	Long-term Fiscal Challenge Provides Impetus to Reexamine Tax Policies and Compliance

The federal government’s financial condition and long-term fiscal outlook  present enormous challenges to the nation’s ability to respond to emerging  forces reshaping American society, the United States’ place in the world,  and the future role of the federal government. Absent policy changes on the spending  and/or revenue sides of the budget, a growing imbalance between  expected federal spending and tax revenues will mean escalating and  eventually unsustainable federal deficits and debt that will threaten our  future economy, standard of living, and, ultimately, our national security. GAO’s long-term simulations illustrate the magnitude of the fiscal  challenges associated with an aging society and the significance of the  related challenges the government will be called upon to address. Underreporting Accounted for Most of the Tax Gap Estimate

The tax gap is an estimate of the difference between the taxes—including  individual income, corporate income, employment, estate, and excise  taxes—that should have been timely and accurately paid and what was  actually paid for a specific year. The estimate is an aggregate of estimates  for the three primary types of noncompliance: (1) underreporting of tax  liabilities on tax returns; (2) underpayment of taxes due from filed returns;  and (3) nonfiling, which refers to the failure to file a required tax return  altogether or timely. Employment tax underreporting accounted for an estimated $54 billion, or  about 16 percent, of the 2001 tax gap and included several taxes that must  be paid by self-employed individuals and employers. IRS’s overall approach to reducing the tax gap consists of improving  service to taxpayers and enhancing enforcement of the tax laws. Reducing the Tax Gap Will Require Expanding Existing Approaches and Considering New Legislative Actions

Given its persistence and size, we need not only to consider expanding  current approaches but also explore new legislation to help IRS in  reducing the tax gap. For example, based on IRS’s most recent  estimate, each 1 percent reduction in the net tax gap would likely yield  nearly $3 billion annually. However, reducing the tax gap will be challenging and it must be  attacked on multiple fronts and with multiple strategies, some of which  follow. Simplify the Tax Code

Efforts to simplify the tax code and otherwise alter current tax policies  may help reduce the tax gap by making it easier for individuals and  businesses to understand and voluntarily comply with their tax  obligations. Requiring more data on information returns dealing with capital  gain income. However,  continued reexamination of opportunities to expand information reporting  and tax withholding could increase the transparency of the tax system. Optimize Resource Allocation

Sound resource allocation is another tool for addressing the tax gap. Chairman Gregg, Senator Conrad and members of the committee, this  concludes my testimony.
Why GAO Did This Study

The Internal Revenue Service's (IRS) most recent estimate of the difference between what taxpayers timely and accurately paid in taxes and what they owed was $345 billion. IRS estimates it will eventually recover some of this tax gap, resulting in an estimated net tax gap of $290 billion. The tax gap arises when taxpayers fail to comply with the tax laws by underreporting tax liabilities on tax returns; underpaying taxes due from filed returns; or nonfiling, which refers to the failure to file a required tax return altogether or in a timely manner. The Chairman and Ranking Minority Member of the Senate Committee on the Budget asked GAO to present information on the causes of and possible solutions to the tax gap. This testimony addresses the nature and extent of the tax gap and the significance of reducing the tax gap, including some steps that may assist with this challenging task. For context, this testimony also addressed GAO's most recent simulations of the long-term fiscal outlook and the need for a fundamental reexamination of major spending and tax policies and priorities.

What GAO Found

Our nation's fiscal policy is on an imprudent and unsustainable course. As long-term budget simulations by GAO show, over the long term we face a large and growing structural deficit due primarily to known demographic trends, rising health care costs, and lower federal revenues as a percentage of the economy. GAO's simulations indicate that the long-term fiscal challenge is too big to be solved by economic growth alone or by making modest changes to existing spending and tax policies. Rather, a fundamental reexamination of major policies and priorities will be important to recapture our future fiscal flexibility. Underreporting of income by businesses and individuals accounted for most of the estimated $345 billion tax gap for 2001, with individual income tax underreporting alone accounting for $197 billion, or over half of the total gap. Corporate income tax and employment tax underreporting accounted for an additional $84 billion of the gap. Reducing the tax gap would help improve fiscal sustainability. Given the tax gap's persistence and size, it will require considering not only options that have been previously proposed but also new administrative and legislative actions. Even modest progress would yield significant revenue; each 1 percent reduction would likely yield nearly $3 billion annually. Reducing the tax gap will be a challenging long-term task, and progress will require attacking the gap with multiple strategies over a sustained period. These strategies could include efforts to regularly obtain data on the extent of, and reasons for, noncompliance; simplify the tax code; provide quality service to taxpayers; enhance enforcement of tax laws by utilizing enforcement tools such as tax withholding, information reporting, and penalties; leverage technology; and optimize resource allocation.