While the Internal Revenue Service has issued a plan that adopts the IRS Oversight Board's goal of 86 percent voluntary compliance by 2009, National Taxpayer Advocate Nina Olson cautioned against IRS efforts to ramp up enforcement excessively and cut corners in its treatment of taxpayers if it is pressured to do too much too soon."For fiscal year 2008, both the Internal Revenue Service and the Taxpayers Advocate Service face similar challenges," she said, in the second of her two annual reports to Congress. "The IRS is under scrutiny for its efforts to close the tax gap, while the TAS is struggling to address taxpayer difficulties that arise as a result of these very efforts."
The IRS plan, its most comprehensive to date, sets out compliance objectives and initiatives in each of seven areas:
* Reducing opportunities for evasion;
* Making a multi-year commitment to research;
* Continuing improvements in information technology;
* Improving compliance activities;
* Enhancing taxpayer service;
* Reforming and simplifying the tax law; and,
* Coordinating with partners and stakeholders.
Although the report set the goal of 86 percent voluntary compliance by 2009, Senate Finance Committee Chairman Max Baucus, D-Mont., hopes to see a 90 percent compliance rate by 2017. "I am very encouraged [by the report], and I believe it is an important step toward fair and more efficient tax administration," he said.
IS IT ENOUGH?
Although the budget contained a number of proposals to close the gap, some observers were unimpressed.
"The proposals are probably a little modest," said former Federal Reserve Bank of Dallas economist Alan D. Viard.
The IRS report recognized that the overall compliance rate has been at or just below 85 percent for decades. The latest estimate of voluntary compliance - the amount of tax paid voluntarily and timely - was 83.7 percent for all taxes and all taxpayers for tax year 2001.
American Institute of CPAs' vice president for taxation Tom Ochsenschlager noted that close to half the gap is attributable to individuals with small businesses. "It's not people making mistakes or not understanding the code," he said. "It's become the industry norm in some small businesses. They almost have to do it to remain competitive."
He agreed with the recommendation for more cooperation between the federal government and state tax agencies. "In Europe, they match income with the value-added tax. Here in the U.S., it's surprising how many jurisdictions are accurate at collecting sales tax. If you tie that with more cooperation between the states and the federal government, it could go a long way."
E. Martin Davidoff, tax liaison chair of the American Association of Attorney-CPAs, noted the difference between underreporting and underpaying in the report's analysis of tax year 2001 data. The underreporting gap was $285 billion, while underpayment was $33.3 billion. "Underpayments are where they're collecting," he said. "To keep it at $33 billion, they've got most of the IRS out there [collecting]."
Most of the underreporting of individual income tax is associated with individuals who have business income, according to the report. The net misreporting percentage for non-farm proprietor income is calculated at 57 percent.
Meanwhile, a just-released study by the Government Accountability Office found that most sole proprietors underreported net business income for tax year 2001, but a small proportion of them accounted for the bulk of understated taxes.
National Federation of Independent Business tax counsel William Rys noted that the group's own survey showed that the complexity of the Tax Code is a huge issue for most of its members. "It's not only the complexity of the code itself, but of how you comply," he said.
Davidoff believes the underreporting gap for large corporations, estimated at $30 billion, is misleading. "I think it's a huge underestimate," he said. "When you compare that to the estimate for small business at $109 billion, it just seems out of proportion. Large business reports so much more revenue and expenses. These figures did not come from the NRP study, but from simply updating some old figures."
In fact, the report acknowledged that the corporate income tax estimates are weak because compliance behavior may have changed since the mid-1980s, which is the last time the IRS collected data on corporate compliance.
The $27 billion figure for non-filing is a gross understatement, according to Davidoff. "I think it's 10 times that," he said. "The IRS is doing a good job of collecting what they know is due, but on getting non-filers there's just not enough undercover work. ... The biggest problem is that Congress doesn't give the IRS a big enough budget."
Mel Schwarz, partner and director of tax legislative affairs for Grant Thornton, praised the IRS for taking steps to make it simpler for small businesses. "That's one way to approach the tax gap - not just put the hammer on people, but help them understand how they can comply and take steps within the system to make it practical to comply," he said.
MANAGING EXPECTATIONS
The report warned the IRS and the public to have "realistic expectations about the ... impact of any reasonable actions to reduce the tax gap, particularly if it is not accompanied by broader simplification and reform of the Tax Code."
Observers agreed with NTA Olson that trying to achieve too much may put undue pressure on taxpayers. "In many respects, we have a freshman Congress," said Paul Cinquemani, director for government relations at the National Association of Tax Professionals. "They think they found $290 billion and said, 'Let's go and collect it, it will solve a lot of our problems.'"
"Are there improvements that can be made?" he asked rhetorically. "Of course. Dramatic improvements? I doubt it."
