Narrowing the Tax Gap
James B. Mackie III Director, Revenue Estimating Division Office of Tax Analysis U.S. Treasury
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Disclaimer
• Any views or opinions are my own and do not necessarily reflect the official views of the U.S. Treasury.
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Bottom Line
• The tax gap is a serious multi-dimensional problem. • 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 strategy.
– Some budget proposals have been enacted.
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Tax Gap Background
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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
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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 errors. – Can’t 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.
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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 4.5%. – No information reporting. Net income from proprietorships, rents, and royalties is underreported by 54%.
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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 selfemployment 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 stages.
• Excise tax compliance has never been studied.
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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).
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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 taxes. • Expectations have to be realistic. • The tax gap is a longstanding, persistent problem. – Compliance rates are about the same as 20 years ago despite large changes in tax law and in tax enforcement. • “There is no low-hanging fruit in this area.” former IRS Commissioner Lawrence Gibbs. – IRS already gets the easy enforcement dollars.
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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 government. • 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 government’s net fiscal position 11 would be smaller because of the cost of collection.
Treasury’s Tax Gap Strategy: Four 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.
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Seven Specific Strategic Components
• (1) Reduce evasion through legislation and regulation. • (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.
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Implementing the Treasury Strategies
• Made some progress on all fronts.
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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.
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Budget Proposals: Legislation to Reduce Evasion (cont.)
• 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 2206.
• Increase and extend to other types of returns penalties on tax preparers for filing erroneous returns. (Issues: MLTN standard, no transition relief.) • Create an erroneous refund penalty.
– HR 2206 also increased the penalty for writing bad checks to pay taxes (not a Budget proposal).
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Budget Proposals: Legislation to Reduce Evasion (cont.)
• Modest revenue pick-up ($29 billion over ten years).
– 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.”
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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.
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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.
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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 effects. – Generally only large changes would be expected to yield measurable revenue. – “Descore” IRS funding reductions – controversial. – Interaction of resources and legislative initiatives.
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Budget Proposals: Legislation to Reduce Evasion (cont.)
• 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.
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Budget Proposals: Legislation to Increase Simplicity
• Simplify the tax treatment of families and savings incentives.
– LSA, RSA, ERSA. – Clarify definition of child, simplify EITC eligibility, reduce complexity of refundable child tax credit.
• These help to reduce the complexity that causes unintentional noncompliance.
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Other Budget Proposals
• $410 million in new IRS funding aimed at the tax gap.
– Additional compliance research. – Investment in information technology. – Enhancement of enforcement activity. – Improvements in taxpayer service.
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Other Budget Proposals: Additional Compliance Research
• New studies for the corporate tax, employment tax, partnerships, and excise taxes. • Update the 2001 National Research Program (NRP) study.
– 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.
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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.
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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.
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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.
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Tax Regulations: Increase Compliance
• Targets specific areas of noncompliance. • Clarifies tax law and increases voluntary compliance. • Recently published guidance will improve compliance.
– Transfer pricing: cross border services. – Foreign tax credit: separation of credit from income. – Reportable transactions rules (tax shelters): create “transactions of interest” category.
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Partners and Stakeholders
• Public roundtable in March
– Hosted by Assistant Sec. Solomon and Commissioner Everson. – 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.
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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.
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Bottom Line (again)
• The tax gap is a serious, multi-dimensional problem. • 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.
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