The Internal Revenue Service recently estimated that the 2001 tax gap ranged from $312 billion to $353 billion. Although the IRS said that it would eventually recoup some of that shortfall, it still leaves a huge net tax gap that the IRS sets at between $257 billion and $298 billion.Previous estimates of the tax gap relied on research conducted for tax years 1988 and earlier. The National Research Program, which examined 2001 returns, was completed in the fall of 2004, and provided the data that the IRS now uses to project estimates of the tax gap. The study found that underreporting of income is the largest component of the tax gap, accounting for more than 80 percent of the total. Non-filing and underpayment account for about 10 percent each.
Long-term budget simulations show large and growing structural deficits due to known demographic trends and rising health care costs, according to the Governmental Accountability Office.
In recent testimony before the Senate Subcommittee on Federal Financial Management, Government Information, and the International Security Committee on Homeland Security and Governmental Affairs, GAO director of strategic issues Michael Brostek, discussed the GAO's tax gap report.
He noted that reducing the difference between what taxpayers timely and accurately pay in taxes and what they should pay under the law could help the nation cope with long-term fiscal challenges. "For example, based on the IRS's most recent estimate, each 1 percent reduction in the net tax gap would likely yield more than $2.5 billion annually," he said. "Thus, a 10 percent to 20 percent reduction of the net tax gap would translate into from $25 billion to $50 billion or more in additional revenue annually."
Brostek highlighted four major points in his testimony:
* Reducing the current tax gap would contribute to our fiscal sustainability while simultaneously improving fairness for those citizens who fully meet their tax obligations, but it must be done with multiple strategies over a sustained period.
* Regularly measuring the extent and nature of noncompliance is critical to effective efforts to reduce the tax gap, given changes in the economy and tax law, but the IRS does not have approved plans, with one exception, for obtaining and maintaining more current compliance data covering the various components of the tax gap beyond tax year 2001.
* Collecting data on the reasons why noncompliance occurs can help the IRS more effectively tailor its efforts to improve compliance. However, the IRS has no specific plans to gather better data than it already collects.
* The IRS's strategies for improving compliance do not have the clear focus on quantitative long-term goals and results measurement that are associated with high-performing organizations and that are incorporated into the statutory management framework that Congress has adopted.
A complicated fight
The GAO report recommended that the tax gap be attacked on multiple fronts and with multiple strategies over a sustained period of time. Brostek said that such strategies could include simplifying the tax code, providing quality service to taxpayers, and enhancing enforcement of tax laws by using tools such as tax withholding and information reporting.
He singled out withholding tax from payments to taxpayers and having third parties report information to the IRS and the taxpayers on income paid to taxpayers. These tools, in particular, have been shown to lower levels of noncompliance, according to the GAO.
"For example, banks and other financial institutions provide information returns [Forms 1099] to account holders and the IRS showing the taxpayer's annual income from some types of investments," Brostek said. "Similarly, most wages, salaries and tip compensation are reported by employers to employees and the IRS through Form W-2. Preliminary findings from [the National Research Program] indicate that more than 98.5 percent of these types of income are accurately reported on individual returns."
Brostek suggested the following as areas where additional withholding or information reporting requirements could serve to improve compliance:
* Require tax withholding and more or better information-return reporting by organizations that make payments to independent contractors for services provided.
* Require information-return reporting on payments made to corporations for services provided.
* Require that information returns dealing with capital gain income report the purchase price, or other cost basis data, as well as the sales price for stocks and bonds.
"Such additional requirements generally impose costs and burdens on the businesses that must implement them," he said. "However, continued examination of opportunities to expand information reporting and tax withholding has the potential to increase the transparency of the tax system and the level of compliance."
Looking for answers
A lasting solution to the tax gap will take a considerable amount of time and resources.
"Confronting the nation's long-term fiscal challenge will require nothing less than a fundamental review, re-examination and reprioritization of all major spending and tax policies and programs that may take a generation or more to resolve," Brostek said.
But failure to address the problems inherent in the tax gap will pose a threat to our economy, our standard of living, and ultimately our national security, he told the subcommittee.
"Our current path also will increasingly constrain our ability to address emerging and unexpected budgetary needs and increase the burdens that will be faced by our children, grandchildren and future generations. While our long-term fiscal imbalance cannot be eliminated with a single strategy, reducing the tax gap should be one part of a broader effort to repair the nation's fiscal health," he said.
The president of the National Treasury Employees Union, Colleen M. Kelley, told the subcommittee that if the IRS wants to close the nation's tax gap, it needs more employees on the front lines of both tax compliance and enforcement.
"Rather than move forward with its plans to drastically cut customer service in order to expand its enforcement role, the IRS needs to strike a balance between offering adequate opportunities for taxpayers to voluntarily comply and enforcing the tax code," she said.
"Effective customer service is one-half of the compliance equation," she told the subcommittee. The IRS "must not be allowed to slash customer service this year, or next, for the sake of bolstering enforcement."
Meanwhile, there are those who believe that the idea of a tax gap is not a bona fide issue.
"To some extent, the tax gap has always been an artificial concept, because the calculations to reduce it always exclude the negative dynamic effects of any new collections devices," said George Pieler, former tax counsel to the Senate Finance Committee.
"The tax gap, at least to some extent, is an artifact of the complexity of the tax code, and the best way to reduce it is to reduce tax rates and special tax breaks, credits and exemptions, which allow people to game the system."
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