the IRS reporting these transactions. Such broad expansions of reporting requirements would be excessively burdensome, and that this consideration outweighs the gains they might bring in increased compliance.
Similarly, requiring much more detailed documentation, such as evidence supporting claims for deductions and credits or providing accounting records supporting business income claims, would quite possibly improve compliance. In some cases more detailed documentation may be appropriate. However, unless carefully targeted, this is likely to impose an unacceptable increase in cost on both taxpayers and the IRS and to decrease privacy.
Another approach to improving compliance would be to change the tax code to remove tax benefits wherever there is the potential for abuse. For example, deductions for non-cash giving could be prohibited. This would prevent the overstatement of charitable deductions by some taxpayers. However, it would also impose a tax increase on the millions of taxpayers who currently take legitimate deductions for non-cash giving. Compliant taxpayers are likely to regard this approach as overly broad.
And here’s former National Taxpayer Advocate Nina Olson on the subject:
Equating the entire tax gap to “tax evasion” is just so disingenuous. And it’s also wrong; it’s incorrect. Evasion has a technical meaning under the law, and generally it requires mens rea, a criminal intent. So much of it is error, or inadvertent…there are a bunch of different types of noncompliance. And if you say [it’s all tax evasion] – and that’s what the Washington Post called it, that’s what the New York Times called it – then that creates distrust among the taxpayers of the tax agencies. [They’re asking], “why am I paying if you’re letting all these people off the hook?”
Her last point is critical, because there’s no free lunch with the tax gap. Our Tax Code has one of the highest tax compliance rates in the world (84 percent) but maintaining that high collection rate depends on the annual good-faith submission of tax returns by millions of taxpayers. Cynically inflating the tax gap problem to increase the IRS budget will reduce confidence in the system. So will turning 87,000 new auditors loose on Main Street.
The Main Street business community is still reeling from the worst global pandemic in a century. It’s also dealing with historic levels of inflation and an economy that’s contracted in the last two quarters. It’s time for lawmakers to focus on real solutions that help these businesses get back on their feet. The Inflation Reduction Act isn’t it.