	Background

In January 2012, IRS estimated that the gross tax gap—the difference  between taxes owed and taxes paid on time—was $450 billion in tax year  2006. These audits are targeted at individual  returns with broader and more complex issues. IRS spent almost 20 percent of the $1.6 billion per year that it devoted to  exams opened in 2007 and 2008 on returns with positive income of at  least $200,000, even though such returns accounted for only 3 percent of  the 136 million individual income tax returns filed per year. 2.) Direct Revenue Return on Investment Was Highest for Examinations of Taxpayers with at Least $200,000 in Positive Income

For the 2 years of cases we reviewed, exams (both correspondence and  field) of taxpayers with positive incomes of at least $200,000 produced  significantly more direct revenue per dollar of cost than exams of lower- income taxpayers. Across income groups, correspondence exams were  significantly more productive than field exams in terms of discounted  direct revenue per dollar of cost. In contrast, the  average direct yield per dollar for field exams of individual taxpayers was  $1.8. Although Some Caution is Warranted, Exam Resource Reallocation Could Produce Significant Direct Revenue Gains

		Modest Reallocations Might Raise Billions of Dollars in Direct Revenue with Little, If Any, Decline in Voluntary Compliance

Our analysis of a hypothetical reallocation of IRS examination resources  for this 2-year period indicates that a shift of about $124 million in  enforcement resources could have increased direct revenue by $1 billion  over the $5.5 billion per year IRS actually collected. The result holds true as long as the  average ratio of direct revenue to cost for each category of returns  remained unchanged. Similar gains would recur annually,  relative to the revenue that IRS otherwise would collect if it did not  change its resource allocation and taxpayer behavior remained  substantially the same. As shown in figure 5, our hypothetical reallocation  would have increased combined coverage rates in most of the tax return  categories we examined. These activities impose compliance costs on taxpayers and economic  efficiency costs on society. Recommendations

To better ensure that IRS’s limited enforcement resources are allocated in  a manner that maximizes the revenue yield of the income tax, subject to  other important objectives of tax administration, such as minimizing  compliance costs and ensuring equitable treatment across different  groups of taxpayers, the Commissioner of Internal Revenue should:  review disparities in the ratios of direct revenue yield to costs across  different enforcement programs and across different groups of cases  within programs and determine whether this evidence provides a  basis for adjusting IRS’s allocation of enforcement resources each  year. GAO staff who made major contributions to this report  are listed in appendix V.

Appendix I: Summary Methodology for Data Analysis

Our principal analysis compares the costs and direct revenues associated  with correspondence and field exams that were opened during fiscal  years 2007 and 2008 across the principal categories of individual  taxpayers that the Internal Revenue Service (IRS) uses for exam planning  purposes. Compliance burden.
Why GAO Did This Study

Heightened attention to federal deficits has increased pressure on IRS to reduce the tax gap--the difference between taxes owed and taxes paid on time--and better enforce taxpayer compliance. Resource limitations and concern over taxpayer burden, however, prevent IRS from auditing more than a small fraction of individual income tax returns filed. How IRS allocates these limited resources demands careful consideration.
As requested, this report (1) describes how IRS allocates resources across individual taxpayer compliance enforcement programs and across types of taxpayers within each program; (2) estimates the direct revenue return on investment for the individual taxpayer enforcement programs and the extent of variation across those programs and across types of taxpayers; and (3) determines the potential for gains from shifting resources from lower-yielding programs and types of taxpayers to higher-yielding ones.
To accomplish these objectives GAO analyzed IRS data on 2007 and 2008 tax returns, reviewed IRS documentation, and interviewed appropriate IRS officials.

What GAO Found

The Internal Revenue Service (IRS) spends most of its enforcement resources on examinations. Correspondence exams of individual tax returns, which target fewer and simpler compliance issues, are significantly less costly on average than the broader and more complex field exams. GAO estimated that the average cost (including overhead) of correspondence exams opened in 2007 and 2008 was $274, compared to an average of $2,278 for field exams. IRS spent almost 20 percent of the $1.6 billion per year that it devoted to exams on returns from taxpayers with positive income of at least $200,000, even though such returns accounted for only 3 percent of the 136 million individual returns filed per year. (Positive income, a measure that IRS uses to classify returns for exam planning purposes, disregards losses that may offset this income).
GAO estimated that, for the 2 years of cases reviewed, correspondence exams were significantly more productive in terms of direct revenue produced per dollar of cost than field exams. Both types of exams of taxpayers with positive incomes of at least $200,000 were significantly more productive than exams of lower-income taxpayers.
GAO demonstrated how these estimates could be used to inform resource allocation decisions. For example, a hypothetical shift of a small share of resources (about $124 million) from exams of tax returns in less productive groups shown in the figure to exams in the more productive groups could have increased direct revenue by $1 billion over the $5.5 billion per year IRS actually collected (as long as the average ratio of direct revenue to cost for each category of returns did not change). These gains would recur annually, relative to the revenue that IRS would collect if it did not change its resource allocation. This particular resource shift would not reduce exam coverage rates significantly and, therefore, should have little, if any, negative effect on voluntary compliance.

What GAO Recommends

GAO recommends that IRS review disparities in the ratios of direct revenue yield to costs across different enforcement programs and across different groups of cases and consider this evidence as a potential basis for adjusting its allocation of enforcement resources each year. IRS agreed with the recommendations.