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 altogether or on time. 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. 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 excise tax nonfiling or for excise tax underreporting. 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. 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. 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 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. 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. 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. 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 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 $28 billion less; if it had been 90 percent, the gap would have been about $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. 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.