IRS revises long-term estimate of ‘tax gap’

For the first time in five years, the Internal Revenue Service revised its long-term estimate of the tax gap, defined as the "amount of tax liability faced by taxpayers that is not paid on time."

In a report released Friday, the IRS put the latest figure at $450 billion as of the 2006 tax year, up from the oft-cited $345 billion figure based on 2001 data.

The compliance rate among taxpayers, however, remained steady at about 83 percent, and the agency cautioned that the estimated overall gap "is not an adequate guide to year-to-year changes in IRS programs or to year-to-year returns on IRS service and enforcement initiatives."

It also noted that underreporting income, more than failure to file or underpayment, accounts for most of the tax gap. The components of tax returns that rely on automatic reporting have the highest rates of compliance, while those without third-party confirmation have lower compliance rates and problems show up only in an audit. The widening of the gap also can be explained in part by improved data measurements, the IRS said.

"This report shows that closing the tax gap needs to be a major focus of tax reform," Senate Finance Committee Chairman Max Baucus, D-Mont., said in a statement. "In an era when we're squeezing the federal budget for every dollar of savings, we have to make every effort to recover these lost funds."

In arguing for a simpler code, Baucus said the $450 billion gap "represents a sum nearly four times the entire 2011 budget of the Department of Veterans Affairs." He cited a statement by the National Taxpayer Advocate that if the estimated $6 billion Americans spend on tax compliance were dedicated to a single industry, it would employ more than 3 million full-time employees.

The tax gap often is cited in debates over the IRS budget and enforcement staffing levels.

Colleen Kelley, president of the National Treasury Employees Union, last February praised the Obama administration's fiscal 2012 budget favoring increases for the IRS.

"This commitment by the White House reflects an understanding of the reality that every dollar invested in the IRS results in additional revenue to the treasury -- an absolutely critical element in attacking the federal deficit and the $345 billion gap between taxes owed and those paid," she said.

Following release of the new tax gap number, Kelley said: "Voluntary tax compliance rates can also be improved through increased customer service coupled with the knowledge that enforcement efforts will be heightened. The IRS brings in 93 percent of the country's revenue. It is imperative to appropriately fund IRS efforts to close the tax gap to help our nation reduce its deficit and to appropriately fund critical public services."

Other specialists, however, say tax code complexity is more of a factor than the quality of IRS enforcement efforts.

"Ultimately, every agency is resource-constrained," said Robert Kerr, senior director for government relations at the National Association of Enrolled Agents. "But we need to be careful of what the goal is. It's easy to say we want 100 percent compliance, but we wouldn't want to live in a country that achieved 100 percent compliance. So it's a question of balance."

Curtis Dubay, senior tax policy analyst at the Heritage Foundation, said, "the tax gap arises because of complexity. I don't think adding to the IRS workforce would do much. The cure is tax reform, to make the code simpler, fairer and more straightforward."