	The Tax Gap Is Spread across Various Types of Taxpayers and Taxes

		Characteristics of the Tax Gap

The gross tax gap has grown in dollar terms since IRS’s previous  estimate for tax year 2001, increasing from $345 billion to $450 billion for  tax year 2006. However, given the growth of the economy and total  federal tax liability over that period, the percentage of taxes owed that  taxpayers paid voluntarily and on time, known as the voluntary  compliance rate, has remained relatively constant—83.7 percent in 2001  and 83.1 percent in 2006. For example, in general, refund fraud related to identity theft would  not be included in the tax gap estimate because it does not involve  evading a tax liability. As shown in table 1,  noncompliance does not come from a single source but rather occurs  across different types of taxes and taxpayers. However, corporate income tax and employment tax also contributed a  significant portion. Nearly 40 percent, or  $179 billion, of the 2006 gross tax gap can be attributed to these types of  business taxpayers who underreport their business income tax, and by  extension their self-employment tax, on their individual income tax  returns. For example, misreporting of non-corporate business  income tax can be largely attributed to sole proprietors who understated  receipts or overstated expenses. Unlike wage and some investment income, sole proprietors’  income is not subject to withholding and only a portion is subject to  information reporting to IRS by third parties. As shown in figure 1, the extent to which individual taxpayers accurately  report their income is related to the extent to which the income is reported  to them and IRS by third parties or taxes on the income are withheld. Various Strategies Are Required to Reduce the Tax Gap

Multiple approaches are needed to reduce the tax gap. No single  approach is likely to fully and cost-effectively address noncompliance  since the noncompliance has multiple causes and spans different types of  taxes and taxpayers. While the tax gap will remain a challenge into the  future, the following strategies could help. These strategies would require  actions by Congress or IRS. Enhancing Information Reporting by Third Parties to IRS

Information reporting is a powerful tool that reduces tax evasion and  helps taxpayers comply voluntarily. Considerations include whether any third parties have accurate  information available in a timely manner, the burden of reporting on the  third parties, and whether IRS can enforce the reporting requirement. Ensuring High-Quality Services to Taxpayers

Ensuring high-quality taxpayer services, such as by telephone and  correspondence or online, can help taxpayers who wish to comply with  tax laws but do not understand their obligations. Tax law changes and other funding priorities have affected IRS’s ability to  provide quality taxpayer services. Devoting Additional Resources to Enforcement

Devoting additional resources to enforcement would enable IRS to  contact millions of potentially noncompliant taxpayers that it currently  identifies but cannot contact given resource constraints. However,  determining the appropriate level of enforcement resources to provide  IRS requires taking into account factors such as how effectively and  efficiently IRS is currently using its resources, how to strike the proper  balance between IRS’s taxpayer service and enforcement activities, and  competing federal funding priorities. The intent  is to allow IRS to match those information returns to tax returns during tax  return filing season rather than after the filing season is complete.will be discussed later, this approach could also help IRS address identity  theft-related fraud and could also allow IRS to use its enforcement  resources on other significant compliance problems. However, the  Commissioner made clear that his vision for more prerefund compliance  checks will take considerable time to implement, will require a major  reworking of some fundamental IRS computer systems, and could impose  some additional burden on third parties. Paid tax return preparers prepare approximately 60 percent of all tax  returns filed, and IRS has acknowledged that paid preparers’ actions  have an enormous impact on its ability to administer tax laws  effectively. Tax whistleblowers can help improve tax compliance by providing  information to IRS on others’ suspected tax noncompliance. According to IRS officials,   Among other benefits, replacing its electronic filing system will  posting more comprehensive information from individual income tax  returns to its computer systems could facilitate the examination process,  expedite taxpayer contacts for faster resolution, and potentially better  define specific tax gap issues. Efforts to simplify or  reform the tax code may help reduce the tax gap by making it easier for  individuals and businesses to understand and voluntarily comply with  their tax obligations. For example, eliminating or combining tax  expenditures, such as exemptions, deductions, and credits, could help  taxpayers reduce unintentional errors and limit opportunities for tax  evasion.
Why GAO Did This Study

In January 2012, IRS estimated that the gross tax gapthe difference between taxes owed and taxes paid on timewas $450 billion for tax year 2006. IRS estimated that it would collect $65 billion through enforcement actions and late payments, leaving a net tax gap of $385 billion. From 2001 to 2006, IRS estimated that the gross tax gap increased by $105 billion. However, the percentage of taxes owed that were paid on time remained relatively constant at 83.1 percent in 2006, compared to 83.7 percent in 2001.
Given persistent levels of noncompliance and large and growing structural deficits, it will be important to understand the causes of tax noncompliance and develop new approaches to minimize it.
This testimony addresses two questions: (1) What types of taxpayers are responsible for the tax gap, and what is the nature of their noncompliance? (2) What are strategies for reducing the tax gap? The statement also discusses potential long-term strategies to prevent refund fraud related to identity theft. This statement is based largely on GAOs recent reports and recommendations on tax noncompliance and updates GAOs 2011 testimony on the tax gap.

What GAO Found

Noncompliance does not have a single source but occurs across different types of taxes and taxpayers. For example, individual income tax accounts for the largest portion of the tax gap, but corporate income tax and employment tax are also significant. Further, misreporting by individuals involves business income, non-business income, deductions, and credits. The extent of misreporting depends on the extent to which income tax is withheld or reported to the Internal Revenue Service (IRS) by third parties. For example, nearly 40 percent, or $179 billion, of the 2006 gross tax gap is due to misreporting of non-corporate business income and related self-employment taxes. Much of this misreporting can be attributed to sole proprietors underreporting receipts or over-reporting expenses. Unlike wage and some investment income, sole proprietors income is not subject to withholding and only a portion is reported to IRS by third parties.
Because noncompliance has multiple causes and spans different types of taxes and taxpayers, multiple approaches are needed to reduce the tax gap. The following strategies could help and will require actions by Congress or IRS.
Enhancing information reporting by third parties to IRS could reduce tax evasion and help taxpayers comply voluntarily. However, identifying additional reporting opportunities can be challenging because third parties may not have accurate information available in a timely manner. Also, adding reporting requirements creates burden for both third parties and IRS.
Ensuring high-quality services to taxpayers , such as by telephone and correspondence or online, can help taxpayers who wish to comply with tax laws but do not understand their obligations. However, tax law changes and funding priorities have recently affected IRSs ability to provide quality taxpayer services.
Devoting additional resources to enforcement would enable IRS to contact millions of potentially noncompliant taxpayers it identifies but cannot contact. To determine the appropriate level of enforcement resources, policymakers would need to consider how to balance taxpayer service and enforcement activities and how effectively and efficiently IRS currently uses its resources.
Expanding compliance checks before IRS issues refunds would involve matching information returns to tax returns during, rather than after, the tax filing season. This approach would require a major reworking of some fundamental IRS computer systems but could help address identity theft-related fraud and allow IRS to use enforcement resources on other compliance problems.
Leveraging external resources, such as paid tax return preparers and whistleblowers , can help improve tax compliance because paid preparers actions have an enormous impact on IRSs ability to effectively administer tax laws, and whistleblowers provide IRS information on suspected noncompliance.
Modernizing information systems would allow IRS to post more comprehensive tax return information to its computer systems, which could facilitate the examination process and expedite taxpayer contacts for faster resolution.
Simplifying the tax code could help taxpayers understand and voluntarily comply with their tax obligations and limit opportunities for tax evasion.

What GAO Recommends

GAO has made numerous prior recommendations regarding actions to close the tax gap. Congress and IRS have acted on some, while others are reflected in the strategies presented in this testimony.