Tax Compliance: Inflation Has Significantly Decreased the Real
Value of Some Penalties (23-AUG-07, GAO-07-1062).
Civil tax penalties are an important tool to encourage taxpayer
compliance with the tax laws. A number of civil tax penalties
have fixed dollar amounts--a specific dollar amount, a minimum or
maximum amount--that are not indexed for inflation. Because of
Congress's concerns that civil penalties are not effectively
achieving their purposes, we agreed to (1) determine the
potential effect of adjusting civil tax penalties for inflation
on the Internal Revenue Service's (IRS) assessment and collection
amounts and (2) describe the likely administrative impact of
regularly adjusting civil tax penalties on IRS and tax
practitioners. GAO examined IRS data on civil tax penalties and
conducted interviews with IRS employees and tax practitioners.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-07-1062
ACCNO: A74974
TITLE: Tax Compliance: Inflation Has Significantly Decreased the
Real Value of Some Penalties
DATE: 08/23/2007
SUBJECT: Administrative costs
Collection procedures
Fines (penalties)
Inflation
Price adjustments
Price indexes
Tax administration
Tax law
Tax violations
Taxpayers
Voluntary compliance
Cost estimates
Program implementation
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GAO-07-1062
* [1]Results in Brief
* [2]Background
* [3]Adjusting Civil Tax Penalties for Inflation May Increase IRS
* [4]Administrative Impact of Implementing Inflation Adjustment t
* [5]Administrative Impact on IRS Expected to Be Relatively Low
* [6]Tax Practitioners Expected Administrative Impact to Be Relat
* [7]Concluding Observations
* [8]Matter for Congressional Consideration
* [9]Agency Comments
* [10]GAO Contact
* [11]Acknowledgments
* [12]GAO's Mission
* [13]Obtaining Copies of GAO Reports and Testimony
* [14]Order by Mail or Phone
* [15]To Report Fraud, Waste, and Abuse in Federal Programs
* [16]Congressional Relations
* [17]Public Affairs
* [18]PDF6-Ordering Information.pdf
* [19]Order by Mail or Phone
Report to the Committee on Finance, U.S. Senate
United States Government Accountability Office
GAO
August 2007
TAX COMPLIANCE
Inflation Has Significantly Decreased the Real Value of Some Penalties
GAO-07-1062
Contents
Letter 1
Results in Brief 2
Background 3
Adjusting Civil Tax Penalties for Inflation May Increase IRS Assessments
and Collections 4
Administrative Impact of Implementing Inflation Adjustment to Civil
Penalties Is Expected to Be Low 7
Concluding Observations 9
Matter for Congressional Consideration 9
Agency Comments 10
Appendix I Scope and Methodology 11
Appendix II GAO Contact and Staff Acknowledgments 14
Tables
Table 1: Estimated Increase in IRS Assessments and Collections from
Inflation Adjusting of Penalties Assessed, 2000-2005 4
Table 2: 2004 Estimated Increase in IRS Collections from Inflation
Adjusting of Four Penalties 5
Table 3: 2007 Inflation-Adjusted Values of Four Civil Tax Penalties with
Fixed Dollar Amounts, by Increase in Collection Amount 6
Abbreviations
CPI-U Consumer Price Index-Urban
ERIS Enforcement Revenue Information System
GDP Gross Domestic Product
IRC Internal Revenue Code
IRS Internal Revenue Service
SB/SE Small-Business/Self-Employed division
W&I Wage and Investment division
This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
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copyright holder may be necessary if you wish to reproduce this material
separately.
United States Government Accountability Office
Washington, DC 20548
August 23, 2007
The Honorable Max Baucus
Chairman
The Honorable Charles E. Grassley
Ranking Member
Committee on Finance
United States Senate
Civil tax penalties are an important tool to encourage taxpayer compliance
with the tax laws.1 The Internal Revenue Code (IRC) has over 150 civil
penalties that potentially deter taxpayer noncompliance. For some of the
penalties, the amount of the penalty is determined as a percentage of tax
liability. For others, the amount of the penalty is a specific dollar
amount. Still other penalties have minimum or maximum amounts that are
specified in dollars. These specific dollar amounts are not indexed for
inflation and decline in real value over time because of inflation, which
may weaken their deterrent effect. Because of your concerns that civil tax
penalties are not effectively achieving their purposes, we agreed to (1)
determine the potential effect of adjusting civil tax penalties for
inflation on assessment and collection amounts and (2) describe the likely
administrative impact on the Internal Revenue Service (IRS) and tax
practitioners of regularly adjusting civil tax penalties.
To determine the potential effect of adjusting civil tax penalties for
inflation on assessment and collection amounts, we analyzed IRS civil tax
penalty assessment and collection data using the Consumer Price
Index-Urban as a basis for inflation adjustments. To gather information on
the likely administrative impact on IRS officials and tax practitioners of
regularly adjusting civil tax penalties, we interviewed officials across
IRS and a limited number of tax practitioners affiliated with relevant
professional organizations. Our interviews with tax practitioners cannot
be used to make inferences about the effect of regular penalty adjustments
on the work of all practitioners and those we interviewed were giving
personal opinions, not the views of the professional associations of which
they are members. We determined that the civil tax penalty assessment and
collection data are sufficiently reliable for our purposes. We conducted
our work from September 2006 through July 2007 in accordance with
generally accepted government auditing standards. For a more detailed
description of our scope and methodology, as well as limitations of the
penalty data, see appendix I.
1For the purposes of this report, civil penalties are defined as any
penalties that are not criminal in nature.
Results in Brief
Adjusting civil tax penalties for inflation on a regular basis to maintain
their real values over time may increase IRS assessments and collections
by tens of millions of dollars per year. Further, the decline in real
value of the fixed dollar amounts of civil tax penalties may weaken the
deterrent effect of these penalties and may result in the inconsistent
treatment of taxpayers over time. Based on our analysis, if the fixed
dollar amounts of civil tax penalties had been adjusted for inflation, the
potential increase in IRS collections would have ranged from an estimated
$38 million to $61 million per year from 2000 to 2005. Almost all of the
estimated increase in collections was generated by the following four
penalties: (1) failure to file tax returns, (2) failure to file correct
information returns, (3) various penalties on returns by exempt
organizations and by certain trusts, and (4) failure to file partnership
returns. For example, our analysis showed that these four penalties would
account for 99 percent of the estimated $61 million in additional IRS
collections for assessments made in calendar year 2004. These estimated
increases result because some of the penalties were set decades ago and
have decreased significantly in real value--by over one-half for some
penalties.
According to IRS officials and tax practitioners we spoke with, the likely
administrative burden associated with adjusting the fixed dollar amounts
of civil tax penalties for inflation on a regular basis would not be large
for all but one affected unit within IRS and would be low for tax
practitioners. Officials from IRS's relatively small Office of Penalties,
which has responsibility for coordinating the changes among multiple IRS
divisions, said that such adjustments might be considerable depending on
the number of penalties being adjusted and would require a
reprioritization of their work. IRS officials from all other affected
units, who are responsible for implementing other periodic updates to IRS
databases and documents, said that the changes required by regular updates
to the fixed dollar amounts of civil penalties would not be significant
and some added that changes would be most burdensome initially and easier
to carry out with each subsequent update. The limited number of tax
practitioners that we spoke with also expected the impact on their work
from inflation adjustments to be relatively low.
We believe that Congress should consider requiring IRS to periodically
adjust for inflation, and round appropriately, the fixed dollar amounts of
civil tax penalties to account for the decrease in real value over time
and so that penalties are consistent over time.
We provided a draft of this report to the Acting Commissioner of Internal
Revenue. IRS provided technical comments, which have been incorporated
where appropriate.
Background
Although Congress has not established mechanisms for regularly adjusting
for inflation the fixed dollar amounts of civil tax penalties administered
by IRS, it has done so for penalties administered by other agencies. When
the Federal Civil Penalties Inflation Adjustment Act of 1990 (Inflation
Adjustment Act)2 was enacted, Congress noted that inflation had weakened
the deterrent effect of many civil penalties. The stated purpose of the
1990 act was "to establish a mechanism that shall (1) allow for regular
adjustment for inflation of civil monetary penalties; (2) maintain the
deterrent effect of civil monetary penalties and promote compliance with
the law; and (3) improve the collection by the Federal Government of civil
monetary penalties." Congress amended the Inflation Adjustment Act in
19963 and required some agencies to examine their covered penalties at
least once every 4 years thereafter and, where possible, make penalty
adjustments.4 The Inflation Adjustment Act exempted penalties under the
IRC of 1986,5 the Tariff Act of 1930, the Occupational Safety and Health
Act of 1970, and the Social Security Act.
As stated earlier, some civil tax penalties are based on a percentage of
liability and therefore are implicitly adjusted for inflation. For
example, the penalty for failure to pay tax obligations is 0.5 percent of
the tax owed per month, not exceeding 25 percent of the total tax
obligations. However, other civil penalties have fixed dollar amounts,
such as minimums or maximums, which are not linked to a percentage of
liability. For example, a minimum penalty of $100 exists for a taxpayer
who fails to file a tax return.6
2Pub. L. No. 101-410 (1990).
3Pub. L. No. 104-134 (1996).
4GAO has suggested that Congress consider amending the Inflation
Adjustment Act because several provisions of the act prevented some
agencies from fully adjusting their penalties for inflation. One of GAO's
suggestions was to permit agencies with exempt penalties to adjust them
for inflation. See GAO, Civil Penalties: Agencies Unable to Fully Adjust
Penalties for Inflation Under Current Law, [20]GAO-03-409 (Washington,
D.C.: Mar. 14, 2003).
5There is no explanation in the legislative history of the Inflation
Adjustment Act for the exclusion of the civil tax penalties.
Adjusting Civil Tax Penalties for Inflation May Increase IRS Assessments and
Collections
Adjusting civil tax penalties for inflation on a regular basis to maintain
their real values over time may increase IRS assessments and collections.
Based on our analysis,7 if the fixed dollar amounts of civil tax penalties
had been adjusted for inflation, the increase in IRS assessments
potentially would have ranged from an estimated $100 million to $320
million and the increase in collections would have ranged from an
estimated $38 million to $61 million per year from 2000 to 2005, as shown
in table 1.8
Table 1: Estimated Increase in IRS Assessments and Collections from
Inflation Adjusting of Penalties Assessed, 2000-2005
Dollars in millions
Penalty adjusted assessment Penalty adjusted collections
Assessment year increase increase
2000 $100.4 $38.2
2001 254.9 42.1
2002 165.3 47.9
2003 267.1 53.2
2004 320.9 61.0
2005 280.5 60.3
Source: GAO analysis of IRS data.
Note: Fluctuations in the assessment amounts are largely due to variations
with the failure to file partnership returns penalty, for which
assessments fluctuate by several hundred million dollars per year.
However, collections do not fluctuate in a similar way because only a
small portion of the assessed amounts for this penalty are collected.
The majority of the estimated increase in collections from adjusting these
penalties for inflation was generated from the following four types of
penalties: (1) failure to file tax returns, (2) failure to file correct
information returns, (3) various penalties on returns by exempt
organizations and by certain trusts, and (4) failure to file partnership
returns. The estimated increases in collections associated with these
penalties for 2004 are shown in table 2. We highlight 2004 data because,
according to IRS officials, approximately 85 percent of penalties are
collected in the 3 years following the assessment. The same four penalty
types account for the majority of the estimated increase in collections
for the prior years. Our analysis showed that these four penalties would
account for approximately 99 percent of the estimated $61 million in
additional IRS collections for assessments made in calendar year 2004.
6The penalty for failing to file a tax return is 0.5 percent of the amount
owed per month, for up to 5 months, but not more than 25 percent of the
amount owed, with a $100 minimum.
7For the limitations of our analysis and the data set, see app. I.
8Some periods over which the analysis was conducted were periods of
relatively low inflation. If inflation rates had been higher, the real
value of fixed penalties would have decreased at a greater rate and we
would expect the impact on collections to be greater.
Table 2: 2004 Estimated Increase in IRS Collections from Inflation
Adjusting of Four Penalties
Dollars in millions
Effective year of
2004 increase in latest penalty
Penalty collections adjustment
Failure to file tax returns (IRC 6651) $37.9 1982
Failure to file correct information 18.3 1989
returns (IRC 6721)
Various penalties on returns by exempt 3.1 1996
organizations and by certain trusts
(IRC 6652(c))
Failure to file partnership returns 0.9 1979
(IRC 6698)
Total $60.2
Source: GAO analysis of IRS data.
Because penalty amounts have not been adjusted for decades in some cases,
the real value of the fixed dollar amounts of these penalties has
decreased. For example, the penalty for failing to file a partnership
return was set at $50 per month in 1979, which is equivalent to about $18
today, or a nearly two-thirds decline in value, as shown in table 3. If
the deterrent effect of penalties depends on the real value of the
penalty, the deterrent effect of these penalties has eroded because of
inflation. In addition, not adjusting these penalties for inflation may
lead to inconsistent treatment of otherwise equal taxpayers over time
because taxpayers penalized when the amounts were set could effectively
pay a higher penalty than taxpayers with the same noncompliance pay years
later. Finally, if the real value of penalties declines, but IRS's costs
to administer them do not, imposing penalties becomes less cost-effective
for IRS and could lead to a decline in their use.9
Table 3: 2007 Inflation-Adjusted Values of Four Civil Tax Penalties with
Fixed Dollar Amounts, by Increase in Collection Amount
Equivalent
dollar amount
of current 2007 penalty Effective
Penalty penalty, in amount if year of
amount not year of latest adjusted for latest
adjusted for adjustment inflation penalty
Penalty inflationa (rounded) (rounded) adjustment
Failure to file tax $100 minimum $47 minimum $214 minimum 1982
returns (IRC 6651)
Failure to file $15, $30, or $9, $18, or $25, $50, or 1989
correct information $50/return $30/return $83/return
returns (IRC 6721)
Various penalties on $20 or $15 or $76/day $26 or 1996
returns by exempt $100/day $131/day
organizations and by
certain trusts (IRC
6652(c))
Failure to file $50/partner $18/partner $145/partner 1979
partnership returns per month
(IRC 6698) per month per month
Source: GAO analysis.
aThe information return penalty amounts vary depending on how late the
taxpayer files the return. If the information return is filed 30 days
late, the penalty is $15 per return, rising to $30 per return if filed 60
days late, and finally to $50 per return if filed after August 1. In the
case of the penalties on returns by exempt organizations and by certain
trusts, the penalty is $20 per day for organizations with gross receipts
under $1,000,000, and increases to $100 per day for organizations with
gross receipts over $1,000,000.
In the past, Congress has established fixed penalty amounts, increased
fixed penalty amounts, or both in order to deter taxpayer noncompliance
with the tax laws. For example, the $100 minimum for failure to file a tax
return was created in 1982 because many persons who owed small amounts of
tax ignored their filing obligations. In addition, Congress increased
penalties for failure to file information returns in 1982 because it
believed that inadequate information reporting of nonwage income was a
substantial factor in the underreporting of such income by taxpayers.10 As
recently as 2006, IRS's National Research Program confirmed Congress's
belief that compliance is highest where there is third-party reporting.11
Congress has also recently adjusted some civil penalties that have fixed
dollar amounts. For example, the minimum penalty for a bad check was
raised from $15 to $25 in May 2007, and the penalty for filing a frivolous
return was raised from $500 to $5,000 in December 2006.
9We will be reviewing this and other issues related to civil tax penalties
as we continue our work for the Senate Committee on Finance.
10In 1989, as part of the Omnibus Budget Reconciliation Act of 1989 (Pub.
L. No. 101-239), IRC 6721 was substantially changed and the values
reaffirmed. Thus, we consider 1989 the year of last penalty adjustment for
the failure to file information returns penalties.
Administrative Impact of Implementing Inflation Adjustment to Civil Penalties Is
Expected to Be Low
We spoke with officials from offices across IRS whose workloads would be
affected if regular adjustments of penalties occurred. IRS officials from
all but one unit said that regularly updating the fixed dollar amounts of
civil tax penalties would not be a significant burden. Officials from one
relatively small office--the Office of Penalties--said that such
adjustments might be considerable depending on the number of penalties
being adjusted and would require a reprioritization of their work since
their office would have lead responsibility for monitoring the
administrative steps necessary to implement the adjustments and
coordinating tasks among a wide range of functions within IRS. In
addition, the limited number of tax practitioners we interviewed told us
that the administrative burden associated with adjusting these penalties
for inflation on a regular basis would be low.
Administrative Impact on IRS Expected to Be Relatively Low
Officials from all but one unit we spoke to within IRS said that regularly
adjusting civil tax penalties for inflation would not be burdensome. Some
officials added that adequate lead time and minimally complex changes
would reduce the administrative impact. For example, officials from the
Office of Forms and Publications and the Office of Chief Counsel said that
adjustments to civil penalty amounts would not affect their work
significantly. While each office would have to address the penalty changes
in documents for which they are responsible, in some cases these documents
are updated regularly already. Similarly, officials responsible for
programming IRS's computer systems explained that these changes would not
require out of the ordinary effort, unless they had little lead time in
which to implement the changes.
However, officials from the Office of Penalties within the Small
Business/Self-Employed division (SB/SE)--the unit which would be
responsible for coordinating IRS's implementation of any adjustments to
penalties among a wide range of functions within IRS--felt that the
administrative burden associated with these changes might be considerable
depending on the number of penalties being adjusted. The Office of
Penalties, which currently consists of 1 manager and 10 analysts, provides
policies, guidelines, training, and oversight for penalty issues IRS-wide,
not just within SB/SE. When legislation affecting penalties is enacted,
the Office of Penalties creates an implementation team that helps
determine what IRS needs to do to implement the new legislation. In the
case of adjusting penalties for inflation, the Office of Penalties would
work with numerous other IRS units to coordinate the necessary changes to
forms, training materials, computer systems, and guidance, among other
things. Regularly changing four penalties would take less effort than
regularly changing all penalties. In addition, the ability of the office
to make these changes would require reprioritization of its work or
receiving more resources. While the Office of Penalties has not done a
formal analysis of the resources needed, an official stated that the
additional work would not require a significant increase in staffing, such
as a doubling of the size of the office. As a result, the amount of
additional resources necessary for the penalty adjustment do not appear to
be of sufficient scale to have a large impact on IRS overall.
11GAO has reported that providing IRS with more enforcement tools,
particularly withholding and information reporting, has the potential to
reduce the tax gap by billions of dollars. See GAO, Tax Compliance:
Opportunities Exist to Reduce the Tax Gap Using a Variety of Approaches,
[21]GAO-06-1000T (Washington, D.C.: July 26, 2006).
Further, officials we interviewed from other IRS units who would perform
the work described by the Office of Penalties said that the administrative
burden would not be significant for them. Some IRS officials who oversee
the implementation of other periodic updates to IRS databases and
documents said that the legislative changes requiring regular updates are
most burdensome initially but become less of an issue in each subsequent
year. Some officials also said that with enough advance notice, they would
be able to integrate the necessary changes into routine updates. For
example, program changes could be integrated into the annual updates that
some Modernization and Information Technology Service programs receive.
Other areas in IRS, such as the Office of Forms and Publications, already
conduct annual and in some cases quarterly updates of their forms, and
according to officials, a change to the tax penalty amount could easily be
included in these regularly scheduled updates.
IRS has a variety of experiences that may provide guidance that would be
relevant to adjusting civil tax penalties with fixed dollar amounts for
inflation. IRS has extensive procedures for implementing statutory changes
to the tax code. Further, IRS has experience implementing inflation
adjustment calculations. For example, tax brackets, standard deduction
amounts, and the itemized deduction limit are among the inflation
adjustments conducted annually by IRS. In addition, the administrative
changes associated with regular updates to the interest rate have some
similarities to the types of changes that an inflation adjustment may
require. For example, the Office of Chief Counsel issues quarterly
guidance on interest rates and the Communications & Liaison Office
provides regular updates on interest changes to the tax professional
community, including practitioner associations. Changes to the civil tax
penalty fixed dollar amounts could be handled in a similar manner.
Tax Practitioners Expected Administrative Impact to Be Relatively Low
The limited number of tax practitioners that we spoke with also expected
the impact on their work from adjustments to the fixed dollar amounts of
civil tax penalties for inflation to be relatively low. For example, one
tax practitioner said that he expected to spend more time explaining
different penalty amounts to clients, particularly in situations where
taxpayers who receive the same penalty in different tax years may not
understand why different penalty amounts were applied. In addition, three
other practitioners we spoke with said that the changes may lead to an
increased reliance on software programs that tax preparers often use to
assist them with determining penalty amounts since making the calculations
involving inflation adjustments could become more onerous for the tax
practitioners to do without software.
Concluding Observations
The real value and potential deterrent effect of civil tax penalties with
fixed dollar amounts has decreased because of inflation. Periodic
adjustments to the fixed dollar amounts of civil tax penalties to account
for inflation, rounded appropriately, may increase the value of
collections by IRS, would keep penalty amounts at the level Congress
initially believed was appropriate to deter noncompliance, and would serve
to maintain consistent treatment of taxpayers over time. Regularly
adjusting the fixed dollar amounts of civil tax penalties for inflation
likely would not put a significant burden on IRS or tax practitioners.
Matter for Congressional Consideration
Congress should consider requiring IRS to periodically adjust for
inflation, and round appropriately, the fixed dollar amounts of the civil
penalties to account for the decrease in real value over time and so that
penalties for the same infraction are consistent over time.
Agency Comments
On July 30, 2007, we sent a draft of this report to IRS for its comment.
We received technical comments that have been incorporated where
appropriate.
As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from
its date. At that time, we will send copies of this report to appropriate
congressional committees and the Acting Commissioner of Internal Revenue.
We also will make copies available to others upon request. In addition,
the report will be available at no charge on the GAO Web site at
[22]http://www.gao.gov .
If you or your staff have any questions concerning this report, please
contact me at (202) 512-9110 or at [23][email protected] . Contact points
for our Offices of Congressional Relations and Public Affairs may be found
on the last page of this report. GAO staff who made major contributions to
this report are listed in appendix II.
Michael Brostek
Director, Tax Issues Strategic Issues Team
Appendix I: Scope and Methodology
To determine the potential effect that adjusting civil tax penalties for
inflation would have on the dollar value of penalty assessments and
collections, we used the Consumer Price Index-Urban (CPI-U) to adjust
actual penalty assessment and collection information contained in the
Enforcement Revenue Information System (ERIS), which was created to track
Internal Revenue Service (IRS) enforcement revenues.
We provided inflation-adjusted estimates for penalties that had been
assessed for at least $1 million in any one year from 2000 to 2005 and had
either a fixed minimum or set amount. This excluded less than two
one-hundredths of a percentage of all assessments each year. In addition,
we assumed that assessment rates and collection rates would stay the same
regardless of penalty amount. This assumption may bias our estimates
upwards because higher penalties may encourage taxpayers to comply with
tax laws and, therefore, IRS would not assess as many penalties. However,
improved compliance could also increase revenues. For collections, we
assumed that a particular collection would increase the inflation-adjusted
penalty amount only if the unadjusted penalty assessment had been paid in
full. For example, if a taxpayer paid $50 of a $100 penalty assessment, we
assumed that the $50 collected was all that would have been collected even
with a higher assessment, and therefore did not adjust the collection
amount. We made this assumption in order to avoid overstating the effect
that adjusting penalties for inflation would have on collections because
the data did not tell us why a penalty was partially collected. To the
extent that taxpayers who paid the unadjusted penalty amount in full would
not pay the adjusted penalty amount in full, our estimates would overstate
additional collections. One reason for a partial collection is that it is
all the taxpayer can afford.
We did not include penalties that are percentage based but have a fixed
maximum in our inflation adjustments. Two penalty categories in the ERIS
data set that we received have fixed maximums and had total assessments of
over $1 million for at least 1 year from 2000 to 2005. In both cases, we
could not determine how much a penalty assessment for the current maximum
would have risen if the maximum had been higher. However, we estimated an
upper bound for the potential increase in collections due to adjusting the
maximums for inflation by assuming that penalties assessed at the current
maximum would have increased by the full rate of inflation. As a result,
we concluded that at most, collections would have risen by approximately
$196,000 over the years 2000 to 2005 if these maximums had been adjusted
for inflation. We also did not include penalties that are based solely on
a percentage of tax liability in our analysis because they are implicitly
adjusted for inflation.
The data contained in the ERIS database were reliable for our purposes,
but some limitations exist. To assess the reliability of the data, we
reviewed relevant documentation, interviewed relevant IRS officials, and
performed electronic data testing. One limitation of the ERIS data is that
it does not include penalties that are self-assessed and paid at the time
of filing. IRS officials estimated that this is about 6 to 7 percent of
all penalty assessments, but that a large majority of these are percentage
based with no fixed dollar amount. For example, many people self-assess
and pay the penalty for withdrawing money from their Individual Retirement
Accounts early. Further, IRS officials acknowledged that some penalties
were incorrectly categorized in the database making it impossible for us
to determine which penalties were being assessed. We determined that 0.4
percent to 1.4 percent of assessments per year from 2000 to 2005 were
incorrectly categorized. For example, in 2000, over $144 million in
assessments and over $28 million in collections were incorrectly
categorized. In 2005, over $343 million in assessments and over $86
million in collections were incorrectly categorized. These two limitations
may bias our estimates downwards.
The federal government produces several broad measures of price changes,
including the CPI-U and the Gross Domestic Product (GDP) price deflator.
The CPI-U measures the average change over time in the prices paid by
consumers for a fixed market basket of consumer goods and services. The
GDP price deflator measures changes over time in the prices of broader
expenditure categories than the CPI-U. We used the CPI-U for the purposes
of this analysis because it is used currently in the tax code to make
inflation adjustments to several provisions, such as the tax rate
schedule, the amount of the standard deduction, and the value of
exemptions.1
To determine the likely effect that regularly adjusting penalties for
inflation would have on the administrative burden of IRS officials, we
interviewed officials in offices across IRS who would be affected if
regular adjustments of penalties occurred. These offices are the
o Office of Penalties within the Small Business/Self Employed
division (SB/SE);
o Learning and Education within SB/SE;
o Wage and Investment division (W&I);
o Tax Exempt/Government Entity division;
o Large and Mid-Size Business division;
o Research, Analysis and Statistics division;
o Legislative Analysis Tracking and Implementation Services;
o Office of Chief Counsel;
o Business Forms and Publications within W&I;
o Enforcement Revenue Data;
o Communications and Liaison; and
o Modernization and Information Technology Services, including
officials who work on the Business Master File, the Financial
Management Information System, the Automated Trust Fund Recovery
system, Report Generation Software, Automated Offers in
Compromise, Penalty and Interest Notice Explanation, Integrated
Data Retrieval System, and the Payer Master File Processing
System.
1Historically, inflation as measured by the CPI-U has tended to outpace
inflation as measured by the GDP price deflator. As a result, if the GDP
deflator had been used instead in this analysis, the estimated revenue
effect of indexing fixed penalties would likely have been somewhat
smaller.
To determine the likely effect that regularly adjusting penalties for
inflation would have on the administrative burden of tax practitioners, we
interviewed tax practitioners affiliated with the American Institute of
Certified Public Accountants, the National Association of Enrolled Agents,
the National Society of Tax Professionals, and the American Bar
Association. In total, we spoke with 28 practitioners. Results from the
nongeneralizable sample of practitioners we selected cannot be used to
make inferences about the effect of regular adjustments of penalties on
the work of all tax practitioners. Additionally, those we spoke with
presented their personal views, not those of the professional associations
through which they were contacted.
We conducted our work from September 2006 through July 2007 in accordance
with generally accepted government auditing standards.
Appendix II: GAO Contact and Staff Acknowledgments
GAO Contact
Michael Brostek, (202) 512-9039 or [24][email protected]
Acknowledgments
In addition to the contact named above, Jonda Van Pelt, Assistant
Director; Benjamin Crawford; Evan Gilman; Edward Nannenhorn; Jasminee
Persaud; Cheryl Peterson; and Ethan Wozniak made key contributions to this
report.
(450519)
[25]www.gao.gov/cgi-bin/getrpt?GAO-07-1062 .
To view the full product, including the scope
and methodology, click on the link above.
For more information, contact Michael Brostek at (202) 512-9110 or
[email protected].
Highlights of [26]GAO-07-1062 , a report to the Committee on Finance, U.S.
Senate
August 2007
TAX COMPLIANCE
Inflation Has Significantly Decreased the Real Value of Some Penalties
Civil tax penalties are an important tool to encourage taxpayer compliance
with the tax laws. A number of civil tax penalties have fixed dollar
amounts--a specific dollar amount, a minimum or maximum amount--that are
not indexed for inflation. Because of your concerns that civil penalties
are not effectively achieving their purposes, we agreed to (1) determine
the potential effect of adjusting civil tax penalties for inflation on the
Internal Revenue Service's (IRS) assessment and collection amounts and (2)
describe the likely administrative impact of regularly adjusting civil tax
penalties on IRS and tax practitioners. GAO examined IRS data on civil tax
penalties and conducted interviews with IRS employees and tax
practitioners.
[27]What GAO Recommends
Congress should consider requiring IRS to periodically adjust for
inflation, and round appropriately, the fixed dollar amounts of civil tax
penalties to account for the decrease in real value over time and so that
penalties for the same infraction are consistent over time. IRS provided
technical comments on a draft of this report that have been incorporated
where appropriate.
Adjusting civil tax penalties for inflation on a regular basis to maintain
their real values over time may increase IRS collections by tens of
millions of dollars per year. Further, the decline in real value of the
fixed dollar amounts of civil tax penalties may weaken the deterrent
effect of these penalties and may result in the inconsistent treatment of
taxpayers over time. If civil tax penalty fixed dollar amounts were
adjusted for inflation, the estimated increase in IRS collections would
have ranged from $38 million to $61 million per year from 2000 to 2005.
Almost all of the estimated increase in collections was generated by four
penalties. These increases result because some of the penalties were set
decades ago and have decreased significantly in real value--by over
one-half for some penalties.
Estimated Increase in IRS Assessments and Collections from Inflation
Adjusting of Penalties Assessed, 2000 - 2005
Dollars in millions
Penalty adjusted assessment Penalty adjusted collections
Assessment year increase increase
2000 $100.4 $38.2
2001 254.9 42.1
2002 165.3 47.9
2003 267.1 53.2
2004 320.9 61.0
2005 280.5 60.3
Source: GAO analysis of IRS data.
According to those we interviewed, the likely administrative burden
associated with adjusting the fixed dollar amounts of civil tax penalties
for inflation on a regular basis would not be significant for IRS and
would be low for tax practitioners. However, officials from the Office of
Penalties, a relatively small office that would be responsible for
coordinating the required changes among multiple IRS divisions, said that
such adjustments might be considerable depending on the number of
penalties being adjusted and would require a reprioritization of work. IRS
officials said that the work required would be easier to implement with
each subsequent update.
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References
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20. http://www.gao.gov/cgi-bin/getrpt?GAO-03-409
21. http://www.gao.gov/cgi-bin/getrpt?GAO-06-1000T
22. http://www.gao.gov/
23. mailto:[email protected]
24. mailto:[email protected]
25. http://www.gao.gov/cgi-bin/getrpt?GAO-07-1062
26. http://www.gao.gov/cgi-bin/getrpt?GAO-07-1062
28. http://www.gao.gov/
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30. http://www.gao.gov/fraudnet/fraudnet.htm
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