	Background

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. Reducing the Tax Gap Could Improve the Nation’s Fiscal Position but Will Require Multiple Strategies

Given its size, even small or moderate reductions in the net tax gap could  yield substantial returns, which could improve the government’s fiscal  position. For example, based on IRS’s most recent estimate, each 1  percent reduction in the net tax gap would likely yield more than $2.5  billion annually. 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. However, reducing the tax gap will be challenging given persistent levels  of noncompliance. The tax gap must be attacked on multiple fronts and  with multiple strategies on a sustained basis. However, for any given set of tax policies, IRS’s efforts to  reduce the tax gap and ensure appropriate levels of compliance will need  to be based on a balanced approach of providing service to taxpayers and  enforcing the tax laws. Providing quality services to taxpayers is an important part of any overall  strategy to improve compliance and thereby reduce the tax gap. Regular Compliance Measurement Can Support Informed Decisions to Reduce the Tax Gap, but IRS Lacks Approved Plans for Such Measurement

Regularly measuring compliance can offer many benefits, including  helping IRS identify new or growing types of noncompliance, identify  changes in tax laws and regulations that may improve compliance, more  effectively target examinations of tax returns, understand the  effectiveness of its programs to promote and enforce compliance, and  determine its resource needs and allocations. Underreporting Accounted for Most of the Tax Gap Estimate

Using its recently collected compliance data, IRS has estimated that  underreporting of individual income taxes represented about half of the  tax gap for 2001 (the estimate ranges from $150 billion to $187 billion out  of a gross tax gap estimate that ranges from $312 billion to $353 billion), as  indicated in table 1. IRS has concerns with the certainty of the overall tax gap estimate in part  because some areas of the estimate rely on old data and outdated  methodologies. Beyond this study of S corporations, IRS has no approved plans to  periodically collect more or better compliance data over the long term. IRS collects data on the reasons for noncompliance for specific tax issues  during its operational examinations of tax returns. According to IRS officials, the agency does not have firm or specific plans  to develop better data on the reasons for noncompliance. IRS’s strategies for improving compliance, which involve improving  taxpayer service and enhancing enforcement of the tax laws, generally  lack a clear focus on long-term, quantitative goals and results  measurement. Like other agencies, IRS faces challenges in implementing a results- oriented management approach. Concluding Observations

Reducing the tax gap is one approach that would help address the looming  fiscal challenges facing the nation. Toward that end, in our July 2005  report on reducing the tax gap, we made recommendations to IRS to  develop plans to periodically measure tax compliance, take steps to  improve its data on the reasons why taxpayers do not comply, and  establish long-term, quantitative goals for voluntary compliance levels  with an initial focus on individual income tax underreporting and total tax  underpayment.
Why GAO Did This Study

Long-term budget simulations by GAO and others show that we face large and growing structural deficits due primarily to known demographic trends and rising health care costs. Reducing the annual tax gap--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 these long-term fiscal challenges. The tax gap arises through the underreporting of tax liabilities, underpayment of taxes due or "nonfiling" of required tax returns. This testimony discusses the findings of GAO's recent tax gap report. It addresses the significance of reducing the tax gap, measuring the extent of the tax gap, collecting data on reasons why noncompliance occurs, and the Internal Revenue Service's (IRS) strategies for reducing the tax gap.

What GAO Found

IRS's recent estimate of the tax gap in 2001 ranged from $312 billion to $353 billion. IRS estimates it will eventually recover some of this tax gap, resulting in a net tax gap of $257 billion to $298 billion. Reducing the tax gap will be challenging given persistent levels of noncompliance. Still, given its size, even small or moderate reductions in the net tax gap could yield substantial returns, which could improve the government's fiscal position. For example, based on IRS's most recent estimate, each 1 percent reduction in the net tax gap would likely yield more than $2.5 billion annually. 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. The tax gap must be attacked on multiple fronts and with multiple strategies over a sustained period of time. These 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. Regularly measuring compliance is also critical to IRS's ability to reduce the tax gap. A significant part of IRS's tax gap estimate is based on recently collected data on individual income tax reporting compliance. However, other areas of the tax gap rely on old data and outdated methodologies. IRS does not have approved plans, with one exception, to collect more current compliance data covering the various components of the tax gap. Although it can be challenging to develop, data on the reasons why taxpayers do not comply with the tax laws could help IRS more effectively tailor its efforts to reduce noncompliance. IRS has begun to capture data on the reasons for noncompliance, but it has concerns with the data. Although IRS is developing a system intended to capture better examination data, it does not have specific plans to develop better data on the reasons for noncompliance. IRS's strategies for reducing the tax gap involve improving taxpayer service and enforcing tax laws, but do not have a clear focus on quantitative long-term goals or results measurement. Establishing clear goals and measuring progress toward them would be consistent with results-oriented management principles and would provide IRS with a solid base upon which to develop a more strategic approach to reducing the tax gap.