However,  other civil penalties have fixed dollar amounts, such as minimums or  maximums, which are not linked to a percentage of liability. Adjusting Civil Tax Penalties for Inflation May Increase IRS Assessments and Collections

Adjusting civil tax penalties for inflation on a regular basis to maintain  their real values over time may increase IRS assessments and collections. Based on our analysis, if the fixed dollar amounts of civil tax penalties  had been adjusted for inflation, the increase in IRS assessments potentially  would have ranged from an estimated $100 million to $320 million and the  increase in collections would have ranged from an estimated $38 million to  $61 million per year from 2000 to 2005, as shown in table 1. If the deterrent  effect of penalties depends on the real value of the penalty, the deterrent  effect of these penalties has eroded because of inflation. IRS officials from  all but one unit said that regularly updating the fixed dollar amounts of  civil tax penalties would not be a significant burden. Officials from one  relatively small office—the Office of Penalties—said that such adjustments  might be considerable depending on the number of penalties being  adjusted and would require a reprioritization of their work since their  office would have lead responsibility for monitoring the administrative  steps necessary to implement the adjustments and coordinating tasks  among a wide range of functions within IRS. In addition, the limited  number of tax practitioners we interviewed told us that the administrative  burden associated with adjusting these penalties for inflation on a regular  basis would be low. IRS has a variety of experiences that may provide guidance that would be  relevant to adjusting civil tax penalties with fixed dollar amounts for  inflation. Changes to the civil tax  penalty fixed dollar amounts could be handled in a similar manner. Concluding Observations

The real value and potential deterrent effect of civil tax penalties with  fixed dollar amounts has decreased because of inflation. Regularly adjusting  the fixed dollar amounts of civil tax penalties for inflation likely would not  put a significant burden on IRS or tax practitioners.
Why GAO Did This Study

Civil tax penalties are an important tool to encourage taxpayer compliance with the tax laws. A number of civil tax penalties have fixed dollar amounts--a specific dollar amount, a minimum or maximum amount--that are not indexed for inflation. Because of Congress's concerns that civil penalties are not effectively achieving their purposes, we agreed to (1) determine the potential effect of adjusting civil tax penalties for inflation on the Internal Revenue Service's (IRS) assessment and collection amounts and (2) describe the likely administrative impact of regularly adjusting civil tax penalties on IRS and tax practitioners. GAO examined IRS data on civil tax penalties and conducted interviews with IRS employees and tax practitioners.

What GAO Found

Adjusting civil tax penalties for inflation on a regular basis to maintain their real values over time may increase IRS collections by tens of millions of dollars per year. Further, the decline in real value of the fixed dollar amounts of civil tax penalties may weaken the deterrent effect of these penalties and may result in the inconsistent treatment of taxpayers over time. If civil tax penalty fixed dollar amounts were adjusted for inflation, the estimated increase in IRS collections would have ranged from $38 million to $61 million per year from 2000 to 2005. Almost all of the estimated increase in collections was generated by four penalties. These increases result because some of the penalties were set decades ago and have decreased significantly in real value--by over one-half for some penalties. According to those we interviewed, the likely administrative burden associated with adjusting the fixed dollar amounts of civil tax penalties for inflation on a regular basis would not be significant for IRS and would be low for tax practitioners. However, officials from the Office of Penalties, a relatively small office that would be responsible for coordinating the required changes among multiple IRS divisions, said that such adjustments might be considerable depending on the number of penalties being adjusted and would require a reprioritization of work. IRS officials said that the work required would be easier to implement with each subsequent update.