Narrowing the Tax Gap

1
Narrowing the Tax Gap

• James B. Mackie III
• Director, Revenue Estimating Division
• Office of Tax Analysis
• U.S. Treasury

2
Disclaimer

• Any views or opinions are my own and do not
  necessarily reflect the official views of the
  U.S. Treasury.

3
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.

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Tax Gap Background
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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

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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.
• Cant 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.

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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.

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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.

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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).

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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.

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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 governments net fiscal
  position would be smaller because of the cost of
  collection.

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Treasurys Tax Gap StrategyFour 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.

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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.

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Implementing the Treasury Strategies

• Made some progress on all fronts.

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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.

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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).

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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.

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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.

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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.

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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.

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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.

22
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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.