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Narrowing the Tax Gap


Narrowing the Tax Gap James B. Mackie III Director, Revenue Estimating Division Office of Tax Analysis U.S. Treasury Disclaimer Any views or opinions are my own and ... – PowerPoint PPT presentation

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Title: Narrowing the Tax Gap

Narrowing the Tax Gap
  • James B. Mackie III
  • Director, Revenue Estimating Division
  • Office of Tax Analysis
  • U.S. Treasury

  • Any views or opinions are my own and do not
    necessarily reflect the official views of the
    U.S. Treasury.

Bottom Line
  • The tax gap is a serious multi-dimensional
  • The tax gap can be reduced but not eliminated.
  • The Administration is committed to working with
    Congress to reduce the tax gap without unduly
    burdening compliant taxpayers.
  • The Treasury has proposed a multi-pronged
    approach to reducing the tax gap and has made
    specific Budget proposals consistent with this
  • Some budget proposals have been enacted.

Tax Gap Background
What is the Tax Gap?
  • Gross tax gap. The difference between the amount
    of tax that taxpayers should pay under the tax
    law and the amount they actually pay on time.
  • Estimate of 345 billion in tax year 2001, 83.7
    voluntary compliance rate.
  • Net tax gap. Gross tax gap less taxes that were
    paid voluntarily but late and recoveries from IRS
    enforcement activities.
  • Estimate of 290 billion in tax year 2001, 86.3
    net compliance rate

Sources of the Tax Gap
  • Caused by many kinds of errors and omissions.
  • Intentional evasion and unintentional errors both
    contribute to the tax gap.
  • Tax complexity leads to unintentional errors and
    creates opportunities for intentional evasion.
  • Better taxpayer service can reduce unintentional
  • Cant tell how much of the gap is from
    unintentional errors.
  • Over 80 of the gross tax gap is from
    underreporting of income.
  • Over 40 is underreporting of net business income
    (individual income tax and self-employment tax).
  • About 10 of the gross tax gap is from
    underpayment of tax and about 10 from nonfiling.

Information Reporting and Withholding
  • Noncompliance is highest among taxpayers whose
    income is not subject to third party information
    reporting or withholding.
  • Withholding. Wages are underreported by 1.
  • Information reporting. Interest income,
    dividends, social security benefits, pensions,
    and unemployment insurance are underreported by
  • No information reporting. Net income from
    proprietorships, rents, and royalties is
    underreported by 54.

Information on the Tax Gap is Dated and Incomplete
  • Identifying the sources and levels of
    noncompliance is critical to designing and
    implementing effective remediation.
  • The main source of information is the National
    Research Program (NRP), which has compliance data
    from 2001.
  • NRP looked only at individual income and
    self-employment taxes.
  • Estimates of compliance for other taxes (e.g.,
    corporate income tax) are based on information
    that is much older studies are 20 years old.
  • Study of S corporation compliance is in final
  • Excise tax compliance has never been studied.

Reducing the Tax Gap vs. Raising Revenue
  • Reducing the tax gap is not the same thing as
    raising revenue.
  • Some tax changes are clearly targeted towards
    noncompliant taxpayers and the tax gap, e.g.,
    increased information reporting, penalties,
    closing specific illegal tax shelters.
  • Some tax changes raise revenue from compliant
    taxpayers and also reduce the tax gap, e.g.,
    eliminating the home office deduction or the
    charitable deduction.
  • Some tax changes simply raise revenue without
    affecting the tax gap (compliance).

Can the Tax Gap Be Closed?
  • The tax gap can be narrowed, and it is important
    to do so.
  • All Americans should pay their fair share of
  • Expectations have to be realistic.
  • The tax gap is a longstanding, persistent
  • Compliance rates are about the same as 20 years
    ago despite large changes in tax law and in tax
  • There is no low-hanging fruit in this area.
  • former IRS Commissioner Lawrence Gibbs.
  • IRS already gets the easy enforcement dollars.

Can the Tax Gap Be Closed? (cont.)
  • Closing the tax gap completely seems infeasible
    if not impossible. It would require draconian and
    costly measures.
  • Universal audits.
  • Very severe penalties.
  • High burden on compliant taxpayers.
  • Increase tensions between taxpayers and the
  • Large reductions in the tax gap would be VERY
    difficult to make and might not be worth the cost
    imposed on the IRS and on taxpayers.
  • Same problems as completely closing the tax gap.
  • 290 billion per year is a large overstatement of
    the achievable reduction in the tax gap.
  • Improvement in the governments net fiscal
    position would be smaller because of the cost of

Treasurys Tax Gap StrategyFour Principles
  • A Comprehensive Strategy for Reducing the Tax
    Gap, OTP, September, 2006.
  • (1) Address unintentional taxpayer errors and
    intentional taxpayer evasion.
  • (2) Target specific sources of noncompliance.
  • (3) Combine enforcement with taxpayer service.
  • (4) Respect taxpayer rights and balance
    enforcement against taxpayer burdens.

Seven Specific Strategic Components
  • (1) Reduce evasion through legislation and
  • (2) Commit to multi-year compliance research.
  • (3) Improve information technology.
  • (4) Improve IRS compliance activities.
  • (5) Enhance taxpayer service.
  • (6) Simplify the tax law.
  • (7) Coordinate with partners and stakeholders.

Implementing the Treasury Strategies
  • Made some progress on all fronts.

Budget Proposals Legislation to Reduce Evasion
  • 16 specific proposals in the FY 2008 Budget.
  • Expand information reporting (7).
  • Three proposals account for most of the revenue.
  • Business payments to corporations File an
    information return for payments summing to 600
    or more to a corporation.
  • Basis on security sales Brokerage houses, mutual
    funds, asset managers, and fiduciaries would be
    required to report adjusted basis on sales of
    publicly traded securities.
  • Merchant payment card reimbursements Card
    processors must report to the IRS gross
    reimbursement payments made to merchants.

Budget Proposals Legislation to Reduce Evasion
  • Improve compliance by business (3).
  • These include a proposal to amend the collection
    due process rules for employment taxes that has
    been enacted in modified form by HR 2206.
  • Strengthen tax administration (3).
  • Make willful failure to file a return a felony.
  • Strengthen penalties (3).
  • Two have been enacted in modified form by HR
  • Increase and extend to other types of returns
    penalties on tax preparers for filing erroneous
    returns. (Issues MLTN standard, no transition
  • Create an erroneous refund penalty.
  • HR 2206 also increased the penalty for writing
    bad checks to pay taxes (not a Budget proposal).

Budget Proposals Legislation to Reduce Evasion
  • Modest revenue pick-up (29 billion over ten
  • Most revenue from information reporting.
  • Proposals focus on noncompliance, not raising
    revenue by changing the baseline against which
    compliance is measured.
  • Respectful of taxpayer rights and burdens.
  • No low-hanging fruit.

Sidebar Treasury Revenue Estimating for
Enforcement Initiatives
  • Two types of revenue effects.
  • Direct revenue immediately related to specific
    enforcement programs, e.g., penalties collected
    and revenues from audits. (These are counted as
    revenue from IRS enforcement.)
  • Indirect revenue from changes in voluntary
    compliance caused by the enforcement initiative.

Sidebar Treasury Revenue Estimating for
Enforcement Initiatives (cont.)
  • Three types of enforcement initiatives.
  • Legislative initiatives.
  • Statutory changes to administrative provisions of
    the IRC.
  • Score direct and indirect revenue effects
    (although the effects can be small).
  • Management initiatives.
  • Redeploy existing enforcement resources to
    increase efficiency.
  • Do not score.
  • Historical productivity increases already in
    baseline tax receipts.
  • Management decisions are made too frequently to
    track and evaluate.

Sidebar Treasury Revenue Estimating for
Enforcement Initiatives (cont.)
  • Resource initiatives.
  • Net additions to current service levels of
    resources applied to IRS enforcement programs.
  • Occasionally (rarely) have scored direct effects.
  • Little information on which to base indirect
  • Generally only large changes would be expected to
    yield measurable revenue.
  • Descore IRS funding reductions controversial.
  • Interaction of resources and legislative

Budget Proposals Legislation to Reduce Evasion
  • Rejected proposals (too draconian)
  • Require individuals to file 1099s for
    transactions with doctors, auto mechanics, dry
    cleaners and other service providers.
  • Require cash transactions to be done with a
    payment card or check and require issuer/bank
    reporting to IRS.
  • Substantially increase the number of IRS agents
    and audits.

Budget Proposals Legislation to Increase
  • Simplify the tax treatment of families and
    savings incentives.
  • Clarify definition of child, simplify EITC
    eligibility, reduce complexity of refundable
    child tax credit.
  • These help to reduce the complexity that causes
    unintentional noncompliance.

Other Budget Proposals
  • 410 million in new IRS funding aimed at the tax
  • Additional compliance research.
  • Investment in information technology.
  • Enhancement of enforcement activity.
  • Improvements in taxpayer service.

Other Budget Proposals Additional Compliance
  • New studies for the corporate tax, employment
    tax, partnerships, and excise taxes.
  • Update the 2001 National Research Program (NRP)
  • IRS just announced that will begin these studies
    in the fall.
  • Multi-year rolling methodology will provide
    regular updates of the data.
  • New studies of the effect of IRS taxpayer service
    on compliance.

Other Budget Proposals Information Technology
  • Upgrade infrastructure.
  • Enhance IT security.
  • Continued work on Customer Account Data Engine,
    Account Management Services, Modernized e-File,
    and Common Services Projects.

Other Budget Proposals Enhanced Enforcement
  • Increase audits of high-risk small business tax
    returns and step up collections and prosecutions.
  • Expand document matching.
  • Increase examination for large complex business
    returns, foreign residents, and smaller firms
    with international activity.
  • Withhold refunds for delinquent taxpayers.
  • Increase oversight to help prevent third parties
    from using tax exempts to reduce taxes.
  • Increase criminal tax investigations.

Other Budget Proposals Enhance Taxpayer Service
  • Expand voluntary income tax assistance programs
    directed towards low income, elderly, limited
    English proficiency, and disabled taxpayers.
  • Improve telephone and Web site services
    recommended by the Taxpayer Assistance Blueprint.

Tax Regulations Increase Compliance
  • Targets specific areas of noncompliance.
  • Clarifies tax law and increases voluntary
  • Recently published guidance will improve
  • Transfer pricing cross border services.
  • Foreign tax credit separation of credit from
  • Reportable transactions rules (tax shelters)
    create transactions of interest category.

Partners and Stakeholders
  • Public roundtable in March
  • Hosted by Assistant Sec. Solomon and Commissioner
  • Insights.
  • Identify specific causes of tax gap and target
    them for reform
  • Remedies should not impose unreasonable burdens
    on compliant taxpayers
  • Simplify the tax code
  • Manage expectations no solution is perfect
  • Work with Congressional staff.
  • Discuss and refine legislative proposals.
  • Increased information sharing with foreign
    countries continually updating and expanding tax
    exchange information agreements (Brazil, 3/2007)
    and renegotiating tax treaties.

Current Work
  • Tax gap project is ongoing.
  • Treasury is working actively to determine the
    next steps consistent with the principles and
    strategies outlined last September.

Bottom Line(again)
  • The tax gap is a serious, multi-dimensional
  • Tax gap can be reduced but not eliminated.
  • The Administration is committed to working with
    Congress to reduce the tax gap without unduly
    burdening compliant taxpayers.
  • The Treasury has proposed a multi-pronged attack
    on the tax gap and has made specific Budget
    proposals consistent with this strategy.
  • Some have been enacted.