Tax Compliance: Reducing the Tax Gap Can Contribute to Fiscal	 
Sustainability but Will Require a Variety of Strategies 	 
(14-APR-05, GAO-05-527T).					 
                                                                 
The Internal Revenue Service's (IRS) recent estimate of the	 
difference between what taxpayers timely and accurately paid in  
taxes and what they owed ranged from $312 billion to $353 billion
for tax year 2001. IRS estimates it will eventually recover some 
of this tax gap, resulting in a net tax gap from $257 billion to 
$298 billion. The tax gap arises when taxpayers fail to comply	 
with the tax laws by underreporting tax liabilities on tax	 
returns; underpaying taxes due from filed returns; or		 
"nonfiling," which refers to the failure to file a required tax  
return altogether or in a timely manner. The Chairman and Ranking
Minority Member of the Senate Committee on Finance asked GAO to  
review a number of issues related to the tax gap. This testimony 
will address GAO's longstanding concerns regarding tax		 
compliance; IRS's efforts to ensure compliance; and the 	 
significance of reducing the tax gap, including some steps that  
may assist with this challenging task. For context, this	 
testimony will also address GAO's most recent simulations of the 
long-term fiscal outlook and the need for a fundamental 	 
reexamination of major spending and tax policies and priorities. 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-527T					        
    ACCNO:   A21680						        
  TITLE:     Tax Compliance: Reducing the Tax Gap Can Contribute to   
Fiscal Sustainability but Will Require a Variety of Strategies	 
     DATE:   04/14/2005 
  SUBJECT:   Delinquent taxes					 
	     Future budget projections				 
	     Noncompliance					 
	     Personal income taxes				 
	     Strategic planning 				 
	     Tax administration 				 
	     Tax law						 
	     Tax returns					 
	     Tax violations					 
	     Taxpayers						 
	     Economic analysis					 
	     Policy evaluation					 
	     Econometric modeling				 
	     Fiscal policies					 
	     Law enforcement					 
	     Tax losses 					 
	     GAO High Risk Series				 
	     IRS National Research Program			 
	     IRS Taxpayer Compliance Measurement		 
	     Program						 
                                                                 
	     Medicare Program					 
	     Social Security Program				 

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GAO-05-527T

                 United States Government Accountability Office

                                 GAO Testimony

Before the Committee on Finance, U.S. Senate

For Release on Delivery Expected at 10:00 a.m. EDT Thursday, April 14,
2005

TAX COMPLIANCE

Reducing the Tax Gap Can Contribute to Fiscal Sustainability but Will Require a
                             Variety of Strategies

Statement of David M. Walker Comptroller General of the United States

                                       A

GAO-05-527T

[IMG]

April 14, 2005

TAX COMPLIANCE

Reducing the Tax Gap Can Contribute to Fiscal Sustainability but Will Require a
Variety of Strategies

                                 What GAO Found

Our nation's fiscal policy is on an unsustainable course. As long-term
budget simulations by GAO, the Congressional Budget Office, and others
show, over the long term we face a large and growing structural deficit
due primarily to known demographic trends and rising health care costs.
All simulations indicate that the long-term fiscal challenge is too big to
be solved by economic growth alone or by making modest changes to existing
spending and tax policies. Rather, a fundamental reexamination of major
policies and priorities will be important to recapture our fiscal
flexibility. Especially relevant to this committee will be deciding
whether and how to change current tax policies and how to ensure that tax
compliance is as high as practically possible. Tax law enforcement is one
factor affecting compliance that has caused concern in the past, due in
part to declines in IRS enforcement occupations, examinations, and other
enforcement results. The recent turnaround in staffing and some
enforcement results is good news, but IRS's recent compliance estimate
indicates that compliance levels have not improved and may be worse than
it originally estimated. Thus, sustained progress in improving compliance
is needed.

Reducing the tax gap would help improve fiscal sustainability, but will be
challenging given persistent noncompliance. This task 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, including reducing tax code complexity, providing quality services
to taxpayers, enhancing enforcement of tax laws, and evaluating the
success of IRS's efforts to promote compliance. Also important is
obtaining current information on the extent of, and reasons for,
noncompliance. IRS's 2001 tax gap estimate is based in part on recently
collected compliance data for individual income tax underreporting.
However, IRS does not have firm plans to obtain compliance data for other
areas of the tax gap or again collect data on individual income tax
underreporting. Finally, IRS lacks quantitative, long-term goals for
improving taxpayer compliance, which would be consistent with
results-oriented management.

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 Individual Corporate                            
      noncompliance     income    income Employment Estate   Excise     Total 
                                                                 No 
                                                           estimate $250-$292 

            Underreporting $150-$187    $30    $66-$71  $4          
              Underpayment         19        2        7  2        1       $32 
                                            No    No             No 
                 Nonfiling         28 estimate estimate  2 estimate       $30 
                     Total $198-$234    $32    $73-$78  $8       $1 $312-$353 

Source: IRS.

Note: Figures may not sum to totals due to rounding.

United States Government Accountability Office

Chairman Grassley, Senator Baucus, and Members of the Committee:

I appreciate this opportunity to discuss the annual tax gap-the difference
between what taxpayers timely and accurately pay in taxes and what they
should pay under the law-and how reducing that gap can help the nation
cope with its large and growing long-term fiscal challenges. Most
recently, the Internal Revenue Service (IRS) estimated a gross tax gap
from $312 billion to $353 billion for tax year 2001.1 IRS estimated that
it would eventually recover some of this amount through late payments and
IRS enforcement actions, resulting in an estimated "net" tax gap for 2001
from $257 billion to $298 billion.2 The tax gap arises when taxpayers fail
to comply with the tax laws, either intentionally or unintentionally. As a
result of their noncompliance, the burden of funding the nation's
commitments, including funding growing budgetdeficits, falls more heavily
on taxpayers who voluntarily pay their taxes. In addition, IRS expends
substantial resources enforcing and explaining tax laws, with the goals of
increasing compliance and reducing the tax gap.

For context in considering the tax gap, I will first provide the committee
with the results of our most recent simulations of the long-term fiscal
outlook. I will also discuss briefly the need for a fundamental
reexamination of major spending and tax policies and priorities that will
be important to recapturing our fiscal flexibility and updating our
programs and priorities to respond to emerging social, economic, and
security challenges. Next, I will discuss our long-standing concerns
regarding tax compliance and IRS's efforts to ensure compliance. Finally,
I will discuss the significance of reducing the tax gap and a number of
issues related to this challenging task, including various means to
potentially improve compliance, measuring the extent of the tax gap, IRS's
understanding of the reasons why taxpayers are noncompliant, and IRS's
plans and strategies for reducing the gap. My remarks are based on our
previous reports on a variety of issues as well as work we are performing
for this committee on the tax gap, which we will address in greater detail
in a forthcoming report, and will be performed under generally accepted
government auditing standards.

1IRS's most recent estimates of the tax gap are preliminary, and as such,
IRS presents them as ranges.

2Throughout this report, references to the tax gap refer to the gross tax
gap unless otherwise noted.

Let me begin by highlighting several major points:

o The overall picture on the long-term fiscal outlook is not news to this
committee. Simply put, our nation's fiscal policy is on an imprudent and
unsustainable course. In addition, our long-term fiscal gap grew much
larger in fiscal year 2004. Long-term budget simulations by GAO, the
Congressional Budget Office (CBO), and others show that over the long term
we face large and growing structural deficits due primarily to known
demographic trends and rising health care costs. Continuing on this
unsustainable fiscal path will gradually erode, if not suddenly damage,
our economy, our standard of living, and ultimately our national security.
Our current path also will increasingly constrain our ability to address
emerging and unexpected budgetary needs and increase the burdens that will
be faced by our children, grandchildren, and future generations.

o Regardless of the assumptions used, all simulations indicate that the
long-term fiscal challenge is too big to be solved by economic growth
alone or by making modest changes to existing spending and tax policies.
Rather, a fundamental reexamination of major spending and tax policies and
priorities will be important to recapturing our fiscal flexibility and
updating our programs and priorities to respond to emerging social,
economic, and security challenges. Ultimately, this reexamination will
need to entail a national discussion about what Americans want from their
government and how much they are willing to pay for those things.
Especially relevant to this committee will be determining whether and how
to change our current tax policies- including the type of tax base, the
degree of progressivity in our tax system, or the extent of tax
preferences in our system-and how to ensure that compliance with any tax
system we may choose is as high as practically possible.

o We have long been concerned about tax noncompliance and IRS's efforts to
address it. Since 1990 we have had various aspects of tax noncompliance on
our high-risk list, and this year we have affirmed our broad concern by
consolidating two prior high-risk areas into one- Enforcement of Tax Laws.
Tax law enforcement is a high-risk area in part because past declines in
IRS's enforcement activities threatened to erode taxpayer compliance.
Declines in key IRS enforcement occupations and examinations and other
enforcement results reinforce

the need to focus greater attention on tax compliance.3 The turnaround
that has begun in staffing and some enforcement results is good news.
However, IRS's preliminary new compliance estimate indicates that
compliance has not improved and may be worse than IRS originally
estimated. Therefore, sustained progress in improving compliance is
needed.

o Reducing the current tax gap would contribute to our fiscal
sustainability while simultaneously improving fairness for those citizens
who fully and timely meet their tax obligations. Although closing the
entire tax gap is not practical, even modest reductions will have very
significant financial benefits-each 1 percent reduction in the tax gap
that we could achieve would likely generate more than $2.5 billion in
revenue annually to help reduce deficits and/or fund our most pressing
national priorities. Reducing the tax gap will be a challenging task given
persistent levels of noncompliance and 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. These
strategies could include efforts to simplify the tax code, provide quality
services to taxpayers, and utilize enforcement tools such as tax
withholding and information reporting.

o Regularly measuring the extent and nature of noncompliance is critical
to effective efforts to reduce the tax gap given changes in the economy
and tax law. A significant portion of IRS's preliminary tax gap estimate
for 2001 is based on recently collected compliance data on individual
income tax reporting, which accounts for nearly 50 percent of the tax gap.
However, for some areas of the tax gap, the estimate relies on outdated
data and methodologies, including data from the 1970s and 1980s used to
estimate corporate income tax underreporting and some employment tax
underreporting. IRS does not have firm plans for obtaining more
contemporary information on compliance for these areas of the tax gap or
again measuring individual income reporting compliance. Further, IRS has
missed opportunities to develop a better understanding of why taxpayers
were noncompliant, which can guide IRS in determining what tools and
techniques to use to address noncompliance. Finally, IRS's strategies for
improving compliance do not have the clear focus on quantitative long-term
goals and results

3GAO, Internal Revenue Service: Assessment of Fiscal Year 2006 Budget
Request and the Interim Results of the 2005 Filing Season, GAO-05-416T
(Washington, D.C.: Apr. 14, 2005).

measurement that are associated with high-performing organizations and
that are incorporated into statutory management framework Congress has
adopted.

BackgroundThe 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 timely and accurately paid 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 timely.4 Estimates for each type of
noncompliance include estimates for some or all of the five types of taxes
that IRS administers.

IRS develops its tax gap estimates by measuring the rate of taxpayer
compliance-the degree to which taxpayers fully and timely complied with
their tax obligations. That rate is then used, along with other data and
assumptions, to estimate the dollar amount of taxes not timely and
accurately paid. For instance, IRS recently estimated that for tax year
2001, from 83.4 percent to 85 percent of owed taxes were paid voluntarily
and timely, which translated into an estimate gross tax gap from $312
billion to $353 billion in taxes not paid that should have been. IRS also
estimates the amount of the unpaid taxes that it will recover through
enforcement and other actions and subtracts that to estimate the net
annual tax gap. For tax year 2001, IRS estimated that it would eventually
recover about $55 billion for a net tax gap from $257 billion to $298
billion.

IRS has estimated the tax gap on multiple occasions, beginning in 1979.
IRS's earlier tax gap estimates relied on the Taxpayer Compliance
Measurement Program (TCMP), through which IRS periodically performed
line-by-line examinations of randomly selected tax returns. TCMP started
with tax year 1963 and examined individual returns most frequently-
generally every 3 years-through tax year 1988. IRS contacted all taxpayers
selected for TCMP studies. IRS did not implement any TCMP

4Taxpayers 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 timely.

studies after 1988 because of concerns about costs and burdens on
taxpayers.5

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 while minimizing taxpayer burden.6 Under NRP,a program
that we haveencouraged, IRS recently completed its initial review of about
46,000 randomly selected individual tax returns from tax year 2001. Unlike
with TCMP studies, IRS did not need to contact taxpayers for every tax
return selected under NRP; handled some taxpayer contacts through
correspondence, as opposed to face-to-face examinations; and during
face-to-face examinations, generally only asked taxpayers to explain
information that it was otherwise unable to verify through IRS and
third-party databases.

IRS has a strategic planning process through which it supports decisions
about strategic goals, program development, and resource allocation. Under
the Government Performance and Results Act of 1993 (GPRA),7 agencies are
to develop strategic plans as the foundation for results
oriented management. GPRA requires that agency strategic plans identify
long-term goals, outline strategies to achieve the goals, and describe how
program evaluations were used to establish or revise the goals. GPRA
requires federal agencies to establish measures to determine the results
of their activities.

  Long-term Fiscal Challenge Provides Impetus to Reexamine Tax Policies and
  Compliance

The nation is facing a range of important new forces that are already
working to reshape American society, our place in the world, and the role
of the federal government. Our capacity to address these and other
emerging needs and challenges will be predicated on when and how we deal
with our fiscal challenges-the long-term fiscal pressures we face are
daunting and unprecedented in the nation's history. As this committee is
well aware, the size and trend of our projected longer-term deficits means
that the nation cannot ignore the resulting fiscal pressures-it is not a

5GAO, Tax Administration: Status of IRS' Efforts to Develop Measures of
Voluntary Compliance, GAO-01-535 (Washington, D.C.: June 18, 2001).

6GAO, Tax Administration: New Compliance Research Effort Is on Track, but
Important Work Remains, GAO-02-769 (Washington, D.C.: June 27, 2002).

7Pub. L. No. 103-62 (1993).

matter of whether the nation deals with the fiscal gap, but when and how.
Unless we take effective and timely action, our near-term and longer-term
deficits present the prospect of chronic and seemingly perpetual budget
shortfalls and constraints becoming a fact of life for years to come. Not
only would continuing deficits eat away at the capacity of everything the
government does, but they will erode our ability to address the wide range
of emerging needs and demands competing for a share of a shrinking budget
pie.

Our long-term simulations illustrate the magnitude of the fiscal
challenges we will face in the future. Figures 1 and 2 present these
simulations under two different sets of assumptions. In the first, we
begin with CBO's January 2005 baseline--constructed according to the
statutory requirements for that baseline.8 Consistent with these
requirements, discretionary spending is assumed to grow with inflation for
the first 10 years and tax cuts scheduled to expire are assumed to expire.
After 2015, discretionary spending is assumed to grow with the economy,
and revenue is held constant as a share of gross domestic product (GDP) at
the 2015 level. In the second figure, two assumptions are changed: (1)
discretionary spending is assumed to grow with the economy after 2005
rather than merely with inflation and (2) all temporary tax cuts are
extended. For both simulations, Social Security and Medicare spending is
based on the 2005 Trustees' intermediate projections, and we assume that
benefits continue to be paid in full after the trust funds are exhausted.

8Congressional Budget Office, The Budget and Economic Outlook: Fiscal
Years 2006 to 2015 (Washington, D.C.: January 2005).

Figure 1: Composition of Spending as a Share of GDP under Baseline
Extended

Percent of GDP

50

40

30  Revenue

20

10

0 2004 2015 2030 2040 Fiscal year

Net interest

Social Security

Medicare and Medicaid

All other spending

Source: GAO's March 2005 analysis.

Note: In addition to the expiration of tax cuts, revenue as a share of GDP
increases through 2015 due to (1) real bracket creep, (2) more taxpayers
becoming subject to the Alternative Minimum Tax (AMT), and (3) increased
revenue from tax-deferred retirement accounts. After 2015, revenue as a
share of GDP is held constant.

Figure 2: Composition of Spending as a Share of GDP Assuming Discretionary
Spending Grows with GDP after 2005 and All Expiring Tax Provisions Are
Extended

Percent of GDP 50

40

30

20

10

0 2004 2015 2030 2040 Fiscal year

Net interest

Social Security

Medicare and Medicaid

All other spending

Source: GAO's March 2005 analysis.

Note: Although expiring tax provisions are extended, revenue as a share of
GDP increases through 2015 due to (1) real bracket creep, (2) more
taxpayers becoming subject to the AMT, and (3) increased revenue from
tax-deferred retirement accounts. After 2015, revenue as a share of GDP is
held constant.

As both these simulations illustrate, absent policy changes on the
spending or revenue side of the budget, the growth in spending on federal
retirement and health entitlements will encumber an escalating share of
the government's resources. Indeed, when we assume that recent tax
reductions are made permanent and discretionary spending keeps pace with
the economy, our long-term simulations suggest that by 2040 federal
revenues may be adequate to pay little more than interest on the federal
debt. Neither slowing the growth in discretionary spending nor allowing
the tax provisions to expire-nor both together-would eliminate the
imbalance. Although revenues will be part of the debate about our fiscal
future, assuming no further borrowing, making no changes to Social
Security, Medicare, Medicaid, and other drivers of the long-term fiscal
gap would require at least a doubling of taxes, and that seems highly

implausible. Such significant tax increases would also likely have an
adverse effect on economic growth and disposable income available to
Americans. Accordingly, substantive reform of Social Security and our
major health programs remains critical to recapturing our future fiscal
flexibility.

Although considerable uncertainty surrounds long-term budget projections,
we know two things for certain: the population is aging and the baby boom
generation is approaching retirement age. The aging population and rising
health care spending will have significant implications not only for the
budget but also the economy as a whole. Figure 3 shows the total future
draw on the economy represented by Social Security, Medicare, and
Medicaid. Under the 2005 Trustees' intermediate estimates and CBO's
long-term Medicaid estimates, spending for these entitlement programs
combined will grow to 15.2 percent of GDP in 2030 from today's 8.5
percent. It is clear that taken together Social Security, Medicare, and
Medicaid represent an unsustainable burden on future generations.

Figure 3: Social Security, Medicare, and Medicaid Spending as a Percent of
GDP

Percent of GDP

30

25

20

15

10

5

0 2000 2010 2020 2030 2040 2050 2060 2070 2080

Medicare

Medicaid

Social Security

Source: GAO analysis based on data from the Office of the Chief Actuary,
Social Security Administration, Office of the Actuary, Centers for
Medicare and Medicaid Services, and the Congressional Budget Office.

Notes: Social Security and Medicare projections based on the intermediate
assumptions of the 2005 Trustees' Reports. Medicaid projections based on
CBO's January 2005 short-term Medicaid estimates and CBO's December 2003
long-term Medicaid projections under mid-range assumptions.

Early action to change these programs would yield the highest fiscal
dividends for the federal budget and would provide a longer period for
prospective beneficiaries to make adjustments in their own planning.
Waiting to build economic resources and reform future claims entails
risks. First, we lose an important window during which today's relatively
large workforce can increase saving and enhance productivity, two elements
critical to growing the future economy. We also lose the opportunity to
reduce the burden of interest in the federal budget, thereby creating a
legacy of higher debt as well as elderly entitlement spending for the
relatively smaller workforce of the future. Most critically, we risk
losing the opportunity to phase in changes gradually so that all can make
the adjustments needed in private and public plans to accommodate this
historic shift. Unfortunately, the long-range challenge has become more
difficult, and the window of opportunity to address the entitlement
challenge is narrowing.

A Fundamental Review, Reexamination, and Reprioritization Is Needed

Confronting the nation's fiscal challenge will require nothing less than a
fundamental review, reexamination, and reprioritization of all major
spending and tax policies and programs that may take a generation or more
to resolve. Traditional incremental approaches to budgeting will need to
give way to more fundamental and periodic reexaminations of the base of
government. Many, if not most, current federal programs and policies were
designed decades ago to respond to trends and challenges that existed at
the time of their creation. If government is to respond effectively to
21st century trends, it cannot accept what it does, how it does it, who
does it, and how it gets financed as "given." Not only do outmoded
commitments, operations, choices of tools, management structures, and tax
programs and policies constitute a burden on future generations, but they
also erode the government's capacity to align itself with the needs and
demands of the 21st century.

Reexamining the base of government will be a challenging task, and we at
GAO believe we have an obligation to assist and support Congress in this
endeavor. To that end, we recently issued a report9 that provides examples
of the kinds of difficult choices the nation faces with regard to
discretionary spending; mandatory spending, including entitlements; as
well as tax policies and compliance activities. Regarding tax policy, a
debate is under way about the future of our tax system that is partly
about whether the goals for the nation's tax system can be best achieved
using the current structure or a fundamentally reformed tax structure. The
debate is also motivated by increasing globalization, the growing
complexity of our tax system, and the growing use of tax preferences whose
aggregate revenue loss has exceeded all discretionary spending in 5 of the
past 10 years.

Although outside the scope of this hearing, today's pressing tax
challenges raise important questions. For example:

o 	Given our current tax system, what tax rate structure is more likely to
raise sufficient revenue to fund government and satisfy the public's
perception of fairness?

9GAO, 21st Century Challenges: Reexamining the Base of the Federal
Government, GAO05-325SP (Washington, D.C.: Feb. 2005).

o 	Which tax preferences need to be reconsidered because they fail to
achieve the objectives intended by the Congress, their costs outweigh
their benefits, they duplicate other programs, or other more cost
effective means exist for achieving their objectives?

o 	Should the basis of the existing system be changed from an income to a
consumption base? Would such a change help respond to challenges posed by
demographic, economic, and technological changes? How would such a change
affect savings and work incentives? How would reforms address such issues
as the impact on state and local tax systems and the distribution of
burden across the nation's taxpayers?

Regarding compliance with our tax laws, the success of our tax system
hinges greatly on the public's perception of its fairness and
understandability. Compliance is influenced not only by the effectiveness
of IRS's enforcement efforts but also by Americans' attitudes about the
tax system and their government. A recent survey indicated that about 12
percent of respondents say it is acceptable to cheat on their taxes.
Furthermore, the complexity of, and frequent revisions to, the tax system
make it more difficult and costly for taxpayers who want to comply to do
so and for IRS to explain and enforce tax laws. Complexity also creates a
fertile ground for those intentionally seeking to evade taxes and often
trips others into unintentional noncompliance. The lack of transparency
also fuels disrespect for the tax system and the government. Thus, a
crucial challenge for reexamination will be to determine how we can best
strengthen enforcement of existing laws to give taxpayers confidence that
their friends, neighbors, and business competitors are paying their fair
share.

Enforcement of Tax Laws Is on GAO's High-Risk List

We have long been concerned about tax noncompliance and IRS efforts to
address it. Collection of unpaid taxes was included in our first high-risk
series report in 1990, with a focus on the backlog of uncollected debts
owed by taxpayers. In 1995, we added Filing Fraud as a separate high-risk
area, narrowing the focus of that high-risk area in 2001 to Earned Income
Credit Noncompliance because of the particularly high incidence of fraud
and other forms of noncompliance in that program. We expanded our concern
about the Collection of Unpaid Taxes in our 2001 high-risk report to
include not only unpaid taxes (including tax evasion and unintentional
noncompliance) known to IRS, but also the broader enforcement issue of
unpaid taxes that IRS has not detected. In our high-risk update that we

issued in January,10 we consolidated these areas into a single high-risk
area-Enforcement of the Tax Laws-because we believe the focus of concern
on the enforcement of tax laws is not confined to any one segment of the
taxpaying population or any single tax provision.

Tax law enforcement is a high-risk area in part because past declines in
IRS's enforcement activities threatened to erode taxpayer compliance. In
recent years, the resources IRS has been able to dedicate to enforcing the
tax laws have declined. For example, the number of revenue agents (those
who examine complex returns), revenue officers (those who perform field
collection work), and special agents (those who perform criminal
investigations) decreased over 21 percent from 1998 through 2003. However,
IRS achieved some staffing gains in 2004 and expects modest gains in 2005.
IRS's proposal for fiscal year 2006, if funded and implemented as planned,
would return enforcement staffing in these occupations to their highest
levels since 1999.11

Concurrently, IRS's enforcement workload-measured by the number of
taxpayer returns filed-has continually increased. For example, from 1997
through 2003, the number of individual income tax returns filed increased
by about 8 percent. Over the same period, returns for high income
individuals grew by about 81 percent.12 Due to their income levels, IRS
believes that these individuals present a particular compliance risk. In
light of declines in enforcement staffing and the increasing number of
returns filed, nearly every indicator of IRS's coverage of its enforcement
workload has declined in recent years. Although in some cases workload
coverage has begun to increase, overall IRS's coverage of known workload
is considerably lower than it was just a few years ago. Figure 4 shows the
trend in examination rates-the proportion of tax returns that IRS examines
each year-for field, correspondence, and total examinations since 1995.
Field examinations involve face-to-face examinations and correspondence
examinations are typically less comprehensive and complex, involving
communication through written notices. IRS experienced steep declines in
examination rates from 1995 to 1999, but the

10GAO, High-Risk Series: An Update, GAO-05-207 (Washington, D.C.: January
2005).

11GAO-05-416T.

12High income individual taxpayers are those reporting $100,000 or more of
"total positive income," which is, in general, the sum of all positive
amounts shown for the various sources of income reported on individual tax
returns and thus excludes net losses.

examination rate has slowly increased since 2000. However, as the figure
shows, the increase in total examination rates of individual filers has
been driven mostly by correspondence examinations, while more complex
field examinations continue to decline.

Figure 4: Examination Rate for Individual Income Tax Returns, Fiscal Years
1995

2004

Examination rate

2.0

1.8

1.6

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Fiscal year

Field Correspondence Total

Source: GAO analysis of IRS data.

On the collection front, IRS's use of enforcement sanctions, such as
liens, levies, and seizures, dropped precipitously during the mid-and late
1990s. In fiscal year 2000, IRS's use of these three sanctions was at 38
percent, 7 percent, and 1 percent, respectively, of fiscal year 1996
levels. However, beginning in fiscal year 2001, IRS's use of liens and
levies began to

increase.13 By fiscal year 2004, IRS's use of liens, levies, and seizures
reached 71 percent, 65 percent, and 4 percent of 1996 levels,
respectively.

Further, IRS's workload has grown ever more complex as the tax code has
grown more complex. IRS is challenged to administer and explain each new
provision, thus absorbing resources that otherwise might be used to
enforce the tax laws. Concurrently, other areas of particularly serious
noncompliance have gained the attention of IRS and Congress, such as
abusive tax shelters and schemes employed by businesses and wealthy
individuals that often involve complex transactions that may span national
boundaries. Given the broad declines in IRS's enforcement workforce, IRS's
decreased ability to follow up on suspected noncompliance, and the
emergence of sophisticated evasion concerns, IRS is challenged in
attempting to ensure that taxpayers fulfill their obligations.

IRS is working to further improve its enforcement efforts. In addition to
recent favorable trends in enforcement staffing, correspondence
examinations, and the use of some enforcement sanctions, IRS has recently
made progress with respect to abusive tax shelters through a number of
initiatives and recent settlement offers that have resulted in billions of
dollars in collected taxes, interest, and penalties. In addition, IRS is
developing a centralized cost accounting system, in part to obtain better
cost and benefit information on compliance activities, and is modernizing
the technology that underpins many core business processes. It has also
redesigned some compliance and collections processes and plans additional
redesigns as technology improves. Finally, the recently completed NRP
study of individual taxpayers not only gives us a benchmark of the status
of taxpayers' compliance but also gives IRS a better basis to target its
enforcement efforts. However, IRS's preliminary compliance estimate based
on NRP indicates that compliance has not improved and may be worse than
IRS originally estimated. As such, sustained progress toward improving
compliance is needed.

13We made a number of recommendations to improve and expand IRS's levy
efforts. See GAO, Tax Administration: IRS's Levy of Federal Payments Could
Generate Millions of Dollars, GAO/GGD-00-65 (Washington, D.C.: Apr. 7,
2000), and Tax Administration: Millions of Dollars Could Be Collected if
IRS Levied More Federal Payments, GAO-01-711 (Washington, D.C.: July 20,
2001).

    Multiple Service and Enforcement Strategies, Periodic Compliance
    Measurement, and A Results-Oriented Compliance Approach May Help IRS Reduce
    the Tax Gap

Reducing the tax gap would be a step toward improving our fiscal
sustainability while simultaneously enhancing fairness for those citizens
who meet their tax obligations. That said, reducing the tax gap is a
challenging task, and closing the entire tax gap is not practical.
Reducing the tax gap will not likely be achieved through a single
solution, but will likely involve multiple strategies that include
reducing tax code complexity, providing quality services to taxpayers, and
enhancing enforcement of the tax laws through the use of tools such as tax
withholding and information reporting that increase the transparency of
income and deductions to both IRS and taxpayers. Also, as IRS moves
forward in continuing to address the tax gap, building and maintaining a
base of information on the extent of, and reasons for, noncompliance as
well as defining desired changes in the tax gap and measuring results of
efforts to address it will be critical.

Reducing the Tax Gap Could Have a Positive Fiscal Impact but Will Require
Multiple Strategies

Given its size, even small or moderate reductions in the net tax gap could
yield substantial returns. For example, based on IRS's most recent
estimate, each 1 percent reduction in the net tax gap would likely yield
more than $2.5 billion annually. Thus, a 10 percent to 20 percent
reduction of the net tax gap would translate into from $25 billion to $50
billion or more in additional revenue annually.14

Although reducing the tax gap may be an attractive means to improve the
nation's fiscal position, achieving this end will be a challenging task
given persistent levels of noncompliance. IRS has made efforts to reduce
the tax gap since the early 1980s; yet the tax gap is still large-although
without these efforts it could be even larger. Also, IRS is challenged in
reducing the tax gap because the tax gap is spread across the five
different types of taxes that IRS administers, and a substantial portion
of the tax gap is attributed to taxpayers who are not subject to
withholding or information reporting requirements. Moreover, as we have
reported in the past,15 closing the entire tax gap may not be feasible nor
desirable, as it could

14Any significant reduction of the tax gap would likely depend on an
improvement in the level of taxpayer compliance. 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 simply because the amount of tax that should
be paid has been reduced, even if the level of compliance remains
unchanged.

15GAO, Taxpayer Compliance: Analyzing the Nature of the Income Tax Gap,
GAO/T-GGD97-35 (Washington, D.C.: Jan. 9, 1997).

entail more intrusive recordkeeping or reporting than the public is
willing to accept or more resources than IRS is able to commit.

Although much of the tax gap that IRS currently recovers is through
enforcement actions, a sole focus on enforcement will not likely be
sufficient to further reduce the net tax gap. Rather, the tax gap must be
attacked on multiple fronts and with multiple strategies on a sustained
basis. For example, efforts to simplify the tax code and otherwise alter
current tax policies may help reduce the tax gap by making it easier for
individuals and business to understand and voluntarily comply with their
tax obligations. For instance, reducing the multiple tax preferences for
retirement savings or education assistance might ease taxpayers' burden in
understanding and complying with the rules associated with these options.
Also, simplification may reduce opportunities for tax evasion through
vehicles such as abusive tax shelters. However, for any given set of tax
policies, IRS's efforts to reduce the tax gap and ensure appropriate
levels of compliance will need to be based on a balanced approach of
providing service to taxpayers and enforcing the tax laws.

Furthermore, providing quality services to taxpayers is an important part
of any overall strategy to improve compliance and thereby reduce the tax
gap. As we have reported in the past,16 one method of improving compliance
through service is to educate taxpayers about confusing or commonly
misunderstood tax requirements. For example, if the forms and instructions
taxpayers use to prepare their taxes are not clear, taxpayers may be
confused and make unintentional errors. One method to ensure that forms
and instructions are sufficiently clear is to test them before use.
However, we reported in 2003 that IRS had tested revisions to only five
individual forms and instructions from July 1997 through June 2002,
although hundreds of forms and instructions had been revised in 2001
alone.17

Finally, in terms of enforcement, IRS will need to use multiple strategies
and techniques to find noncompliant taxpayers and bring them into
compliance. However, a pair of tools has been shown to lead to high levels
of compliance: withholding tax from payments to taxpayers and having

16GAO/T-GGD-97-35.

17GAO, Tax Administration: IRS Should Reassess the Level of Resources for
Testing Forms and Instructions, GAO-03-486 (Washington, D.C.: Apr. 11,
2003).

third parties report information to IRS and the taxpayers on income paid
to taxpayers. For example, banks and other financial institutions provide
information returns (Forms 1099) to account holders and IRS showing the
taxpayers' annual income from some types of investments. Similarly, most
wages, salaries, and tip compensation are reported by employers to
employees and IRS through Form W-2. Preliminary findings from NRP indicate
that more than 98.5 percent of these types of income are accurately
reported on individual returns.

In the past, we have identified a few potential areas where additional
withholding or information reporting requirements could serve to improve
compliance:18

o 	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 separately report on their tax
returns the total amount of payments to independent contractors.19

o 	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 1997,20 payments made by
others to corporations are generally not covered by information returns.

18GAO, Tax Gap: Many Actions Taken, but a Cohesive Compliance Strategy
Needed, GAO/GGD-94-123 (Washington, D.C.: May 11, 1994).

19GAO, Tax Administration: Approaches for Improving Independent Contractor
Compliance, GAO/GGD-92-108 (Washington, D.C.: July 23, 1992).

20Taxpayer Relief Act of 1997, Pub. L. No. 105-34 (1997).

o 	Require more data on information returns dealing with capital gain
income. Past IRS studies have indicated that much of the noncompliance
associated with capital gains is a result of taxpayers overstating an
asset's "basis," the amount of money originally paid for the asset.
Currently, financial institutions are required to report the sales prices,
but not the purchase prices, of stocks and bonds on information returns.
Without information on purchase prices, IRS cannot use efficient and
effective computer-matching programs to check for compliance and must use
much more costly means to examine taxpayer returns in order to verify
capital gain income.

Although withholding and information returns are highly effective in
encouraging compliance, such additional requirements generally impose
costs and burdens on the businesses that must implement them. However,
continued reexamination of opportunities to expand information reporting
and tax withholding could increase the transparency of the tax system.
Such reexamination could be especially relevant toward improving
compliance in areas that are particularly complex or challenging to
administer, such as noncash charitable contributions or net income and
losses passed through from "flow-through" entities such as S corporations
and partnerships to their shareholders and partners.21

Finally, making progress on closing the tax gap requires that the tools
and techniques being used to promote compliance are evaluated to ensure
that they actually are effective. IRS evaluates some of its efforts to
assess how well they work, perhaps most notably its current effort to test
new procedures designed to reduce noncompliance with the Earned Income Tax
Credit,22 but misses other opportunities. For example, the lack of testing
for forms and instructions mentioned earlier is one instance where
improved evaluation would be worthwhile. We also reported in 2002 that the
effectiveness of the Federal Tax Deposit Alert program-a program that
since 1972 has been intended to reduce delinquencies in paying

21Partnerships and S corporations are businesses commonly referred to as
flow-through entities, as they do not generally pay taxes on income.
Instead, they distribute net income and losses to partners, shareholders,
and beneficiaries, who are subsequently required to report net income or
losses on their individual tax returns and pay any applicable taxes.

22GAO, Earned Income Credit: Qualifying Child Certification Test Appears
Justified, but Evaluation Plan Is Incomplete, GAO-03-794 (Washington,
D.C.: Sept. 30, 2003), and Earned Income Tax Credit: Implementation of
Three New Tests Proceeded Smoothly, But Tests and Evaluation Plans Were
Not Fully Documented, GAO-05-92 (Washington, D.C.: Dec. 30, 2004).

employment taxes-could not be evaluated because IRS had no system to track
contacts IRS made with delinquent employers.23 The availability of current
compliance information should enhance IRS's ability to evaluate the
success of its efforts to promote compliance.

Regular Compliance Measurement Can Support Informed Decisions to Reduce
the Tax Gap, but IRS Lacks Firm Plans for Such Measurement

Regularly measuring compliance can offer many benefits, including helping
IRS identify new or major types of noncompliance, identify changes in tax
laws and regulations that may improve compliance, more effectively target
examinations of tax returns or other enforcement programs, understand the
effectiveness of its programs to promote and enforce compliance, and
determine its resource needs and allocations. For example, by analyzing
1979 and 1982 TCMP data, IRS identified significant noncompliance with the
number of dependents claimed on tax returns and justified a legislative
change to address the noncompliance. As a result, for tax year 1987
taxpayers claimed about 5 million fewer dependents on their returns than
would have been expected without the change in law. In addition, tax
compliance data are useful outside of IRS for tax policy analysis, revenue
estimating, and research.

A significant portion of IRS's new tax gap estimate is based on recent
compliance data. IRS used data from NRP to update individual income tax
underreporting and the portion of individual employment tax underreporting
from self-employed individuals.24 Completion of NRP is a substantial
achievement-as table 1 indicates, underreporting of individual income
taxes represented about half of the tax gap for 2001 (the estimate ranges
from $150 billion to $187 billion out of a gross tax gap estimate that
ranges from $312 billion to $353 billion). Also, from $51 billion to $56
billion of the $66 billion to $71 billion in estimated underreported
employment tax was due to self-employment tax underreporting. IRS used
current, actual data from its Master Files to calculate the underpayment
segment of the tax gap.

23GAO, Tax Administration: IRS's Efforts to Improve Compliance With
Employment Tax Requirements Should Be Evaluated, GAO-02-92 (Washington,
D.C.: Jan. 15, 2002).

24Self-employed individuals are required to calculate and remit Social
Security and Medicare taxes to the U.S. Treasury each quarter, while
employers generally withhold these taxes from their employees' wages,
match these amounts, and are required to remit these withholdings to
Treasury at least quarterly.

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 $150-$187 $30 $66-$71 $4 No estimate

                                   $250-$292

            Underpayment               19 2              7            2 1 $32 
               Nonfiling     28 No estimate  No estimate             2 No $30 
                                                                estimate      
                   Total      $198-$234 $32    $73-$78        $8 $1 $312-$353 

Source: IRS.

Note: Figures may not sum to totals due to rounding.

IRS has concerns with the certainty of the overall tax gap estimate in
part because some areas of the estimate rely on old data and IRS has no
estimates for other areas of the tax gap. IRS does not have estimates for
corporate income, employment, and excise tax nonfiling or for excise tax
underreporting. For these types of noncompliance, IRS maintains that the
data are either difficult to collect, imprecise, or unavailable. IRS has
not recently collected compliance data for the remaining segments of the
tax gap. For example, IRS used data from the 1970s and 1980s to estimate
underreporting of corporate income taxes and employer-withheld employment
taxes.

IRS is taking several steps that could improve the tax gap estimate for
tax year 2001. IRS plans to further analyze the preliminary results from
NRP and expects to publish a revised estimate by the end of 2005. The
revised estimate will incorporate new methodologies, including those for
estimating overall individual income tax underreporting as well as for the
portion attributable to self-employed individuals who operate businesses
informally, and for estimating individual income tax nonfiling. In
addition, IRS research officials have proposed a compliance measurement
study that will allow IRS to update underreporting estimates involving
flow-through entities. This study, which IRS intends to begin in fiscal
year 2006, would take 2 to 3 years to complete. Because either individual
taxpayers or corporations may be recipients of income (or losses) from
flow-through entities, this study could affect IRS's estimates for the
underreporting gap for individual and corporate income tax.

While these data and methodology updates could improve the tax gap
estimates, IRS has no documented plans to periodically collect more or
better compliance data over the long term. Other than the proposed study
of flow-through entities, IRS does not have plans to collect compliance
data for other segments of the tax gap. Also, IRS has indicated that given
its current research priorities, it would not begin another NRP study of
individual income tax returns before 2008, if at all, and would not
complete such a study until at least 2010. When IRS initially proposed the
NRP study, it had planned to study individual income tax underreporting on
a 3-year cycle.

According to IRS officials, IRS has not committed to regularly collecting
compliance data because of the associated costs and burdens. Taxpayers
whose returns are examined through compliance studies such as NRP bear
costs in terms of time and money. Also, IRS incurs costs, including direct
costs and opportunity costs-revenue that IRS potentially forgoes by using
its resources to examine randomly selected returns, which may include
returns from compliant taxpayers, as opposed to traditional examinations
that focus on taxpayer returns that likely contain noncompliance and may
more consistently produce additional tax assessments.

Although the costs and burdens of compliance measurement are legitimate
concerns, as we have reported in the past, we believe compliance studies
to be good investments.25 Without current compliance data, IRS is less
able to determine key areas of noncompliance to address and actions to
take to maximize the use of its limited resources. The lack of firm plans
to continually obtain fresh compliance data is troubling because the
frequency of data collection can have a large impact on the quality and
utility of compliance data. As we have reported in the past, the longer
the time between compliance measurement surveys, the less useful they
become given changes in the economy and tax law.26

In designing the NRP study, IRS balanced the costs, burdens, and
compliance risk of studying that area of the tax gap. Any plans for
obtaining and maintaining reasonably current information on compliance
levels for all portions of the tax gap would similarly need to take into

25GAO, Tax Administration: IRS' Plans to Measure Tax Compliance Can Be
Improved, GAO/GGD-93-52 (Washington, D.C.: Apr. 5, 1993).

26GAO/GGD-93-52.

account costs, burdens, and compliance risks in determining which areas of
compliance to measure and the scope and frequency of such measurement.

Knowing the Reasons for Noncompliance Could Help Guide Compliance Efforts,
but IRS Has Concerns with Its Data on These Reasons

Data on whether taxpayers are unintentionally or intentionally
noncompliant with specific tax provisions are critical to IRS for deciding
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. Recognizing such benefits, the National Taxpayer Advocate
has urged IRS to consider performing additional research into causes of
noncompliance.27 We have also reported in the past28 that rigorous
research of the causes of noncompliance seems intuitive.

IRS collects data on the reasons for noncompliance for specific tax issues
during its examinations of tax returns, including those reviewed for NRP.
However, IRS has a number of concerns with the data:

o 	The database is incomplete as not all examiners have been sending
information on the results, including reasons, of closed examinations to
be entered into the database.

o 	IRS has not tested the adequacy of the controls for data entry or the
reliability of the data being collected. IRS has found instances where
examiners close examinations without assigning a reason for noncompliance
or by assigning the same reason to all instances of noncompliance,
regardless of the situation.

o 	IRS has not trained all examiners to deal with the subjectivity of
determining reasons to ensure consistent understanding of the reason
categories.

27Testimony of Nina E. Olson, National Taxpayer Advocate, before the
Senate Committee on Finance, July 21, 2004, and Internal Revenue Service,
Taxpayer Advocate Service, National Taxpayer Advocate 2004 Annual Report
to Congress (Washington, D.C.: Dec. 31, 2004).

28GAO, Tax Research: IRS Has Made Progress but Major Challenges Remain,
GAO/GGD-96109 (Washington, D.C.: June 5, 1996).

o 	The data are not representative of the population of noncompliant
taxpayers because the examined tax returns were not selected randomly.

As IRS continues to collect data on the reasons for noncompliance in the
future, it will be important to take these concerns into account.
Additionally, as with its efforts to measure compliance, it will be
important for IRS to consider the costs and burden of obtaining data on
the reasons for noncompliance.

Long-term, Quantitative Goals for Improving Taxpayers' Compliance Would Be
Consistent with Results-Oriented Management

Focusing on outcome-oriented goals and establishing measures to assess the
actual results, effects, or impact of a program or activity compared to
its intended purpose can help agencies improve performance and
stakeholders determine whether programs have produced desired results. As
such, establishing long-term, quantitative compliance goals offers several
benefits for IRS. Perhaps most important, compliance goals coupled with
periodic measurements of compliance levels would provide IRS with a better
basis for determining to what extent its various service and enforcement
efforts contribute to compliance. Additionally, long-term, quantitative
goals may help IRS consider new strategies to improve compliance,
especially since these strategies could take several years to implement.
For example, IRS's progress toward the goal of having 80 percent of all
individual tax returns electronically filed by 200729 has required
enhancement of its technology, development of software to support
electronic filing, education of taxpayers and practitioners, and other
steps that could not be completed in a short time frame. Focusing on
intended results can also promote strategic and disciplined management
decisions that are more likely to be effective because managers who use
fact-based performance analysis are better able to target areas most in
need of improvement and select appropriate interventions. Likewise, agency
accountability can be enhanced when both agency management and external
stakeholders such as Congress can readily measure an agency's progress
toward meeting its goals. Finally, setting long-term, quantitative goals
would be consistent with results-oriented management principles that are
associated with high-performing organizations and incorporated into the
statutory management framework Congress has adopted through GPRA.

29Congress established this electronic filing goal in the IRS
Restructuring and Reform Act of 1998, Pub. L. No. 105-206 (1998).

IRS's strategies for improving compliance generally lack a clear focus on
long-term, quantitative goals and results measurement. Although IRS has
established broad qualitative goals and strategies for improving taxpayer
service and enhancing enforcement of the tax laws, it has not specified by
how much it hopes these strategies will improve compliance. IRS has also
identified measures, such as compliance rates for tax reporting, filing,
and payment as well as the percentage of Americans who think it is
acceptable to cheat on their taxes,30 which are intended to gauge the
progress of its strategies toward its broad goals. However, IRS does not
always collect recent data to update these measures and has not
established quantitative goals against which to compare the measures. In
response to a President's Management Agenda31 initiative to better
integrate budget and performance information, IRS officials said that they
are considering various long-term goals for the agency. These goals are to
be released by May 2005. The officials have not indicated how many goals
will be related to improving taxpayer compliance or whether they will be
quantitative and resultsoriented.

Not unlike other agencies,32 IRS faces challenges in implementing a
resultsoriented management approach, such as identifying and collecting
the necessary data to make informed judgments about what goals to set and
to subsequently measure its progress in reaching such goals. However,
having completed the NRP review of income underreporting by individuals,
IRS now has an improved foundation for setting a goal or goals for
improving

30Other measures for enhancing enforcement are (1) the percentage of
priority guidance list items published (percentage of tax issues IRS will
address through regulations, notices, and other forms of guidance) and (2)
average cycle time between receipt and completion of an audit case.

31The President's Management Agenda is intended to help the federal
government become more results-oriented and encourage federal managers to
ask whether their programs are working as intended and, if not, what can
be done to achieve greater results.

32GAO, The Government Performance and Results Act: 1997 Governmentwide
Implementation Will Be Uneven, GAO/GGD-97-109 (Washington, D.C.: June 2,
1997), and Results-Oriented Government: GPRA Has Established a Solid
Foundation for Achieving Greater Results, GAO-04-38 (Washington, D.C.:
Mar. 10, 2004).

taxpayers' compliance.33 Nevertheless, measuring progress toward any goals
that may be set could be challenging. For example, IRS researchers have
found it difficult to determine the extent to which its enforcement
actions deter noncompliance or its services improve compliance among
taxpayers who want to comply. Measuring these effects is complicated in
part because many factors outside of IRS's actions can affect compliance.
However, as the National Taxpayer Advocate's 2004 annual report to
Congress34 pointed out, current and existing data on noncompliance may
help IRS better understand and address this challenge. Furthermore, even
if IRS is unable to show that its actions directly affected compliance
rates, periodic measurements of compliance levels can indicate the extent
to which compliance is improving or declining and provide a basis for
reexamining existing programs and triggering corrective actions if
necessary.

    Concluding Observations

The nation is currently on an imprudent and unsustainable fiscal path that
threatens our future. If we act now to address the looming fiscal
challenges facing the nation, the lives of our children and grandchildren
will be measurably better than if we wait. Nevertheless, the decisions we
must make will not be easy. They involve difficult choices about the role
of government in our lives and our economy. Acting now will impose
sacrifices, but today we have more options with less severe consequences
than if we wait.

Reducing the tax gap is one option that would help. While our long
termfiscal imbalance is too large to be eliminated by one strategy,
reducing the tax gap can ease the difficult decisions that are needed.
But, regardless of the contribution that a reduced tax gap can make to
easing our long-term challenges, we need to make concerted efforts to
address the tax gap because it is fundamentally unfair and threatens
Americans' trust in their

33The Internal Revenue Service Restructuring and Reform Act of 1998, Pub.
L. No. 105-206 (1998), specifically prohibits IRS from using its records
of tax enforcement results to evaluate employees or to impose or suggest
production quotas or goals with respect to such employees. That
restriction does not, however, prevent IRS from using its records of tax
enforcement results to examine whether its current enforcement efforts are
effective in deterring noncompliance and to in turn establish long-term
strategies and priorities for improvement.

34Internal Revenue Service, Taxpayer Advocate Service, National Taxpayer
Advocate 2004 Annual Report to Congress.

government. The tax gap is both a measure of the burden and frustration of
taxpayers who want to comply but are tripped by tax code complexity and of
willful tax cheating by a minority who want the benefits of government
services without paying their fair share.

Chairman Grassley, Senator Baucus, and Members of the Committee, this
concludes my testimony. At the request of the committee, in the near
future, we will issue a report that addresses the tax gap in greater
detail and, as appropriate, may make recommendations related to the topics
covered in my statement. We look forward to continuing to support the
committee's oversight of the tax gap and related issues. I would be happy
to answer any questions you may have at this time.

Contact and 	For further information on this testimony, please contact
Michael Brostek on (202) 512-9110 or [email protected]. Individuals making
key

Acknowledgments	contributions to this testimony include Jeff Arkin,
Elizabeth Fan, Shannon Groff, George Guttman, Michael Rose, and Tom Short.

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