Report Date: April 13, 2003

  Criminal Enforcement In Shambles

Criminal enforcement of the nation's tax laws by the IRS has plummeted to an all time low, according to an analysis of very timely Justice Department data obtained by the Transactional Records Access Clearinghouse (TRAC).

Tax prosecutions brought as a result of IRS investigations currently are running at about half of what they were only ten years ago. (See graph.) This sharp decline has continued at the same time that the nation has been swept by a flood of reports about corporate crime studded with such names as Enron, Arthur Anderson, WorldCom, Adelphi Communications and Health South.

The apparent surge in white collar crime -- which mostly came into public view in 2002 -- may have played a role in the estimated $5 trillion loss in the market value of stocks, the trashing of the pensions and lifetime savings of millions of investors, pensioners and workers and the prosecution of scores of high level executives.

It also prompted President George Bush to travel to Wall Street last summer to announce the launching of what he said was a broad new federal program "to expose and punish acts of corruption, move corporate accounting out of the shadows and protect small investors and pension holders."

In his July 9, 2002 speech, the president said that the "misdeeds now being uncovered in some corners of corporate America are threatening the financial well-being of many workers and investors. At this moment, America's greatest economic need is higher ethical standards -- standards enforced by strict laws and upheld by responsible business leaders."

Curiously, however, government records show that the criminal investigators of the IRS -- long considered the government's most sophisticated team of financial fraud sleuths -- apparently did not get the word. In addition, other records show that the Bush Administration did not include the tax agency in its new plan to "punish those who refuse to play by the rules..."

Here are some highlights:

• In FY 1993, the Justice Department credited the IRS with being the lead agency for 1,064 tax prosecutions. In FY 2002, there were 512 such prosecutions, about half of the 1993 total. If current trends continue, annual tax prosecutions may fall as low as 360 based upon data covering the first four months of FY 2003. (See graph and table.)
• Criminal prosecutions for nontax crimes where IRS was the lead agency - drug offenses, money laundering, currency violations, etc. - have also collapsed from 1,705 in FY 1993 down to 667 for FY 2002. (See graph and table.)
• Civil suits filed by the IRS in federal courts - according to reports from the U.S. Attorneys -- dropped off even more sharply, from 2,172 in FY 1993 to 575 in FY 2002. (See graph and table.)
• The Justice Department data show that despite the concerns expressed by President Bush in the summer of 2002, securities fraud prosecutions brought each year on the basis of IRS investigations were minimal: 10 in 1993, 6 in 1994, 4 in 1995, 2 in 1996, 7 in 1997, 6 in 1998, 22 in 1999, 12 in 2000, 9 in 2001 and 10 in 2002.

The collapse of IRS criminal and civil enforcement actions brought in district court do not appear to be explained by changes in IRS staffing levels. While there have been some recent ups and downs, IRS figures show staffing for tax fraud and financial investigations today are about the same a decade ago when criminal prosecution levels were much higher. In 1990 there were 2,794 IRS criminal investigators employed; in 2002 there were 2,907. (See graph and table.)

The downward trends in criminal tax prosecutions are not a recent phenomena but an extension of long-term trends that have continued for at least two decades. In 1980 tax prosecutions were 1,680 - three to four times higher than current levels. (See table.)

 Corporate Responsibility and the Bush Administration

Over the past decade IRS's use of its arsenal of administrative penalties for serious corporate violators - those for civil fraud and negligence - have, despite the booming economy of those years, also collapsed:

• In FY 1993, according to IRS figures, there were 2,376 negligence penalties assessed against corporate violators. By FY 2002, only 22 such penalties were assessed. (See graph and table.)
• The total number of corporate fraud penalties assessed in FY 2002, according to the IRS, was only 159, down from 555 ten years earlier in FY 1993. (See graph and table.)

The centerpiece of President Bush's plan to combat what many believe was a business crime wave was the creation of a new Corporate Fraud Task Force. Headed by the Deputy Attorney General, the other members of the new Justice Department task force include the FBI director, the assistant attorneys general in charge of the department's criminal and tax divisions and six U.S. Attorneys. An interagency group working with the task force includes the Secretary of the Treasury, the chairman of the Securities and Exchange Commission (SEC) and the Chief Inspector of the United States Postal Inspection Service.

Noticeably absent from both the Corporate Task Force and the Task Force's interagency group -- according to a membership list on the Justice Department's web site -- is the IRS. The tax agency now has almost three thousand criminal tax investigators and for many decades was considered the government's most effective investigative arm when it came to uncovering serious financial crimes.

The failure of the Bush Administration to include the IRS in its special enforcement team is puzzling. Although one aspect of the administration's new corporate crime program involved a request for extra funds to hire additional SEC enforcement officers, the IRS as of several months ago had 19 times more investigators than the SEC. Also surprising is that despite the request to strengthen the SEC, information from the Office of Personnel Management shows a recent month-by-month decline in the number of SEC investigators agents -- 185 in December of 2001, 183 in March of 2002, 179 in June of 2002, 154 in September of 2002 and 151 in December of 2002.

 Going After The Little Guys

But even if the Bush Administration had chosen to send in the most experienced IRS criminal investigators to man the front lines in its war against big-time corporate fraud, it is not clear how well they would have done.

The question is highlighted by a special TRAC study suggesting that the tax agency recently appears to have had little direct experience in investigating possible criminal activities of major corporations. In seeking to gather more complete information about those who were in fact charged with criminal violations as a result of IRS investigations, TRAC examined the public records that we could locate concerning every criminal case concluded during a single month -- January of 2003 -- that the Justice Department credited to the IRS. While TRAC's search of court and newspaper records was not always successful, for those cases where additional information was found, not one of them appeared to come even close to involving a Fortune 500 company. For example:

• Rosalind Johnson was convicted in the Northern District of Georgia of preparing false income tax returns by systematically inflating the charitable donations of individual taxpayers.
• Dexter Lamar Anderson, a sales representative for the Lorillard Tobacco Co., was found guilty in the Western Louisiana federal court of filing false income tax returns. The charge against Anderson related to funds he had embezzled from the company.
• Dinart Serpa, who owns four Dunkin Donut franchises in Massachusetts, was sentenced in federal court for filing false income tax returns in connection with an illegal rebate scheme with a North Shore dairy.
• Aurora Trevino, the owner of a wholesale flower company in California, was convicted on charges surrounding the failure to pay about $70,000 in taxes.
• Daryl E. Montgomery, a convicted and imprisoned murderer, was convicted for a second time for participating in a scheme in which bogus tax returns claiming almost a $1 million in refunds were filed with the IRS.

Tax fraud is always a serious crime and none of these cases was necessarily unimportant. At the same time, however, it can fairly be said that TRAC's search of court and newspaper records concerning 79 IRS matters disposed of in federal district court in January did not find a single one aimed at what might be considered big time corporate criminality.

 A Weakened Early Warning System

IRS audits of business partnerships, S-corporations and fiduciary trusts -- financial arrangements known to the agency as "pass through entities" -- have for many years served as an effective tool for identifying all kinds of serious tax fraud, civil and criminal. Though the audits of these entities are valuable in their own right, they also have helped the IRS spot the knowing tax fraud schemes that can appropriately be attacked with criminal prosecutions.

In a report last September to the IRS Oversight Board, the outgoing commissioner, Charles O. Rossotti, expressed concern that more and more of the pass through entities were not being audited. Five years ago, he said, almost 6 out of every thousand partnerships, S-corporations and fiduciaries were subject to an exam. In FY 2001, only 3 out of every thousand in this special group were audited. He noted that in a recent year entities filing these kinds of returns reported gross revenue of $6 trillion and incomes to the partners and shareholders of more than $660 billion. (See graph and table.)

In addition to documenting the long-term growth in the number of tax returns being filed each year, Commissioner Rossotti also noted that the tax revenue stream of the nation has now become "dominated by sources that provide greater opportunities for manipulation by those who wish to take advantage in the decline of IRS compliance resources."

 Bigger Problems, Less Information

During the last few years, the IRS was one of the most open enforcement agencies in the world. Based partly on the belief that taxpayers would be more willing to pull their load when they understood what the tax collectors were up to, Commissioner Rossotti adopted a general policy of providing very detailed information about the operations of the agency to anyone who asked for it. There is some evidence that Commissioner Rossotti's open book policy contributed to a gradual improvement in public support for the IRS. There is no question, however, that the policy also resulted in the disclosure of embarrassing problems demanding correction. Why, for example, were low income taxpayers audited at a higher rate than wealthier taxpayers? Why, for another example, were the largest corporations with headquarters in northern New York subject to vastly more audits than similar corporations in Delaware? As a result of the disclosure of these and other kinds of problems, Congressional hearings were held, newspaper articles were published and the IRS itself sought to confront the apparent shortcomings that became visible because of agency's unusual openness.

On March 26, 2003 former Commissioner Rossotti's open door policy seemed to come to an end when Eric Toder, director of the IRS's Office of Research and Analysis, informed TRAC that this year the agency would not provide most of the information that it has readily made available since 1998. Toder's abrupt announcement came after almost a year of discussions in which the agency had appeared to indicate the Rossotti approach to information disclosure would be continued.

Although the availability of information from other sources such as the Executive Office for United States Attorneys and the IRS Oversight Board means that the public, Congress, and tax scholars will continue to find useful data on TRAC's free IRS web site, if the recent action of the Research Analysis and Statistics Office is not reversed, it will have a long-term negative impact on the availability of comprehensive information about the actual functioning of the IRS.

 The Past is not Always the Prologue

It is not known why tax fraud prosecutions based on IRS investigations have continued to collapse or why the Bush Administration did not sign the IRS as an active member in its Corporate Fraud Task Force. But it is known that American presidents going back for more than 70 years have from time to time called on the IRS when they saw the need for effective investigators. For example:

• One of the IRS' most famous, most difficult and most successful investigations got under way in the late 1920s when President Herbert Hoover decided that the Chicago gangster Al Capone's powerful crime syndicate had to be stopped. Hoover personally ordered the IRS to go to work. On October 24, 1931, as a result of what is widely acknowledged as a brilliant investigation, Capone was sentenced to eleven years in prison for failing to pay more than $300,000 in back taxes and penalties.
• A few years later, again as the result of a brilliant IRS investigation, Thomas Pendergast, the corrupt political boss of Kansas City, Mo., pleaded guilty to tax evasion and was sentenced to 15 months in prison.
• In the early 1940s, in an effort to deprive our World War Two enemies of resources, the IRS was asked to lead a program to locate and freeze the funds belonging to German and Japanese aliens then living in the United States. As a result of its work, President Roosevelt in 1942 congratulated the head of criminal investigating unit for its incorruptibility and "A-1 efficiency."
• In 1945, Cincinnati businessman Robert Gould, the multimillionaire president of a national restaurant chain, and New Yorker Henry Lustig, were sentenced to six and four years imprisonment after their conviction on tax fraud charges.
• The dismantling of organized crime groups was given a high priority in 1960 when John F. Kennedy became president and Robert F. Kennedy became attorney general. Partly because of the FBI's long-standing reluctance to take on the Mafia, the Kennedy brothers called upon the IRS to play a lead role in their long-term campaign to weaken the political and economic power of mob organizations in a number of major cities.
• Spiro Agnew, the vice president of the United States, was forced to resign after pleading guilty in 1973 to one count of tax evasion.
• Marc Rich, an international financier, was indicted on charges of evading $48 million in taxes in 1983 and fled the country. President Clinton, in one of his last acts in office, pardoned him.
• In December of 1983, Rudolph W. Giuiliani, then the U.S. Attorney in the Southern District of New York (Manhattan), announced the indictment of five men on charges they had supplied investors with more than $130 million in false income tax deductions through fraudulent securities trades. The case was said to have been the biggest criminal tax fraud case ever brought by the government up to that time and involved trades in securities that Giuliani said were "bogus, prearranged, fictitious and manipulated."
• Leona Helmsley, the wealthy hotel executive, was convicted in 1989 of evading $2.5 million in taxes over three years. She was sentenced to two years in prison and fined $7 million.

 Administrative IRS Enforcement Starts to Recover

After many years of precipitous decline, the use of three of the agency's basic enforcement mechanisms has slowly begun to climb. In FY 1993, for example, the IRS filed 2.6 million levies. In 2000, the agency filed only 219,778 levies, about one tenth of that previous high. Very recently, the use of levies has begun to slowly increase, 447,201 in FY 2001 and 667,000 in 2002. The decline in liens was slightly less precipitous, 959,356 in 1993, 167,867 in 1999. Once again there has been a turnaround in last few years, 428,379 in 2001, 492,000 in 2002. Of the three basic IRS enforcement tools, the drop in the application of its basic seizure authority was sharpest, almost completely disappearing from the IRS repertory: 9,626 in 1993, 161 in 1999. For the last two years seizures went to 255 in FY 2001 and then to 364 in 2002. (See graph and table.)

The agency's overall audit rates for individuals and corporations, while extremely low, no longer appear to be declining. In 2002 -- the rate of service center audits and district audits for individuals was only a fraction of above one half of one percent (0.57%). This compares with a 0.58% rate in FY 2001. These rates for individual taxpayers are substantially below what they were in the early 1990s. (See graph and table.) Similarly, regular corporate audit rates (0.88% in FY 2002 versus 0.89% in FY 2001) - are only one third what they were just a decade ago. (See graph and table.)

In September 2002, the outgoing IRS Commissioner submitted a report to the IRS Oversight Board presenting his view of the overall position of the IRS and its ability to enforce the tax laws. While Mr. Rossotti saw some hopeful signs, his overall judgement was troubling. The cumulative agency trends of the previous ten years, he said, have created "a huge gap between the number of taxpayers whom the IRS knows are not filing, not reporting or not paying what they owe and our capacity to require them to comply."