# Presentation: 335281

## 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 do not necessarily reflect the official views of the U.S. Treasury.

## 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.

## 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 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.

## 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%.

## 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 stages.
- 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 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.

## 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 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.

## 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.

## 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 (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).

## 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.”

## 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 effects.
- Generally only large changes would be expected to yield measurable revenue.
- “Descore” IRS funding reductions – controversial.
- Interaction of resources and legislative initiatives.

## 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.

## 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.

## 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.

## 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.

## 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 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.

## 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.

## 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 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.