The IRS Under Siege: How Trump Policies Could Cost the U.S. Treasury $1 Trillion by 2025

The U.S. tax system is facing an existential threat—one that could cost taxpayers over $1 trillion by 2025, according to economist Larry Summers. The root cause? A combination of politicization, underfunding, and a deliberate erosion of the IRS’s enforcement capabilities. This crisis has profound implications for federal revenue, economic stability, and investor confidence.

The Tax Gap: A $1 Trillion Loophole

The “tax gap”—the difference between taxes owed and those collected—has ballooned to $606 billion in 2022, according to IRS data. Summers warns this could surpass $1 trillion by 2025 if current trends persist. The problem isn’t just underpayment but a systemic breakdown in enforcement.

The IRS’s ability to audit and pursue delinquent taxpayers has been crippled by relentless budget cuts. Over the past decade, its workforce has shrunk by 40% (from 100,000 to ~60,000 employees), with layoffs disproportionately hitting audit divisions. This has created a “race to the bottom,” where high-income individuals and corporations exploit reduced scrutiny to underreport income.

The Politicization Problem

Summers’ most scathing critique targets the weaponization of the IRS by the Trump administration. Threats to revoke Harvard’s tax-exempt status over political disagreements and requests to audit political foes (e.g., Mike Lindell of MyPillow) have undermined the agency’s neutrality. Summers argues that any Treasury Secretary complicit in such actions should resign, calling it a betrayal of institutional integrity.

The fallout extends beyond ethics. A workforce demoralized by partisan interference is less effective at core functions like collecting taxes. Meanwhile, the administration’s focus on slashing IRS funding while cutting corporate tax rates has created a perverse incentive: reduced enforcement means less revenue to fund public services, even as loopholes grow.

Trade Wars and Economic Headwinds

The $1 trillion revenue hole isn’t the only storm on the horizon. The IMF warns that President Trump’s tariffs could slash U.S. GDP growth to 1.8% in 2025, down from 2.8% in 2024. This slowdown reduces tax receipts from corporate profits and consumer spending, compounding the IRS’s revenue shortfall.

Legal and Market Risks

A lawsuit challenging Trump’s use of emergency powers to impose tariffs may add further uncertainty. Legal experts argue that invoking the International Emergency Economic Powers Act (IEEPA) for trade wars exceeds presidential authority, potentially invalidating tariff revenue. If courts side with plaintiffs, the administration could face a double whammy: lost tariff revenue and a weakened case for future policies.

The Investment Case: Prepare for Volatility

For investors, the risks are multifaceted:
1. Equity Markets: A shrinking tax base could force fiscal austerity or higher borrowing, pressuring sectors like healthcare and infrastructure.
2. Treasuries: Bond yields may rise as investors demand higher returns for inflation and default risks tied to lower revenue.
3. Dollar Decline: Persistent trade deficits and geopolitical instability could weaken the U.S. dollar, favoring commodities or foreign equities.

Conclusion: A $1 Trillion Wake-Up Call

The $1 trillion tax gap isn’t just a fiscal crisis—it’s a political one. Summers’ warnings highlight a system at risk of collapse, with consequences extending far beyond budgets. The data is clear: every 1% reduction in IRS staff correlates with a $20 billion increase in the tax gap, per Tax Policy Center estimates.

Investors should brace for volatility in 2025. Sectors reliant on stable government funding—like defense contractors or public utilities—could face delays or cuts. Meanwhile, companies with exposure to trade wars (e.g., automakers, tech firms) face margin pressures.

The ultimate test lies in whether Congress can depoliticize the IRS and reinvest in enforcement. If not, the $1 trillion shortfall could become a $2 trillion reality—a stark reminder that trust in institutions isn’t just philosophical; it’s economic.

Data sources: IRS, IMF, Tax Policy Center, Institute on Taxation and Economic Policy.