United States Government Accountability Office

GAO Testimony 

Before the Committee on the Budget, 

U.S. Senate

TAX COMPLIANCE 

Multiple Approaches Are 

Needed to Reduce the Tax 

Gap 

Statement of Michael Brostek 

Director, Tax Issues 

Strategic Issues Team 

For Release on Delivery

Expected at 10:00 a.m. EST 

Tuesday, January 23, 2007 

 

GAO-07-391T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

January 23, 2007

TAX COMPLIANCE

Multiple Approaches Are Needed to 

Highlights of GAO-07-391T, a testimony to Reduce the Tax Gap 

the Committee on the Budget, U.S. 

Senate 

The tax gap—the difference 

between the tax amounts taxpayers 

pay voluntarily and on time and 

what they should pay under the 

law—has been a long-standing

problem in spite of many efforts to 

reduce it. Most recently, the 

Internal Revenue Service (IRS)

estimated a gross tax gap for tax 

year 2001 of $345 billion and 

estimated it would recover $55 

billion of this gap, resulting in a net 

tax gap of $290 billion. When some

taxpayers fail to comply, the

burden of funding the nation’s 

commitments falls more heavily on 

compliant taxpayers. Reducing the 

tax gap would help improve the 

nation’s fiscal stability. For 

example, each 1 percent reduction 

in the net tax gap would likely yield

$3 billion annually. 

GAO was asked to discuss the tax 

gap and various approaches to

reduce it. This testimony discusses 

the need for taking multiple

approaches and to what extent the 

tax gap could be reduced through 

three overall approaches— 

simplifying or reforming the tax 

system, providing IRS with

additional enforcement tools, and 

devoting additional resources to 

enforcement. This statement is

based on prior GAO work. 

What GAO Recommends

GAO is not making any new 

recommendations but highlights

areas for possible attention. 

Multiple approaches are needed to reduce the tax gap. No single approach is

likely to fully and cost-effectively address noncompliance since, for example, 

it has multiple causes and spans different types of taxes and taxpayers. 

Simplifying or reforming the tax code, providing IRS more enforcement 

tools, and devoting additional resources to enforcement are three major 

approaches, but providing quality services to taxpayers also is a necessary

foundation for voluntary compliance. Such steps as periodically measuring 

noncompliance and its causes, setting tax gap reduction goals, evaluating the 

results of any initiatives to reduce the tax gap, optimizing the allocation of 

IRS’s resources, and leveraging technology to enhance IRS’s efficiency 

would also contribute to tax gap reduction. 

Simplifying the tax code or fundamental tax reform has the potential to 

reduce the tax gap by billions of dollars. IRS has estimated that errors in 

claiming tax credits and deductions for tax year 2001 contributed $32 billion 

to the tax gap. Thus, considerable potential exists. However, these

provisions serve purposes Congress has judged to be important and 

eliminating or consolidating them could be complicated. Fundamental tax 

reform would most likely result in a smaller tax gap if the new system has 

few, if any, exceptions (e.g., few tax preferences) and taxable transactions 

are transparent to tax administrators. These characteristics are difficult to 

achieve, and any tax system could be subject to noncompliance. 

Withholding and information reporting are particularly powerful tools to 

reduce the tax gap. They could help reduce the tax gap by billions of dollars, 

especially if they make underreported income transparent to IRS. These 

tools have led to high, sustained levels of taxpayer compliance and improved 

IRS resource allocation by helping IRS identify and prioritize its contacts 

with noncompliant taxpayers. As GAO previously suggested, reporting the 

cost, or basis, of securities sales is one option to improve taxpayers’ 

compliance. However, designing additional withholding and information 

reporting requirements may be challenging given that many types of income

are already subject to reporting, underreporting exists in many forms, and 

withholding and reporting requirements impose costs on third parties. 

Devoting additional resources to enforcement has the potential to help 

reduce the tax gap by billions of dollars. However, determining the 

appropriate level of IRS enforcement resources requires taking into account 

such factors as how well IRS uses its resources, the proper balance between 

taxpayer service and enforcement activities, and competing federal funding 

priorities. If Congress provides IRS more enforcement resources, the amount 

of tax gap reduction would depend on factors such as the size of budget 

increases, how IRS manages any additional resources, and the indirect 

increase in taxpayers’ voluntary compliance resulting from expanded 

enforcement. Increasing IRS’s funding would enable it to contact millions of 

potentially noncompliant taxpayers it identifies but does not contact. 

www.gao.gov/cgi-bin/getrpt?GAO-07-391T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Michael 

Brostek at (202) 512-9110 or 

brostekm@gao.gov. 
Chairman Conrad, Senator Gregg, Members of the Committee: 

I appreciate this opportunity to discuss the tax gap—the difference 

between what taxpayers pay in taxes voluntarily and on time and what 

they should pay under the law—and what is achievable in reducing the 

gap. Most recently, the Internal Revenue Service (IRS) estimated that for 

tax year 2001, taxpayers paid about 84 percent of the taxes that should 

have been paid on time under the law, resulting in an estimated gross tax 

gap of $345 billion. IRS estimated that it would eventually recover around 

$55 billion of the 2001 tax gap through late payments and IRS enforcement 

actions, leaving a net tax gap of $290 billion.1

 Because of taxpayer 

noncompliance, the burden of funding the nation’s commitments falls 

more heavily on taxpayers who willingly and accurately pay their taxes. 

Reducing the tax gap would help improve the nation’s fiscal stability. For 

example, based on IRS’s estimate, each 1 percent reduction in the net tax 

gap would likely yield nearly $3 billion annually. However, the tax gap has 

been a persistent problem in spite of a myriad of congressional and IRS 

efforts to reduce it, as the rate at which taxpayers voluntarily comply with 

our tax laws has changed little over the past three decades. Likewise, 

factors such as globalization and the ever-increasing complexity of the tax

code challenge IRS’s ability to administer the tax code. 

My remarks focus on what is achievable in reducing the tax gap through a

variety of approaches. First I will discuss the need for multiple approaches 

towards reducing the tax gap. Then I will discuss three specific tax gap 

reduction approaches: (1) simplifying or reforming the tax system; (2) 

providing IRS additional enforcement authority and tools, such as 

information reporting2

 and tax withholding,3 through changes to the tax 

laws; and (3) devoting additional resources to enforcement under the 

existing tax laws. My remarks are based on our previous work on a variety 

of issues, in particular, recent testimonies and a report on reducing the tax 

 1

Throughout this statement, references to the tax gap refer to the gross tax gap unless 

otherwise noted. 

2

Information reporting involves the filing of information returns with IRS and taxpayers 

that contain information on certain transactions, such as wage and salary information

employers report to employees and IRS through Form W-2. 

3

An example of tax withholding is when employers withhold taxes on the wages that 

employees earn and remit them to IRS. 

Page 1 GAO-07-391T 
gap.4

 These efforts were conducted in accordance with generally accepted 

government auditing standards. 

Let me begin by highlighting four major points: 

• Multiple approaches are needed to reduce the tax gap. No single approach

is likely to fully and cost-effectively address noncompliance since, for 

example, it has multiple causes and spans different types of taxes and 

taxpayers. Simplifying or reforming the tax code, providing IRS more 

enforcement tools, and devoting additional resources to enforcement are 

three major approaches discussed below, but providing quality services to

taxpayers also is a necessary foundation for voluntary compliance. Quality 

services can help taxpayers who wish to comply but do not understand 

their obligations, whereas enforcement actions may be needed for those 

who intentionally evade their tax obligations. Such steps as periodically 

measuring noncompliance and its causes, setting tax gap reduction goals,

considering the costs and benefits of initiatives to reduce the gap, 

evaluating the results of such initiatives undertaken, optimizing the 

allocation of IRS’s resources, and leveraging technology to enhance IRS’s 

efficiency would also contribute to tax gap reduction. 

• Simplifying the tax code or fundamental tax reform has the potential to 

reduce the tax gap by many billions of dollars. For example, IRS estimated 

that errors in claiming tax credits and deductions for tax year 2001 

contributed $32 billion to the tax gap. Reducing the number of such credits 

and deductions therefore has some direct potential to reduce the tax gap. 

However, these credits and deductions serve purposes Congress has 

judged to be important, and eliminating them likely would be complicated. 

Fundamental tax reform, such as shifting to a consumption tax system, 

would most likely result in a smaller tax gap if the new system has few, if 

any, exceptions (e.g., few or no tax preferences) and taxable transactions

are transparent to tax administrators. These characteristics are difficult to

 4

GAO, Tax Compliance: Opportunities Exist to Reduce the Tax Gap Using a Variety of 

Approaches, GAO-06-1000T (Washington, D.C.: July 26, 2006); Tax Gap: Making

Significant Progress in Improving Tax Compliance Rests on Enhancing Current IRS

Techniques and Adopting New Legislative Actions, GAO-06-453T (Washington, D.C.: Feb.

15, 2006); Tax Gap: Multiple Strategies, Better Compliance Data, and Long-Term Goals

Are Needed to Improve Taxpayer Compliance, GAO-06-208T (Washington, D.C.: Oct. 26, 

2005); Tax Compliance: Better Compliance Data and Long-term Goals Would Support a

More Strategic IRS Approach to Reducing the Tax Gap, GAO-05-753 (Washington, D.C.: 

July 18, 2005); and Tax Compliance: Reducing the Tax Gap Can Contribute to Fiscal

Sustainability but Will Require a Variety of Strategies, GAO-05-527T (Washington, D.C.: 

Apr. 14, 2005). 

Page 2 GAO-07-391T 
achieve in any system, and any tax system could be subject to

noncompliance. 

• Providing IRS with more enforcement tools, particularly withholding and 

information reporting, also has the potential to reduce the tax gap by

billions of dollars, especially if those tools help IRS deal with the largest 

contributor to the tax gap—underreported income. Tax withholding and 

information reporting have been shown to lead to high, sustained levels of

taxpayer compliance because the income taxpayers earn is transparent to 

them and IRS. Also, using these tools can help IRS better allocate its 

resources by improving its ability to identify and prioritize noncompliant 

taxpayers to be contacted. For example, we found that having third parties 

report to taxpayers and IRS the cost, or basis, of stocks and mutual funds 

that taxpayers sell could help taxpayers improve their voluntary 

compliance and help IRS allocate its enforcement efforts concerning these

transactions. However, designing withholding or information reporting 

requirements to address underreporting may be challenging given that 

many types of income are already subject to such requirements, 

underreporting exists in many forms, and any requirements could impose 

costs and burdens on the third parties that withhold or report. 

• Devoting additional resources to enforcement has the potential to help 

reduce the tax gap by billions of dollars. However, determining the 

appropriate level of enforcement resources to provide IRS requires taking

into account factors such as how effectively and efficiently IRS is 

currently using its resources, how to strike the proper balance between 

IRS’s taxpayer service and enforcement activities, and competing federal

funding priorities. If Congress were to provide IRS more enforcement 

resources, the amount the tax gap could be reduced depends in part on 

factors such as the size of budget increases, how IRS manages any 

additional resources, and the indirect increase in taxpayers’ voluntary 

compliance resulting from expanded enforcement. Providing IRS with 

additional funding would enable it to contact millions of potentially 

noncompliant taxpayers it identifies but currently cannot contact given 

resource constraints. 

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 paid voluntarily and on time 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 

Background 

Page 3 GAO-07-391T 
altogether or on time.5

 IRS’s tax gap estimates for each type of

noncompliance include estimates for some or all of the five types of taxes 

that IRS administers. As shown in table 1, underreporting of tax liabilities 

accounted for most of the tax gap estimate for tax year 2001. 

Table 1: IRS’s Tax Year 2001 Gross Tax Gap Estimates by Type of Noncompliance and Type of Tax 

Dollars in billions 

Type of tax

Type of noncompliance

Individual 

income tax 

Corporate 

income tax Employment tax Estate tax Excise tax Total

Underreporting $197 $30 $54 $4 No estimate $285

Underpayment 23 2 5 2 $1 $34

Nonfiling 25 No estimate No estimate 2 No estimate $27

Total $244 $32 $59 $8 $1 $345

Source: IRS. 

Note: Figures may not sum to totals because of rounding. 

IRS has estimated the tax gap on multiple occasions, beginning in 1979,

relying on its Taxpayer Compliance Measurement Program (TCMP). IRS 

did not implement any TCMP studies after 1988 because of concerns about 

costs and burdens on taxpayers. Recognizing the need for current 

compliance data, in 2002 IRS implemented a new compliance study called

the National Research Program (NRP) to produce such data for tax year 

2001 while minimizing taxpayer burden. 

IRS has concerns with the certainty of the tax gap estimate for tax year 

2001 in part because some areas of the estimate rely on old data, IRS has 

no estimates for other areas of the tax gap, and it is inherently difficult to

measure some types of noncompliance. IRS used data from NRP to 

estimate individual income tax underreporting and the portion of 

employment tax underreporting attributed to self-employed individuals. 

The underpayment segment of the tax gap is not an estimate, but rather 

represents the tax amounts that taxpayers reported on time but did not 

pay on time. Other areas of the estimate, such as corporate income tax and 

employer-withheld employment tax underreporting, rely on decades-old 

data. Also, IRS has no estimates for corporate income, employment, and 

 5

Taxpayers who receive filing extensions, pay their full tax liability by payment due dates, 

and file returns prior to extension deadlines are considered to have filed on time. 

Page 4 GAO-07-391T 
excise tax nonfiling or for excise tax underreporting.6

 In addition, it is 

inherently difficult for IRS to observe and measure some types of 

underreporting or nonfiling, such as tracking cash payments that 

businesses make to their employees, as businesses and employees may not 

report these payments to IRS in order to avoid paying employment and 

income taxes, respectively.7

IRS’s overall approach to reducing the tax gap consists of improving 

service to taxpayers and enhancing enforcement of the tax laws. IRS seeks 

to improve voluntary compliance through efforts such as education and

outreach programs and tax form simplification. IRS uses its enforcement 

authority to ensure that taxpayers are reporting and paying the proper 

amounts of taxes through efforts such as examining tax returns and 

matching the amount of income taxpayers report on their tax returns to 

the income amounts reported on information returns it receives from third 

parties. IRS reports that it collected over $48 billion in fiscal year 2006 

from noncompliant taxpayers it identified through its various enforcement 

programs. 

In spite of IRS’s efforts to improve taxpayer compliance, the rate at which 

taxpayers pay their taxes voluntarily and on time has tended to range from

around 81 percent to around 84 percent over the past three decades. Any 

significant reduction of the tax gap would likely depend on an

improvement in the level of taxpayer compliance.8

No single approach is likely to fully and cost-effectively address 

noncompliance and therefore multiple approaches are likely to be needed. 

The tax gap has multiple causes; spans five types of taxes; and is spread 

over several types of taxpayers including individuals, corporations, and 

partnerships. Thus, for example, while simplifying laws should help when

noncompliance is due to taxpayers’ confusion, enforcement may be 

Multiple Approaches 

Are Needed to Reduce 

the Tax Gap 

 6

For these types of noncompliance, IRS maintains that the data are either difficult to 

collect, imprecise, or unavailable. 

7

For a more detailed discussion about data sources and methodologies used in estimating 

the tax gap, see GAO-05-753. 

8

In some instances, the amount of the tax gap can change without a corresponding change 

in the level of compliance. For example, a reduction in marginal tax rates could result in a

smaller tax gap even if the level of compliance remains unchanged because the amount of 

taxes that should be paid has been reduced. The tax gap would also tend to increase over

time, even if the rate of taxpayer compliance remained unchanged, because of inflation. 

Page 5 GAO-07-391T 
needed for taxpayers who understand their obligations but decline to

fulfill them. Similarly, while devoting more resources to enforcement 

should increase taxes assessed and collected, too great an enforcement 

presence likely would not be tolerated. 

Simplifying or reforming the tax code, providing IRS more enforcement 

tools, and devoting additional resources to enforcement are three major 

tax gap reduction approaches discussed in more detail below, but 

providing quality services to taxpayers plays an important role in 

improving compliance and reducing the tax gap. IRS taxpayer services 

include education and outreach programs, simplifying the tax process, and 

revising forms and publications to make them electronically accessible 

and more easily understood by diverse taxpayer communities. For 

example, if tax forms and instructions are unclear, taxpayers may be 

confused and make unintentional errors. Quality taxpayer services would 

also be a key consideration in implementing any of the approaches for tax 

gap reduction. For example, expanding enforcement efforts would 

increase interactions with taxpayers, requiring processes to efficiently

communicate with taxpayers. Also, changing tax laws and regulations 

would require educating taxpayers of the new requirements in a clear, 

timely, and accessible manner. In 2006, we reported that IRS improved its 

two most commonly used services—telephone and Web site assistance—

for the 2006 filing season.9

 Increased funding financed some of the 

improvements, but a significant portion has been financed internally by 

efficiencies gained from increased electronic filing of tax returns and 

other operational improvements. 

Although quality service helps taxpayers comply, showing a direct 

relationship between quality service and compliance levels is very 

challenging. As required by Congress, IRS is in the midst of a study that is 

to result in a 5-year plan for taxpayer service activities, which is to include 

long-term quantitative goals and to balance service and enforcement. Part 

of the study focuses on the effect of taxpayer service on compliance. A 

Phase I report was issued in April 2006 and a Phase II report is due in early

2007, which is to include, among other things, a multiyear plan for 

taxpayer service activities and improvement initiatives. 

 9

GAO, Internal Revenue Service: Assessment of the Interim Results of the 2006 Filing 

Season and Fiscal Year 2007 Budget Request, GAO-06-499T (Washington, D.C.: Apr. 27, 

2006). 

Page 6 GAO-07-391T 
However, in deciding on the appropriate mix of approaches to use in 

reducing the tax gap, many factors or issues could affect strategic 

decisions. Among the broad factors to consider are the likely effectiveness 

of any approach, fairness, enforceability, and sustainability. Beyond these,

our work points to the importance of the following: 

• Measuring compliance levels periodically and setting long-term 

goals. A data-based plan is one key to closing the tax gap. To the extent 

that IRS can develop better compliance data, it can develop more effective

approaches for reducing the gap. Regularly measuring the magnitude of, 

and the reasons for, noncompliance provides insights on how to reduce 

the gap through potential changes to tax laws and IRS programs. In July 

2005, we recommended that IRS periodically measure tax compliance, 

identify reasons for noncompliance, and establish voluntary compliance 

goals.10 IRS agreed with the recommendations and established a voluntary 

tax compliance goal of 85 percent by 2009. Furthermore, we have 

identified alternative ways to measure compliance, including conducting 

examinations of small samples of tax returns over multiple years, instead 

of conducting examinations for a larger sample of returns for one tax year, 

to allow IRS to track compliance trends annually. 

• Considering the costs and burdens. Any action to reduce the tax gap 

will create costs and burdens for IRS; taxpayers; and third parties, such as 

those who file information returns. For example, withholding and 

information reporting requirements impose some costs and burdens on 

those who track and report information. These costs and burdens need to

be reasonable in relation to the improvements expected to arise from new 

compliance strategies. 

• Evaluating the results. Evaluating the actions taken by IRS to reduce 

the tax gap would help maximize IRS’s effectiveness. Evaluations can be 

challenging because it is difficult to isolate the effects of IRS’s actions 

from other influences on taxpayers’ compliance. Our work has discussed 

how to address these challenges, for example by using research to link 

actions with the outputs and desired effects. 

• Optimizing resource allocation. Developing reliable measures of the 

return on investment for strategies to reduce the tax gap would help 

inform IRS resource allocation decisions. IRS has rough measures of 

return on investment based on the additional taxes it assesses. Developing

 10GAO-05-753. 

Page 7 GAO-07-391T 
such measures is difficult because of incomplete data on the costs of 

enforcement and collected revenues. Beyond direct revenues, IRS’s 

enforcement actions have indirect revenue effects, which are difficult to 

measure. However, indirect effects could far exceed direct revenue effects 

and would be important to consider in connection with continued 

development of return on investment measures. In general though, the 

impacts of tax gap reduction by improving voluntary tax compliance can 

be quite large. For example, if the estimated 83.7 percent voluntary 

compliance rate that produced a gross tax gap of $345 billion in tax year 

2001 had been 85 percent, this tax gap would have been about $287 billion 

less; if it had been 90 percent, the gap would have been about $132 133 

billion less. 

• Leveraging technology. Better use of technology could help IRS be more 

efficient in reducing the tax gap. IRS is modernizing its technology, which

has paid off in terms of telephone service, resource allocation, electronic 

filing, and data analysis capability. However, this ongoing modernization 

will need strong management and prudent investments to maximize 

potential efficiencies. 

Congress has been encouraging IRS to develop an overall tax gap 

reduction plan or strategy that could include a mix of approaches like 

simplifying code provisions, increased enforcement, and reconsidering the 

level of resources devoted to enforcement. Some progress has been made

towards laying out the broad elements of a plan or strategy for reducing 

the tax gap. On September 26, 2006, the U.S. Department of the Treasury 

(Treasury), Office of Tax Policy released “A Comprehensive Strategy for 

Reducing the Tax Gap.” However, the document generally does not 

identify specific approaches that Treasury and IRS will undertake to 

reduce the tax gap, the related time frames for such steps, or explanations

of how much the tax gap would be reduced. The document said that such 

additional details the would be part of the fiscal year 2008 IRS budget 

request that will be deliberated during early 2007 because of the resource 

implications associated with tax gap reduction. 

Page 8 GAO-07-391T 
Tax law simplification and reform both have the potential to reduce the 

tax gap by billions of dollars. The extent to which the tax gap would be 

reduced depends on which parts of the tax system would be simplified and 

in what manner as well as how any reform of the tax system is designed 

and implemented. Neither approach, however, will eliminate the gap.

Further, changes in the tax laws and system to improve tax compliance 

could have unintended effects on other tax system objectives, such as 

those involving economic behavior or equity. 

Simplification has the potential to reduce the tax gap for at least three 

broad reasons. First, it could help taxpayers to comply voluntarily with 

more certainty, reducing inadvertent errors by those who want to comply

but are confused because of complexity. Second, it may limit 

opportunities for tax evasion, reducing intentional noncompliance by

taxpayers who can misuse the complex code provisions to hide their 

noncompliance or to achieve ends through tax shelters. Third, tax code

complexity may erode taxpayers’ willingness to comply voluntarily if they 

cannot understand its provisions or they see others taking advantage of 

complexity to intentionally underreport their taxes. 

Simplification could take multiple forms. One form would be to retain 

existing laws but make them simpler. For example, in our July 2005 

report11 on postsecondary tax preferences, we noted that the definition of 

a qualifying postsecondary education expense differed somewhat among 

some tax code provisions, for instance with some including the cost to 

purchase books and others not. Making definitions consistent across code 

provisions may reduce taxpayer errors. Although we cannot say the errors 

were due to these differences in definitions, in a limited study of paid 

preparer services to taxpayers, we found some preparers claiming 

unallowable expenses for books.12 Further, the Joint Committee on 

Taxation suggested that such dissimilar definitions may increase the 

likelihood of taxpayer errors and increase taxpayer frustration.13

Reducing the Tax Gap 

through Tax 

Simplification or Tax 

System Reform 

Depends on Their 

Design and May Have 

Effects Beyond Tax 

Compliance 

 11GAO, Student Aid and Postsecondary Tax Preferences: Limited Research Exists on the

Effectiveness of Tools to Assist Students and Families through Title IV Student Aid and

Tax Preferences, GAO-05-684 (Washington, D.C.: July 29, 2005). 

12GAO, Paid Tax Return Preparers: In a Limited Study, Chain Preparers Made Serious

Errors, GAO-06-563T (Washington, D.C.: Apr. 4, 2006). 

13U.S. Congress, Joint Committee on Taxation, Study of the Overall State of the Federal

Tax System, vol. II, 125-6 (April 2001). 

Page 9 GAO-07-391T 
Another tax code provision in which complexity may have contributed to 

the individual tax gap involves the earned income tax credit, for which IRS 

estimated a tax loss of up to about $10 billion for tax year 1999.14 Although 

some of this noncompliance may be intentional, we15 and the National 

Taxpayer Advocate16 have previously reported that confusion over the 

complex rules governing eligibility for claiming the credit could cause 

taxpayers to fail to comply inadvertently. 

Although retaining but simplifying tax code provisions may help reduce 

the tax gap, doing so may not be easy, may conflict with other policy 

decisions, and may have unintended consequences. The simplification of 

the definition of a qualifying child across various code sections is an 

example. We suggested in the early 1990s that standardizing the definition

of a qualifying child could reduce taxpayer errors and reduce their 

burden.17 A change was not made until 2004.18 However, some have 

suggested that the change has created some unintended consequences, 

such as increasing some taxpayers’ ability to reduce their taxes in ways 

Congress may not have intended.19

Another form of simplification could be to broaden the tax base while 

reducing tax rates, which could minimize incentives for not complying. 

This base- broadening could include a review of whether existing tax 

expenditures are achieving intended results at a reasonable cost in lost 

revenue and added burden and eliminating or consolidating those that are 

not. Among the many causes of tax code complexity is the growing 

number of preferential provisions in the code, defined in statute20 as tax 

 14IRS measured the extent of noncompliance with the earned income tax credit in a study 

separate from NRP. 

15GAO-06-208T. 

16Internal Revenue Service, Taxpayer Advocate Service, National Taxpayer Advocate 2004 

Annual Report to Congress (Washington, D.C.: Dec. 31, 2004). 

17See GAO, Tax Administration: Erroneous Dependent and Filing Status Claims, 

GAO/GGD-93-60, (Washington, D.C: Mar.19, 1993). 

18Pub. L. No. 108-311 (2004). 

19See Nina E. Olson, “Uniform Qualifying Child Definition: Uniformity for Most Taxpayers,”

Tax Notes, (April 10, 2006), 225-228; and John Buckley, “Uniform Definition of a Child: 

Large Unintended Consequences,” Tax Notes, (March 20, 2006), 1345-1349.

20The Congressional Budget and Impoundment Control Act of 1974, Pub. L. No. 93-344, § 3,

88 Stat. 299 (July 12, 1974) (codified at 2 U.S.C. § 622(3)). 

Page 10 GAO-07-391T 
expenditures, such as tax exemptions, exclusions, deductions, credits, and 

deferrals.21 The number of these tax expenditures has more than doubled 

from 1974 through 2005. Tax expenditures can contribute to the tax gap if

taxpayers claim them improperly. For example, IRS’s recent tax gap 

estimate includes a $32 billion loss in individual income taxes for tax year 

2001 because of noncompliance with these provisions. Simplifying these 

provisions of the tax code would not likely yield $32 billion in revenue 

because even simplified provisions likely would have some associated 

noncompliance. Nevertheless, the estimate suggests that simplification 

could have important tax gap consequences, particularly if simplification 

also accounted for any noncompliance that arises because of complexity 

on the income side of the tax gap for individuals.

22

Despite the potential benefits that simplification may yield, these credits 

and deductions serve purposes that Congress has judged to be important 

to advance federal goals. Eliminating them or consolidating them likely 

would be complicated, and would likely create winners and losers. 

Elimination also could conflict with other objectives such as encouraging

certain economic activity or improving equity. 

Similar trade-offs exist with possible fundamental tax reforms that would 

move away from an income tax system to some other system, such as a 

consumption tax, national sales tax, or value added tax. Fundamental tax 

reform would most likely result in a smaller tax gap if the new system has 

few tax preferences or complex tax code provisions and if taxable 

transactions are transparent. However, these characteristics are difficult 

to achieve in any system and experience suggests that simply adopting a 

fundamentally different tax system may not by itself eliminate any tax

gap.23 Any tax system could be subject to noncompliance, and its design 

and operation, including the types of tools made available to tax 

administrators, will affect the size of any corresponding tax gap. Further, 

the motivating forces behind tax reform likely include factors beyond tax

 21GAO, Government Performance and Accountability: Tax Expenditures Represent a

Substantial Federal Commitment and Need to Be Reexamined, GAO-05-690 (Washington,

D.C.: Sept. 23, 2005). 

22The tax gap for underreported individual income taxes exceeded $150 billion for tax year 

2001. However, IRS does not have data on how much of this noncompliance arose because 

of complexity. 

23For example, in a 2004 report, the National Audit Office in the United Kingdom reported

on the 15.7 percent gap for the value added tax, which was introduced three decades

earlier. 

Page 11 GAO-07-391T 
compliance, such as economic effectiveness, equity, and burden, which 

could in some cases carry greater weight in designing an alternative tax

system than ensuring the highest levels of compliance. 

Changing the tax laws to provide IRS with additional enforcement tools, 

such as expanded tax withholding and information reporting, could also 

reduce the tax gap by many billions of dollars, particularly with regard to

underreporting—the largest segment of the tax gap. Tax withholding 

promotes compliance because employers or other parties subtract taxes 

owed from a taxpayer’s income and remit them to IRS. Information 

reporting tends to lead to high levels of compliance because income 

taxpayers earn is transparent to them and IRS. In both cases, high levels of

compliance tend to be maintained over time. Also, withholding and 

information reporting help IRS to better identify noncompliant taxpayers 

and prioritize contacting them, which enables IRS to better allocate its 

resources. However, designing new withholding or information reporting 

requirements to address underreporting can be challenging given that 

many types of income are already subject to at least some form of 

withholding or information reporting, underreporting exists in varied 

forms, and the requirements could impose costs and burdens on third 

parties. 

Taxpayers tend to report income subject to tax withholding or information 

reporting with high levels of compliance, as shown in figure 1, because the 

income is transparent to the taxpayers as well as to IRS. Additionally, once

withholding or information reporting requirements are in place for 

particular types of income, compliance tends to remain high over time. For 

example, for wages and salaries, which are subject to tax withholding and

substantial information reporting, the percentage of income that taxpayers 

misreport has consistently been measured at around 1 percent over time.

Providing IRS with 

Additional 

Enforcement Tools 

Potentially Could 

Improve Compliance 

Significantly, but 

Identifying and 

Designing Such Tools 

Can Be Challenging 

Page 12 GAO-07-391T 
Figure 1: Individual Net Income Misreporting Categorized by the Extent of Income

Subject to Withholding and Information Reporting, Tax Year 2001 

In the past, we have identified a few specific areas where additional 

withholding or information reporting requirements could serve to improve 

compliance:

• Require more data on information returns dealing with capital 

gains income from securities sales. Recently, we reported that an 

estimated 36 percent of taxpayers misreported their capital gains or losses 

from the sale of securities, such as corporate stocks and mutual funds.24

Further, around half of the taxpayers who misreported did so because 

 24GAO, Capital Gains Tax Gap: Requiring Brokers to Report Securities Cost Basis Would

Improve Compliance if Related Challenges Are Addressed, GAO-06-603 (Washington, D.C.: 

June 13, 2006). 

Page 13 GAO-07-391T 
they failed to report the securities’ cost, or basis, sometimes because they

did not know the securities’ basis or failed to take certain events into 

account that required them to adjust the basis of their securities. When 

taxpayers sell securities like stock and mutual funds through brokers, the 

brokers are required to report information on the sale, including the 

amount of gross proceeds the taxpayer received; however, brokers are not 

required to report basis information for the sale of these securities. We 

found that requiring brokers to report basis information for securities 

sales could improve taxpayers’ compliance in reporting their securities 

gains and losses and help IRS identify noncompliant taxpayers. However, 

we were unable to estimate the extent to which a basis reporting 

requirement would reduce the capital gains tax gap because of limitations 

with the compliance data on capital gains and because neither IRS nor we 

know the portion of the capital gains tax gap attributed to securities sales. 

• Requiring tax withholding and more or better information return 

reporting on payments made to independent contractors. Past IRS 

data have shown that independent contractors report 97 percent of the 

income that appears on information returns, while contractors that do not

receive these returns report only 83 percent of income. We have also 

identified other options for improving information reporting for 

independent contractors, including increasing penalties for failing to file 

required information returns, lowering the $600 threshold for requiring 

such returns, and requiring businesses to report separately on their tax 

returns the total amount of payments to independent contractors.25

• Requiring information return reporting on payments made to 

corporations. Unlike payments made to sole proprietors, payments made 

to corporations for services are generally not required to be reported on 

information returns. IRS and GAO have contended that the lack of such a

requirement leads to lower levels of compliance for small corporations. 

Although Congress has required federal agencies to provide information 

returns on payments made to contractors since 1997,26 payments made by 

others to corporations are generally not covered by information returns. 

Information reporting helps IRS to better allocate its resources to the 

extent that it helps IRS better identify noncompliant taxpayers and the 

potential for additional revenue that could be obtained by contacting these 

taxpayers. For example, IRS officials told us that receiving information on 

 25GAO, Tax Administration: Approaches for Improving Independent Contractor 

Compliance, GAO/GGD-92-108 (Washington, D.C.: July 23, 1992). 

26Taxpayer Relief Act of 1997, Pub. L. No. 105-34 (1997). 

Page 14 GAO-07-391T 
basis for taxpayers’ securities sales would allow IRS to determine more 

precisely taxpayers’ income for securities sales through its document 

matching programs and would allow it to identify which taxpayers who 

misreported securities income have the greatest potential for additional 

tax assessments. Similarly, IRS could use basis information to improve 

both aspects of its examination program—examinations of tax returns 

through correspondence and examinations of tax returns face to face with

the taxpayer. Currently, capital gains issues are too complex and time 

consuming for IRS to examine through correspondence. However, IRS 

officials told us that receiving cost basis information might enable IRS to 

examine noncompliant taxpayers through correspondence because it 

could productively select tax returns to examine. Also, having cost basis 

information could help IRS identify the best cases to examine face to face,

making the examinations more productive while simultaneously reducing 

the burden imposed on compliant taxpayers who otherwise would be 

selected for examination.

Although withholding and information reporting lead to high levels of 

compliance, designing new requirements to address underreporting could 

be challenging given that many types of income, including wages and 

salaries, dividend and interest income, and income from pensions and 

Social Security are already subject to withholding or substantial 

information reporting. Also, challenges arise in establishing new 

withholding or information reporting requirements for certain other types 

of income that are extensively underreported. Such underreporting may be

difficult to determine because of complex tax laws or transactions or the 

lack of a practical and reliable third-party source to provide information 

on the taxable income. 

For example, while withholding or information reporting mechanisms on 

nonfarm sole proprietor and informal supplier income27 would likely 

improve their compliance, comprehensive mechanisms that are practical

and effective are difficult to identify. As shown in figure 1, this income is 

not subject to information reporting, and these taxpayers misreported 

 27Nonfarm proprietors are self-employed individuals other than farmers who should file 

Schedule C with their individual tax returns to report profits and losses from their 

businesses. Sole proprietors include those who provide services, such as doctors or

accountants; produce goods, such as manufacturers; and sell goods at fixed locations, such

as car dealers and grocers. Informal suppliers are sole proprietors who work alone or with

few workers and, by definition, operate in an informal manner. Informal suppliers include 

those who make home repairs, provide child care, or sell goods at roadside stands. These 

taxpayers should report business profits or losses on Schedule C. 

Page 15 GAO-07-391T 
about half of the income they earned for tax year 2001. Informal suppliers 

by definition receive income in an informal manner through services they

provide to a variety of individual citizens or small businesses. Whereas 

businesses may have the capacity to perform withholding and information 

reporting functions for their employees, it may be challenging to extend

withholding or information reporting responsibilities to the individual 

citizens that receive services, who may not have the resources or 

knowledge to comply with such requirements. 

Finally, implementing tax withholding and information reporting 

requirements generally imposes costs and burdens on the businesses that 

must implement them, and, in some cases, on taxpayers. For example, 

expanding information reporting on securities sales to include basis 

information will impose costs on the brokers who would track and report 

the information. Further, trying to close the entire tax gap with these 

enforcement tools could entail more intrusive recordkeeping or reporting 

than the public is willing to accept. 

Devoting more resources to enforcement has the potential to help reduce 

the tax gap by billions of dollars, as IRS would be able to expand its 

enforcement efforts to reach a greater number of potentially noncompliant 

taxpayers. However, determining the appropriate level of enforcement 

resources to provide IRS requires taking into account many factors, such 

as how effectively and efficiently IRS is currently using its resources, how 

to strike the proper balance between IRS’s taxpayer service and 

enforcement activities, and competing federal funding priorities. If 

Congress were to provide IRS more enforcement resources, the amount of 

the tax gap that could be reduced depends in part on the size of any 

increase in IRS’s budget, how IRS would manage any additional resources, 

and the indirect increase in taxpayers’ voluntary compliance that would 

likely result from expanded IRS enforcement. 

Given resource constraints, IRS is unable to contact millions of additional 

taxpayers for whom it has evidence of potential noncompliance. With 

additional resources, IRS would be able to assess and collect additional 

taxes and further reduce the tax gap. In 2002, IRS estimated that a $2.2 

billion funding increase would allow it to take enforcement actions against 

potentially noncompliant taxpayers it identifies but cannot contact and 

Devoting Additional 

Resources to 

Enforcement Likely

Could Reduce the Tax 

Gap, but to What 

Extent Is Difficult to 

Predict 

Page 16 GAO-07-391T 
would yield an estimated $30 billion in revenue.

28 For example, IRS 

estimated that it contacted about 3 million of the over 13 million taxpayers 

it identified as potentially noncompliant through its matching of tax 

returns to information returns. IRS estimated that contacting the 

additional 10 million potentially noncompliant taxpayers it identified, at a 

cost of about $230 million, could yield nearly $7 billion in potentially 

collectible revenue. We did not evaluate the accuracy of the estimate, and 

as will be discussed below, many factors suggest that it is difficult to 

estimate reliably net revenue increases that might come from additional 

enforcement efforts.29

Although additional enforcement funding has the potential to reduce the 

tax gap, the extent to which it would help depends on several factors. 

First, and perhaps most obviously, the amount of tax gap reduction would 

depend in part on the size of any budget increase. Generally, larger budget 

increases should result in larger reductions in the tax gap. The degree to

which revenues would increase from expanded enforcement depends on 

many variables, such as how quickly IRS can ramp up efforts, how well 

IRS selects the best cases to be worked, and how taxpayers react to 

enforcement efforts. Estimating those revenue increases would require 

assumptions about these and other variables. Because actual experience is 

likely to diverge from those assumptions, the actual revenue increases are 

likely to differ from the estimates. The lack of reliable key data 

compounds the difficulty of estimating the likely revenues. To the extent 

possible, obtaining better data on key variables would provide a better 

understanding of the likely results with any increased enforcement 

resources. 

With additional resources for enforcement, IRS would be able to assess 

and collect additional taxes, but the related tax gap reductions may not be 

immediate. If IRS uses the resources to hire more enforcement staff, the 

reductions may occur gradually as IRS is able to hire and train the staff. 

Also, several years can elapse after IRS assesses taxes before it actually 

collects these taxes. 

 28Commissioner of Internal Revenue Charles O. Rossotti, Report to the IRS Oversight 

Board: Assessment of IRS and the Tax System, October 2002. 

29The overall tax gap has many components. Thus, if the tax gap in a specific area is 

reduced either through congressional actions like simplifying provisions or through IRS 

actions, the size of the overall gap may not be reduced if other portions of the gap increase. 

Page 17 GAO-07-391T 
Similarly, the amounts of taxes actually collected can vary substantially 

from the related tax amounts assessed through enforcement actions by the 

type of tax or taxpayer involved. In a 1998 report, we found that 5 years 

after taxes were assessed against individual taxpayers with business 

income, 48 percent of the assessed taxes had been collected, whereas for 

the largest corporate taxpayers, 97 percent of assessed taxes had been

collected.

30

Over the last 2 years, IRS has requested and received additional funding 

targeted for enforcement activities that it estimated will result in 

additional revenue. In its fiscal year 2007 budget request, IRS requested an 

approximate 2 percent increase in funding from fiscal year 2006 to expand

its enforcement efforts, including tax return examination and tax 

collection activities, with the goal of increasing individual taxpayer 

compliance and addressing concerns that we and others have raised31

regarding the erosion of IRS’s enforcement presence. In estimating the 

revenue that it would obtain from the increased funding, IRS accounted 

for several factors, including opportunity costs because of training, which 

draws experienced enforcement personnel away from the field; 

differences in average enforcement revenue obtained per full-time 

employee by enforcement activity; and differences in the types and 

complexity of cases worked by new hires and experienced hires. IRS 

forecasted that in the first year after expanding enforcement activities, the 

additional revenue to be collected is less than half the amount to be 

collected in later years. This example underscores the logic that if IRS is to 

receive a relatively large funding increase, it likely would be better to 

provide it in small but steady amounts. 

The amount of tax gap reduction likely to be achieved from any budget

increase also depends on how well IRS can use information about 

noncompliance to manage the additional resources. Because IRS does not 

have compliance data for some segments of the tax gap and others are 

based on old data, IRS cannot easily track the extent to which compliance 

 30GAO, Tax Administration: IRS Measures Could Provide a More Balanced Picture of

Audit Results and Costs, GAO/GGD-98-128 (Washington, D.C.: June 23, 1998). 

31GAO issued a number of products regarding the erosion of IRS’s enforcement presence 

and a continued growth in noncompliance. For examples, see GAO, Tax Administration: 

Impact of Compliance and Collection Program Declines on Taxpayers, GAO-02-674 

(Washington, D.C.: May 22, 2003); High Risk Series: An Update, GAO-05-207 (Washington,

D.C.: January 2005); and our tax gap products cited earlier in this statement, GAO-06-1000T, 

GAO-06-453T, GAO-06-208T, GAO-05-753, and GAO-05-527T. 

Page 18 GAO-07-391T 
is improving or declining. IRS also has concerns with its information on 

whether taxpayers unintentionally or intentionally fail to comply with the 

tax laws. Knowing the reasons for taxpayer noncompliance can help IRS 

decide whether its efforts to address specific areas of noncompliance 

should focus on nonenforcement activities, such as improved forms or 

publications, or enforcement activities to pursue intentional 

noncompliance. To the extent that compliance data are outdated and IRS 

does not know the reason for taxpayer noncompliance, IRS may be less 

able to target resources efficiently to achieve the greatest tax gap 

reduction at the least taxpayer burden. 

IRS has taken important steps to better ensure efficient allocation and use.

For example, the NRP study has provided better data on which taxpayers 

are most likely to be noncompliant. IRS is using the data to improve its 

audit selection processes in hopes of reducing the number of audits that 

result in no change, which should reduce unnecessary burden on 

compliant taxpayers and increase enforcement staff productivity (as 

measured by direct enforcement revenue). 

As part of an effort to make the best use of its enforcement resources, IRS 

has developed rough measures of return on investment in terms of tax 

revenue that it assesses from uncovering noncompliance. Generally, IRS 

cites an average return on investment for enforcement of 4:1, that is, IRS 

estimates that it collects $4 in revenue for every $1 of funding. Where IRS 

has developed return on investment estimates for specific programs, it 

finds substantial variation depending on the type of enforcement action.

For instance, the ratio of estimated tax revenue gains to additional 

spending for pursuing known individual tax debts through phone calls is 

13:1, versus a ratio of 32:1 for matching the amount of income taxpayers 

report on their tax returns to the income amounts reported on information 

returns. In addition to returns on investment estimates being rough, IRS 

lacks information on the incremental returns on investment from pursuing

the “next best case” for some enforcement programs. It is the marginal 

revenue gain from these cases that matters in estimating the direct 

revenue from expanded enforcement. Developing such measures is 

difficult because of incomplete information on all the costs and all the tax 

revenue ultimately collected from specific enforcement efforts. Because 

IRS’s current estimates of the revenue effects of additional funding are 

imprecise, the actual revenue that might be gained from expanding 

different enforcement efforts is subject to uncertainty. 

Given the variation in estimated returns on investment for different types 

of IRS compliance efforts, the amount of tax gap reduction that may be 

Page 19 GAO-07-391T 
achieved from an increase in IRS’s resources would depend on how IRS 

allocates the increase. Although it might be tempting to allocate resources 

heavily toward areas with the highest estimated return, allocation 

decisions must take into account diverse and difficult issues. For instance, 

although one enforcement activity may have a high estimated return, that 

return may drop off quickly as IRS works its way through potential 

noncompliance cases. In addition, IRS dedicates examination resources 

across all types of taxpayers so that all taxpayers receive some signal that 

noncompliance is being addressed. Further, issues of fairness can arise if 

IRS focuses its efforts only on particular groups of taxpayers. 

Beyond direct tax revenue collection, expanded enforcement efforts could 

reduce the tax gap even more, as widespread agreement exists that IRS 

enforcement programs have an indirect effect through increases in 

voluntary tax compliance.32 The precise magnitude of the indirect effects 

of enforcement is not known with a high level of confidence given 

challenges in measuring compliance; developing reasonable assumptions 

about taxpayer behavior; and accounting for factors outside of IRS’s 

actions that can affect taxpayer compliance, such as changes in tax law. 

However, several research studies have offered insights to help better 

understand the indirect effects of IRS enforcement on voluntary tax 

compliance and show that they could exceed the direct effect of revenue

obtained.33

When taxpayers do not pay all of their taxes, honest taxpayers carry a 

greater burden to fund government programs and the nation is less able to

address its long-term fiscal challenges. Thus, reducing the tax gap is 

Concluding 

Observations 

 32Two types of indirect effect are (1) the increase in voluntary compliance in the larger 

population resulting from examinations or other enforcement and nonenforcement actions

on targeted taxpayers, and (2) the increase in voluntary compliance of the targeted 

taxpayer in subsequent years. 

33Economists have estimated the indirect effect of an examination on voluntary compliance 

to range from 6 to 12 times the amount of proposed tax adjustments. See Alan H. Plumley,

The Determinants of Individual Income Tax Compliance: Estimating The Impacts of 

Tax Policy, Enforcement, and IRS Responsiveness, Publication 1916 (Rev. 11-96) 

(Washington, D.C.: November 1996), 2, 35-36; Jeffrey A. Dubin, Michael J. Graetz, and Louis 

L. Wilde, “The Effect of Audit Rates on the Federal Individual Income Tax, 1977-1986,” 43

National Tax Journal, (1990), 395, 396, 405; and Jeffrey A. Dubin, “Criminal Investigation 

Enforcement Activities and Taxpayer Noncompliance” (paper written for the IRS Research

Conference, June 2004), http://www.irs.gov/pub/irs-soi/04dubin.pdf (downloaded July 1, 

2005). 

Page 20 GAO-07-391T 
important, even though closing the entire tax gap is neither feasible nor 

desirable because of costs and intrusiveness. All of the approaches I have

discussed have the potential to reduce the tax gap alone or in

combination, and no single approach is clearly and always superior to the

others. As a result, IRS needs a strategy to attack the tax gap on multiple 

fronts with multiple approaches. 

Mr. Chairman and Members of the Committee, this concludes my 

testimony. I would be happy to answer any question you may have at this 

time. 

For further information on this testimony, please contact Michael Brostek 

on (202) 512-9110 or brostekm@gao.gov. Contact points for our Offices of 

Congressional Relations and Public Affairs may be found on the last page 

of this testimony. Individuals making key contributions to this testimony 

include Tom Short, Assistant Director; Jeff Arkin; and Elizabeth Fan. 

Contact and 

Acknowledgments 

Page 21 GAO-07-391T (450565) 
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