Does the IRS somewhat encourage dirty money to be taxed? I'm guessing they would prefer to have it highly taxed but perhaps getting some tax is second best.

In New Zealand "Income that is earned from illegal activities needs to have tax paid on it." however they do try to deter money laundering, tax evasion and tax fraud.

In New Zealand it is getting harder to launder money because cash is not used as much as it used to be. Certainly a legitimate kebab shop should now receive the majority of their money as card payments. Few businesses here would have a majority of takings in cash.