In January 2012, IRS estimated that the gross tax gap—the difference between taxes owed and taxes paid on time—was $450 billion in tax year 2006. IRS estimated that it would eventually recover about $65 billion of this amount through late payments and enforcement actions, leaving a net tax gap of $385 billion. The tax gap has been a persistent problem in spite of extensive congressional and IRS efforts to reduce it. In past work we have said that reducing the tax gap will not likely be achieved through a single solution. Rather, the tax gap must be attacked on multiple fronts and with multiple strategies over a sustained period of time. On the enforcement front, IRS’s efforts to ensure compliance of individual taxpayers combine several distinct programs that collectively monitor and correct noncompliance with income tax filing, reporting, and payment requirements. These programs fill different roles in the enforcement process and vary in the number of taxpayers covered, the resources used, and their level of automation. IRS’s Math Error program electronically checks all filed tax returns for obvious math errors as returns are processed. The Math Error program reviews and adjusts items specifically listed in Internal Revenue Code section 6213. The specific issues that the program has authority to review include calculation errors, entries that are inconsistent with or exceed statutory limits, various omissions, inclusions, and entries of information, or incorrect use of an IRS table. IRS collects information on taxpayers from employers, financial institutions, and other third parties and compiles these data in the Information Returns Processing (IRP) system. The Automated Underreporter (AUR) program electronically matches the IRP data against the information that taxpayers report on their forms 1040 as a means of identifying potentially underreported income or unwarranted deductions or tax credits. The matching process takes place months after taxpayers have filed their tax returns. For tax year 2010, AUR identified approximately 23.8 million potential discrepancies between taxpayer income, deduction, and other information reported by third parties and the information supplied by taxpayers on their individual income tax returns. IRS officials said that resource constraints prevent them from contacting taxpayers for all of the cases in which discrepancies are identified. If a mismatch exceeds a certain tax threshold, AUR reviewers decide if it warrants a notice to the taxpayer asking for an explanation of the discrepancy or payment of any additional tax assessed. IRS guidance directs reviewers to consider the reasonableness of the taxpayers’ responses, but reviewers generally do not examine the accuracy of the information in the responses because they do not have examination authority. For certain issues, AUR reviewers may refer cases for a correspondence examination. The Automated Substitute for Return (ASFR) program uses data from the IRP system to identify persons who did not file returns, construct tax returns for certain nonfilers, and assess tax, interest, and penalties based on those substitute returns. IRS does not pursue all of the constructed returns. Potential cases fall into one of ten priority levels and are worked highest-priority first. ASFR officials said they make budget decisions by taking into account the resources available to the program and determine the level of new cases that will be worked over the following year. In fiscal year 2011, the ASFR program closed nearly 1.4 million cases. Correspondence examinations are formal audits of individual taxpayers but do not involve face-to-face meetings with taxpayers. Instead, these examinations target specific issues that are limited in scope and complexity, easily documented, and can be handled quickly and efficiently through correspondence between the taxpayer and the IRS examiner. Tax returns are selected as potential cases through automated business rules that filter or select tax returns according to predetermined criteria. These business rules can detect multiple potential issues, all of which can be worked through a single correspondence exam. Examiners have the authority to review additional issues on a return even if they were not identified by the automatic filters. Field examinations are conducted in face-to-face meetings between the taxpayer and the IRS examiner. These audits are targeted at individual returns with broader and more complex issues. Unlike correspondence examinations, the field examination program has a classification process where an experienced tax examiner will review a potential case to determine which, if any, issues should be examined. Individual tax returns are selected for field examination in a variety of ways. Some returns are selected in the pursuit of specifically identified compliance issues, such as abusive transactions or offshore compliance. Others are selected on the basis of a statistical formula that attempts to predict the potential for additional tax assessments, and yet others are selected randomly for research purposes. Regardless of why the return was initially selected for audit, an examiner will review the return in its entirety to determine if other issues are present. The responsibility for operating these individual taxpayer enforcement programs largely rests with IRS’s Small Business/Self-Employed (SB/SE) Division, which handles complex individual returns, and Wage and Investment (W&I) Division, which handles simpler returns. SB/SE operates parts of all four IRP and exam programs; W&I operates parts of three programs, excluding field examinations. Correspondence and field exams accounted for more than 80 percent of the total administrative costs of the four programs we reviewed over the 2-year period we examined. (Total costs include direct examination time, training and other offline activities of examiners, supervisory and administrative support, and other overhead costs allocable to each program.) Based on data for hourly costs and time spent on different types of cases that IRS provided, we estimated that the cost per case for field exams, $2,278, was many times greater than those for correspondence exams, $274, AUR, $52, and ASFR, $72. (See fig. 1.) IRS spent almost 20 percent of the $1.6 billion per year that it devoted to exams opened in 2007 and 2008 on returns with positive income of at least $200,000, even though such returns accounted for only 3 percent of the 136 million individual income tax returns filed per year. The share of total cost for these returns was greater than their share of total returns because they were examined at above average rates and, compared to lower-income returns, field exams were a greater proportion of their examinations. (See fig. 2.) For the 2 years of cases we reviewed, exams (both correspondence and field) of taxpayers with positive incomes of at least $200,000 produced significantly more direct revenue per dollar of cost than exams of lower- income taxpayers. Across income groups, correspondence exams were significantly more productive than field exams in terms of discounted direct revenue per dollar of cost. (See fig. 3 and table 1 in app. II.) We estimated that the average direct revenue yield per dollar of cost across all correspondence exams of individual taxpayers was $7. In contrast, the average direct yield per dollar for field exams of individual taxpayers was $1.8. We also estimated that the direct revenue per dollar of cost was about $22 for AUR cases and about $31 for ASFR cases. Exams that are more complicated than average are likely to require both more time to complete and more highly skilled examiners, who cost more per hour. In estimating the results for field exams in figure 3, we incorporated differences in the amount of time spent on each field exam, which is recorded in the ERIS database, but we did not account for differences in hourly costs relating to varying skill levels of examiners across cases because the data available for that purpose were limited.Nevertheless, to test the potential sensitivity of our results to this missing factor, we estimated an alternative set of field exam results, using an ERIS data element that reflects the expected difficulty of an exam. We also tested the effect of differences in locality pay for field examiners in different geographic locations. (See app. I for further details.) We found that adjusting for skill levels likely reduces some of the differences in direct revenue per dollar of cost across field exam categories; adjusting for location has a negligible effect. (See table 3 in app. II.) IRS would be able to estimate ratios of direct revenue to cost that better incorporate differences in the hourly costs across examiners with different skill levels if data from IRS’s timekeeping system that records the number of hours that each employee charged to specific exam cases were matched to revenue data for the same cases. Our analysis of a hypothetical reallocation of IRS examination resources for this 2-year period indicates that a shift of about $124 million in enforcement resources could have increased direct revenue by $1 billion over the $5.5 billion per year IRS actually collected. This result is based on shifting the $124 million from exams of lower-income returns with the earned income tax credit (EITC) and lower-income business returns without EITC to exams of higher-income returns and lower-income nonbusiness returns without EITC. The result holds true as long as the average ratio of direct revenue to cost for each category of returns remained unchanged. (See fig. 4.) Similar gains would recur annually, relative to the revenue that IRS otherwise would collect if it did not change its resource allocation and taxpayer behavior remained substantially the same. We took account of several constraints when designing our hypothetical resource reallocation example. First, we did not want to suggest a large- scale change because some reallocations cannot be made quickly, particularly if they require a different distribution of examiner skills than exists in IRS’s current workforce. The $124 million that we shifted represents less than 8 percent of the $1.6 billion per year that IRS devoted to examinations of individual tax returns for the 2 years we studied and we shifted less than 5 percent of existing field exam resources ($1.1 billion per year) to correspondence exams. Second, we did not want to end up with extreme coverage rates (either high or low) in any return category.