Tax Gap: Multiple Strategies, Better Compliance Data, and
Long-Term Goals Are Needed to Improve Taxpayer Compliance
(26-OCT-05, GAO-06-208T).
Long-term budget simulations by GAO and others show that we face
large and growing structural deficits due primarily to known
demographic trends and rising health care costs. Reducing the
annual tax gap--the difference between what taxpayers timely and
accurately pay in taxes and what they should pay under the
law--could help the nation cope with these long-term fiscal
challenges. The tax gap arises through the underreporting of tax
liabilities, underpayment of taxes due or "nonfiling" of required
tax returns. This testimony discusses the findings of GAO's
recent tax gap report. It addresses the significance of reducing
the tax gap, measuring the extent of the tax gap, collecting data
on reasons why noncompliance occurs, and the Internal Revenue
Service's (IRS) strategies for reducing the tax gap.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-06-208T
ACCNO: A40317
TITLE: Tax Gap: Multiple Strategies, Better Compliance Data, and
Long-Term Goals Are Needed to Improve Taxpayer Compliance
DATE: 10/26/2005
SUBJECT: Deficit reduction
Econometric modeling
Income taxes
Noncompliance
Strategic planning
Tax administration
Tax evasion
Tax nonpayment
Tax violations
Taxpayers
Earned Income Tax Credit
IRS Taxpayer Compliance Measurement
Program
IRS National Research Program
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GAO-06-208T
United States Government Accountability Office
GAO Testimony
Before the Subcommittee on Federal Financial Management, Government
Information, and International Security, Committee on Homeland Security
and Governmental Affairs, U. S. Senate
For Release on Delivery Expected at 2:30 p.m. EDT
Wednesday, October 26, 2005 TAX GAP
Multiple Strategies, Better Compliance Data, and Long-Term Goals Are Needed to
Improve Taxpayer Compliance
Statement of Michael Brostek, Director Strategic Issues
GAO-06-208T
[IMG]
October 26, 2005
TAX GAP
Multiple Strategies, Better Compliance Data, and Long-term Goals Are Needed to
Improve Taxpayer Compliance
What GAO Found
IRS's recent estimate of the tax gap in 2001 ranged from $312 billion to
$353 billion. IRS estimates it will eventually recover some of this tax
gap, resulting in a net tax gap of $257 billion to $298 billion. Reducing
the tax gap will be challenging given persistent levels of noncompliance.
Still, given its size, even small or moderate reductions in the net tax
gap could yield substantial returns, which could improve the government's
fiscal position. 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.
The tax gap must be attacked on multiple fronts and with multiple
strategies over a sustained period of time. These strategies could include
simplifying the tax code, providing quality service to taxpayers, and
enhancing enforcement of tax laws by using tools such as tax withholding
and information reporting.
Regularly measuring compliance is also critical to IRS's ability to reduce
the tax gap. A significant part of IRS's tax gap estimate is based on
recently collected data on individual income tax reporting compliance.
However, other areas of the tax gap rely on old data and outdated
methodologies. IRS does not have approved plans, with one exception, to
collect more current compliance data covering the various components of
the tax gap.
Although it can be challenging to develop, data on the reasons why
taxpayers do not comply with the tax laws could help IRS more effectively
tailor its efforts to reduce noncompliance. IRS has begun to capture data
on the reasons for noncompliance, but it has concerns with the data.
Although IRS is developing a system intended to capture better examination
data, it does not have specific plans to develop better data on the
reasons for noncompliance.
IRS's strategies for reducing the tax gap involve improving taxpayer
service and enforcing tax laws, but do not have a clear focus on
quantitative longterm goals or results measurement. Establishing clear
goals and measuring progress toward them would be consistent with
results-oriented management principles and would provide IRS with a solid
base upon which to develop a more strategic approach to reducing the tax
gap.
United States Government Accountability Office
Mr. Chairman and Members of the Subcommittee:
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
intentionally or unintentionally fail to comply with the tax laws. Their
failure to pay taxes increases the burden of funding the nation's
commitments on those taxpayers who voluntarily pay their taxes.
Mr. Chairman, as I know you and the Comptroller General have discussed in
the past, confronting the nation's long-term 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. Simply put, our nation's fiscal
policy is on an imprudent and unsustainable course. 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. While our long-term fiscal imbalance cannot be eliminated
with a single strategy, reducing the tax gap should be one part of a
broader effort to repair the nation's fiscal health.
My remarks are based on our previous work on a variety of issues, in
particular the Comptroller General's recent testimony and our report on
1IRS's most recent estimates of the tax gap are preliminary, and as such,
IRS presents them as ranges.
2Throughout this statement, references to the tax gap refer to the gross
tax gap unless otherwise noted.
reducing the tax gap.3 These efforts were conducted in accordance with
generally accepted government auditing standards.
Let me begin by highlighting four major points:
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 but must be done with
multiple strategies over a sustained period.
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, but IRS does not have approved plans, with one exception, for
obtaining and maintaining more current compliance data covering the
various components of the tax gap beyond tax year 2001.
o Collecting data on the reasons why noncompliance occurs can help IRS
more effectively tailor its efforts to improve compliance. However, IRS
has no specific plans to gather better data than it already collects.
o Finally, IRS's strategies for improving compliance do not have the
clear focus on quantitative long-term goals and results measurement that
are associated with high-performing organizations and that are
incorporated into the statutory management framework Congress has adopted.
In our July 2005 report on reducing the tax gap, we made recommendations
that IRS develop plans to periodically measure tax compliance, take steps
to improve its data on the reasons why taxpayers do not comply, and
establish long-term, quantitative goals for voluntary compliance levels
with an initial focus on individual income tax underreporting and total
tax underpayment. Taken together, these steps can help IRS build a
foundation to understand how its taxpayer service and enforcement efforts
affect compliance, improve the efforts, and make progress on reducing the
tax gap. The Commissioner of Internal Revenue agreed with our
recommendations, highlighted challenges associated with
3GAO, Tax Compliance: Reducing the Tax Gap Can Contribute to Fiscal
Sustainability but Will Require a Variety of Strategies, GAO-05-527T
(Washington, D.C.: Apr. 14, 2005), and Tax Compliance: Better Compliance
Data and Long-term Goals Would Support a More Strategic IRS Approach to
Reducing the Tax Gap, GAO-05-753 (Washington, D.C.: July 18, 2005).
Background
them, and commented on various steps IRS would take to implement each
recommendation.
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 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 ranging from
$312 billion to $353 billion.
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.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 for tax year 2001 while
minimizing taxpayer burden.6
IRS has a strategic planning process through which it supports decisions
about strategic goals, program development, and resource allocation.
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.
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).
Reducing the Tax Gap Could Improve the Nation's Fiscal Position but Will
Require Multiple Strategies
Under the Government Performance and Results Act of 1993 (GPRA),7 agencies
are to develop strategic plans as the foundation for resultsoriented
management.
Given its size, even small or moderate reductions in the net tax gap could
yield substantial returns, which could improve the government's fiscal
position. 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.8
However, reducing the tax gap will be challenging given persistent levels
of noncompliance.9 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 businesses to
understand and voluntarily comply with their tax obligations.10 For
instance, the multiple tax preferences for education assistance might
increase taxpayers' burden in understanding and complying with the rules
associated with these options. In our July 2005 report on postsecondary
tax preferences, we found that hundreds of thousands of taxpayers do not
appear to make optimal decisions when selecting education-related tax
7Pub. L. No. 103-62 (1993).
8Any 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.
9Recognizing these challenges, 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. See GAO, High-Risk Series: An
Update, GAO-05-207 (Washington, D.C.: Jan. 2005).
10GAO's report, Understanding the Tax Reform Debate, discusses a number of
topics, such as the growing complexity of the current tax system, that tax
experts have identified as those that should be considered when evaluating
tax policy. See GAO, Understanding the Tax Reform Debate: Background,
Criteria, & Questions, GAO-05-1009SP (Washington, D.C.: Sept. 2005).
preferences.11 One explanation of these taxpayers' choices may be the
complexity of postsecondary tax preferences, which experts have commonly
identified as difficult for tax filers to use. 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.
Providing quality services to taxpayers is an important part of any
overall strategy to improve compliance and thereby reduce the tax gap. One
method of improving compliance through service is to educate taxpayers
about confusing or commonly misunderstood tax requirements.12 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.13
In terms of enforcement, IRS will need to use multiple strategies and
techniques to find noncompliant taxpayers and bring them into compliance.
In particular, as figure 1 shows, a pair of tools have been shown to lower
levels of noncompliance: withholding tax from payments to taxpayers and
having 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.
11GAO, Student Aid and Postsecondary Tax Preferences: Limited Research
Exists on the Effectiveness of Tools to Assist Students and Families
through Title IV Student Aid and Tax Preferences, GAO-05-684 (Washington,
D.C.: July 29, 2005).
12GAO/T-GGD-97-35.
13GAO, Tax Administration: IRS Should Reassess the Level of Resources for
Testing Forms and Instructions, GAO-03-486 (Washington, D.C.: Apr. 11,
2003).
Figure 1: Taxpayer Noncompliance Categorized by Amount of Withholding and
Information Reporting, 1992
In the past, we have identified a few specific areas where additional
withholding or information reporting requirements could serve to improve
compliance:14
o Requiring tax withholding and more or better information return
reporting by organizations that make payments to independent contractors
for services provided.15
14GAO, Tax Gap: Many Actions Taken, but a Cohesive Compliance Strategy
Needed, GAO/GGD-94-123 (Washington, D.C.: May 11, 1994).
15GAO, Tax Administration: Approaches for Improving Independent Contractor
Compliance, GAO/GGD-92-108 (Washington, D.C.: July 23, 1992).
o Requiring information return reporting on payments made to
corporations for services provided.
o Require that information returns dealing with capital gain income
report the purchase price, or other cost basis data, as well as the sales
price for stocks and bonds.
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 examination of opportunities to expand information reporting and
tax withholding has the potential to increase the transparency of the tax
system and the level of compliance.
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
Credit16-but misses other opportunities. For example, we 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
employment taxes-could not be evaluated because IRS had no system to track
contacts IRS made with delinquent employers.17
16GAO, 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).
17GAO, Tax Administration: IRS's Efforts to Improve Compliance With
Employment Tax Requirements Should Be Evaluated, GAO-02-92 (Washington,
D.C.: Jan. 15, 2002).
Regular Compliance Measurement Can Support Informed Decisions to Reduce
the Tax Gap, but IRS Lacks Approved Plans for Such Measurement
Regularly measuring compliance can offer many benefits, including helping
IRS identify new or growing types of noncompliance, identify changes in
tax laws and regulations that may improve compliance, more effectively
target examinations of tax returns, understand the effectiveness of its
programs to promote and enforce compliance, and determine its resource
needs and allocations.18 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.
Tax compliance data are also useful outside of IRS. Other federal agencies
and offices use compliance data for tax policy analysis, revenue
estimating, and research. Further, the longer the time between compliance
measurement surveys, the less useful they become given changes in the
economy and tax law.19 Without current compliance data, IRS has limited
capability to determine key areas of noncompliance to address and actions
to take to maximize the use of its limited resources.
Underreporting Accounted for Most of the Tax Gap Estimate
Using its recently collected compliance data, IRS has estimated that
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), as indicated in table 1.
18GAO, Tax Administration: IRS' Plans to Measure Tax Compliance Can Be
Improved, GAO/GGD-93-52 (Washington, D.C.: Apr. 5, 1993).
19GAO/GGD-93-52.
Table 1: IRS's Preliminary 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 income
income
noncompliance tax tax Employment tax Estate Excise tax Total
tax
Underreporting $150-$187 $30 $66-$71 $4 No $250-$292
estimate
Underpayment 19 2 7 2 1 $32
Nonfiling 28 No estimate No 2 No $30
estimate estimate
Total $198-$234 $32 $73-$78 $8 $1 $312-$353
Source: IRS.
Note: Figures may not sum to totals due to rounding.
Within the underreporting estimate, IRS attributed about $150 billion to
$187 billion, or about 50 percent of the total tax gap, to individual
income tax underreporting, including underreporting of business income,
such as sole proprietor,20 informal supplier,21 and farm income (about $83
billion to $99 billion); nonbusiness income, such as wages, interest and
capital gains (about $42 billion to $57 billion); overstated income
adjustments, deductions, and exemptions (about $14 billion to $16
billion); and overstated credits (about $11 billion to $14 billion).
Underreporting of corporate income tax contributed an estimated $30
billion, or about 10 percent, to the 2001 tax gap, which included both
small corporations (those reporting assets of $10 million or less) and
large corporations (those reporting assets of over $10 million).22
Employment tax underreporting accounted for an estimated $66 billion to
$71 billion, or about 20 percent, of the 2001 tax gap and included several
taxes that must be paid by self-employed individuals and employers.
Selfemployed individuals are generally required to calculate and remit
Social Security and Medicare taxes to the U.S. Treasury each quarter.
Employers
20Sole proprietors are self-employed individuals who should file a
Schedule C with their individual tax return to report profits and losses
from their business. Sole proprietors include those who provide services,
such as doctors or accountants; produce goods, such as manufacturers; and
sell goods at fixed locations, such as car dealers and grocers.
21Informal suppliers are sole proprietors who work alone or with few
workers and, by definition, operate in an "informal" manner. Informal
suppliers include those who make home repairs, provide child care, or sell
goods at roadside stands. These taxpayers should report business profits
or losses on a Schedule C.
22GAO-05-753.
are required to withhold these taxes from their employees' wages, match
these amounts, and remit withholdings to Treasury at least quarterly.
Underreported self-employment23 and employer-withheld employment taxes
respectively contributed an estimated $51 billion to $56 billion and $14
billion to IRS's tax gap estimate. The employment tax underreporting
estimate also includes underreporting of federal unemployment taxes (about
$1 billion).
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 outdated
methodologies. For example, IRS used data from the 1970s and 1980s to
estimate underreporting of corporate income taxes and employer-withheld
employment taxes. IRS has no estimates for other areas of the tax gap,
such as 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.
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.24
IRS Plans to Issue a Revised Tax Gap Estimate, but Has No Approved Plans
to Regularly Collect Compliance Data
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 has begun a compliance measurement study that will allow IRS
to
23As employment taxes and income taxes for self-employed taxpayers are
largely assessed on the same income, self-employed individuals who
underreport their income consequently underreport the employment tax due
on that income.
24For a more detailed discussion about data sources and methodologies used
in estimating the tax gap, see GAO-05-753.
update underreporting estimates involving S corporations.25 This study,
which IRS began in July 2005, is scheduled to take 2 to 3 years to
complete. Because individual taxpayers may be recipients of income (or
losses) from S corporations, this study could affect IRS's estimates for
the underreporting gap for individual income tax.
Beyond this study of S corporations, IRS has no approved plans to
periodically collect more or better compliance data over the long term.
Also, IRS has indicated that given its current research priorities, it
would not begin another NRP study of individual income tax returns before
2008, and would not complete such a study until at least 2010. When IRS
initially proposed the tax year 2001 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 both direct costs and
opportunity costs-revenue that IRS potentially forgoes by using its
resources to examine randomly selected returns, which are more likely to
include returns from compliant taxpayers and less likely to produce
additional tax assessments compared to traditional examinations. One IRS
official also emphasized that IRS has fewer resources than in the past to
conduct examinations as well as compliance studies.
Although the costs and burdens of compliance measurement are legitimate
concerns, we believe compliance studies to be good investments.26 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. Any plans for obtaining and
maintaining reasonably current information on compliance levels for all
portions of the tax gap would need to take into account costs, burdens,
and compliance risks in determining which areas of compliance to measure
and the scope and frequency of such measurement.
25S corporations, as well as partnerships, are businesses commonly
referred to as flowthrough 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. According to an IRS research official, IRS expects to
conduct a compliance measurement study of partnerships at a later date.
26GAO/GGD-93-52.
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. For example, taxpayers may unintentionally claim the Earned
Income Tax Credit (EITC) because they do not understand the child
residency requirements for this credit (i.e., a qualifying child must live
with the taxpayer for more than half of the year). This type of
unintentional noncompliance may require IRS to more clearly explain the
EITC requirements within related forms and publications. However, other
taxpayers may file false EITC claims with the intent of evading tax
liability, which may suggest a strategy that relies on IRS's enforcement
programs and tools. Similar situations could exist for other tax code
provisions. Recognizing the benefits of better compliance data, we, as
well as the National Taxpayer Advocate, have urged IRS to consider
performing additional research into causes of noncompliance.27
IRS collects data on the reasons for noncompliance for specific tax issues
during its operational examinations of tax returns. In many of these
cases, it is difficult for examiners to determine a taxpayer's
intent-whether the noncompliance is unintentional or intentional. Unless
the evidence clearly points to the reason, the examiner would have to make
subjective judgments about why the noncompliance occurred. IRS has a
number of other concerns with the data:
o The database is incomplete because not all examination results,
including data on reasons for noncompliance, were being 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.
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); and GAO, Tax Research: IRS
Has Made Progress but Major Challenges Remain, GAO/GGD-96-109 (Washington,
D.C.: June 5, 1996).
o IRS has not trained all examiners to ensure consistent understanding
and use of the various codes to indicate the reason for noncompliance.
o The data do not represent the population of noncompliant taxpayers but
Long-term, Quantitative Goals for Improving Taxpayers' Compliance Would Be
Consistent with Results-Oriented Management
rather only those who had their tax returns examined.
According to IRS officials, the agency does not have firm or specific
plans to develop better data on the reasons for noncompliance. One
official explained that IRS decided not to improve the consistency of its
current reason data because it is devoting its limited resources to other
efforts, such as developing the Examination Desktop Support System.
Although this system is intended to allow examiners to capture better
examination data, specific system features have not yet been identified to
improve examiners' selection of reason codes. IRS officials said that the
system could be enhanced in the future to improve the data on reasons for
noncompliance and that they plan to consider such enhancements. If IRS
enhances the data on reasons for noncompliance, it will be important to
consider factors such as how complete and reliable such data need to be,
and whether to collect the data for all types of noncompliance or for all
examinations (as opposed to a targeted random sample).
Focusing on outcome-oriented goals and establishing measures to assess the
actual results of a program compared to its intended purpose can help
agencies improve performance and stakeholders determine whether programs
have produced desired results. Furthermore, 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. As such, establishing long-term, quantitative compliance
goals coupled with periodic measurements of compliance levels offers
several benefits for IRS. These benefits include providing a better basis
for determining to what extent its various service and enforcement efforts
contribute to compliance, considering new strategies to improve compliance
over time,28 and promoting strategic and
28For example, IRS's progress toward the goal of having 80 percent of all
individual tax returns electronically filed by 2007 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. Congress
established this electronic filing goal in the IRS Restructuring and
Reform Act of 1998, Pub.
L. No. 105-206 (1998).
disciplined management decisions that target areas most in need of
improvement.
IRS's strategies for improving compliance, which involve improving
taxpayer service and enhancing enforcement of the tax laws, generally lack
a clear focus on long-term, quantitative goals and results measurement. In
response to a President's Management Agenda29 initiative to better
integrate budget and performance information, IRS officials said that they
are considering various long-term goals for the agency. However, IRS has
not yet set a time frame for publicly releasing the goals or indicated how
many goals will be related to improving taxpayer compliance or whether
they will be quantitative and results-oriented. According to IRS
officials, developing long-term, results-oriented goals is a complex
process that requires sustained management commitment. These factors
contribute to IRS's uncertainty about when it will publicly release its
goals.
Like other agencies,30 IRS faces challenges in implementing a
resultsoriented management approach. For example, collecting reliable
compliance data, developing reasonable assumptions about taxpayer
behavior, and accounting for factors outside of IRS's actions that can
affect taxpayer compliance, such as changes in tax law, make it difficult
to estimate the effect of IRS's enforcement and service activities.31
However, 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. Moreover, having completed the NRP review of individual
29The 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.
30GAO, 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).
31As discussed in our July 2005 tax gap report, several research studies
have offered insights to better understand the direct and indirect effects
of IRS's activities on tax revenue and voluntary compliance. Indirect
effects arise when voluntary compliance increases in the larger population
or in subsequent years due to examinations, or other enforcement and
service actions, on targeted taxpayers. Although these studies generally
indicate that IRS activities have positive tax effects, the magnitude of
these effects is not yet known with a high level of confidence given
compliance measurement challenges.
Concluding Observations
Contact and Acknowledgments
(450452)
income tax underreporting, IRS now has an improved foundation for setting
a goal or goals for improving taxpayers' compliance.
Reducing the tax gap is one approach that would help address the looming
fiscal challenges facing the nation. While our long term-fiscal imbalance
is too large to be eliminated by one strategy, reducing the tax gap can
ease the difficult decisions that are needed. Toward that end, in our July
2005 report on reducing the tax gap, we made recommendations to IRS to
develop plans to periodically measure tax compliance, take steps to
improve its data on the reasons why taxpayers do not comply, and establish
long-term, quantitative goals for voluntary compliance levels with an
initial focus on individual income tax underreporting and total tax
underpayment. Taken together, these steps can help IRS build a foundation
to understand how its taxpayer service and enforcement efforts affect
compliance, improve the efforts, and make progress on reducing the tax
gap. The Commissioner of Internal Revenue agreed with our recommendations,
highlighted challenges associated with them, and commented on various
steps IRS would take to implement each recommendation.
Mr. Chairman and Members of the Subcommittee, this concludes my testimony.
I would be happy to answer any questions you may have at this time.
For further information on this testimony, please contact Michael Brostek
on (202) 512-9110 or [email protected]. Individuals making key
contributions to this testimony include Jeff Arkin, Elizabeth Fan, Shannon
Groff, George Guttman, Michael Rose, and Tom Short.
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