Using Data from the Internal Revenue Service's National Research
Program to Identify Potential Opportunities to Reduce the Tax Gap
(15-MAR-07, GAO-07-423R).
The Internal Revenue Service (IRS) most recently estimated that
the gross tax gap--the difference between what taxpayers pay in
taxes voluntarily and on time and what they should pay under the
law--reached $345 billion for tax year 2001. The tax gap arises
when taxpayers fail to comply with their individual income,
corporate income, employment, estate, or excise tax obligations
through (1) underreporting of tax liabilities on tax returns; (2)
underpayment of taxes due from filed returns; or (3) nonfiling,
which refers to the failure to file a required tax return
altogether or on time. IRS's tax gap estimates are based on a
variety of data sources. Recently, IRS studied individual
taxpayer compliance through the National Research Program (NRP),
and used the resulting compliance data to estimate the tax gap
for individual income tax underreporting and the portion of
employment tax underreporting attributed to self-employment taxes
for tax year 2001. NRP, which involved reviewing around 46,000
individual tax returns, has yielded very important new
information on taxpayer compliance for the first time since IRS's
previous compliance measurement study was undertaken for tax year
1988. Compliance measurement studies such as NRP have the
potential to identify ways to improve taxpayer compliance, which
could in turn reduce the tax gap and improve the nation's fiscal
stability. For example, each 1 percent reduction in the net tax
gap would likely yield around $3 billion annually. Given its
potential to improve individual taxpayer compliance, you asked us
to review the results of the 2001 NRP study. In response, we
agreed to identify (1) specific areas of individual taxpayer
noncompliance that are promising targets for additional research
to improve reporting compliance, and (2) opportunities, if any,
found through the course of our work to improve future NRP
studies.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-07-423R
ACCNO: A66985
TITLE: Using Data from the Internal Revenue Service's National
Research Program to Identify Potential Opportunities to Reduce
the Tax Gap
DATE: 03/15/2007
SUBJECT: Income taxes
Personal income taxes
Research programs
Tax credit
Tax evasion
Tax law
Tax returns
Taxpayers
Voluntary compliance
Tax gap
Earned Income Credit
IRS National Research Program
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te
n
March 15, 2007
The Honorable Max Baucus
Chairman
Committee on Finance
United States Senate
The Honorable Charles E. Grassley
Ranking Minority Member
Committee on Finance
United States Senate
Subject: Using Data from the Internal Revenue Service's National Research
Program to Identify Potential Opportunities to Reduce the Tax Gap
The Internal Revenue Service (IRS) most recently estimated that the gross
tax gap--the difference between what taxpayers pay in taxes voluntarily
and on time and what they should pay under the law--reached $345 billion
for tax year 2001.^1 The tax gap arises when taxpayers fail to comply with
their individual income, corporate income, employment, estate, or excise
tax obligations through (1) underreporting of tax liabilities on tax
returns; (2) underpayment of taxes due from filed returns; or
(3) nonfiling, which refers to the failure to file a required tax return
altogether or on time.
IRS's tax gap estimates are based on a variety of data sources. Recently,
IRS studied individual taxpayer compliance through the National Research
Program (NRP), and used the resulting compliance data to estimate the tax
gap for individual income tax underreporting and the portion of employment
tax underreporting attributed to self-employment taxes for tax year
2001.^2 NRP, which involved reviewing around 46,000 individual tax
returns, has yielded very important new information on taxpayer compliance
for the first time since IRS's previous compliance measurement study was
undertaken for tax year 1988.^3 Compliance measurement studies such as NRP
have the potential to identify ways to improve taxpayer compliance, which
could in turn reduce the tax gap and improve the nation's fiscal
stability. For example, each 1 percent reduction in the net tax gap would
likely yield around $3 billion annually.
^1IRS estimated that it would eventually collect about $55 billion of the
gross tax gap through late payments and IRS enforcement actions, leaving a
net tax gap of around $290 billion. Unless otherwise noted, references to
the tax gap refer to the gross tax gap.
^2Self-employed individuals are generally required to calculate and remit
Social Security and Medicare taxes to the U.S. Treasury each quarter. As
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.
Given its potential to improve individual taxpayer compliance, you asked
us to review the results of the 2001 NRP study. In response, we agreed to
identify (1) specific areas of individual taxpayer noncompliance that are
promising targets for additional research to improve reporting compliance,
and (2) opportunities, if any, found through the course of our work to
improve future NRP studies.
To identify specific areas of individual taxpayer noncompliance that are
promising targets for additional research to improve reporting compliance,
we examined IRS's tax gap estimates for tax year 2001 and the underlying
data from NRP upon which IRS based its estimates. We determined that IRS's
tax gap and compliance estimates were sufficiently reliable for the
purposes of this engagement based on our previous reviews of the tax gap
and NRP data. For a fuller description of how we selected promising
targets, see enclosure 1. To identify opportunities, if any, found through
the course of our work to improve future NRP studies, we identified
weaknesses in NRP that we found during this and other GAO reviews that
used NRP data and, based on discussions with IRS research and compliance
officials, identified opportunities to address any such weaknesses. We
conducted our work from September 2006 through February 2007 in accordance
with generally accepted government auditing standards.
On February 28, 2007, we briefed your staff on the results of our work.
This report formally conveys the information provided during that briefing
(which appears in enclosure 1).
Results
Areas of individual taxpayer noncompliance that are promising targets for
additional research to improve reporting compliance include:
o income/losses from partnerships and S corporations,
o income/losses from rental real estate,
o sole proprietor income/losses,
o income/losses from farming,
o other income--net operating losses,
o gambling income/losses,
o capital gains for assets other than securities,
o other gains/losses,
o Earned Income Tax Credit,
o Additional Child Tax Credit,
o deduction for charitable contributions,
o deduction for medical and dental expenses,
o deduction for job expenses and most other deductions, and
o exemptions.
^3For tax years 1963 through 1988, IRS measured compliance for various
types of tax and taxpayers through its Taxpayer Compliance Measurement
Program (TCMP). IRS did not implement any TCMP studies after tax year 1988
because of concerns about costs to and burdens on taxpayers. See GAO, 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).
Our process for selecting these areas and further information on these
areas appears in enclosure 1.
IRS could benefit from electronically capturing complete NRP examination
case files. Although IRS creates an electronic record for each tax return
reviewed for NRP, these records do not contain all of the information
contained in the corresponding hard copy examination case files. For
example, information taxpayers provide to IRS during examinations is only
included in the paper case file and not in the electronic records.
Furthermore, some paper case files are not obtainable. For a prior review
on the capital gains tax gap for securities,^4 IRS was not able to provide
11 percent of NRP examination case files we requested because complete
files could not be located or were being used by IRS units. Having
complete electronic NRP examination case files would make it easier for
IRS to get the full value from NRP studies because the files could be
assessed more easily than hard copy files. Additionally, complete
electronic case files would lower the risk of lost files and would allow
files to be accessed simultaneously by multiple users. According to IRS
research and examination officials, the cost and timing of electronically
capturing complete examination case files would vary by how they are made
electronic.
Conclusion
NRP is an important research program that could help IRS identify ways to
reduce taxpayer noncompliance and the tax gap. An evaluation of NRP data
revealed a variety of areas of noncompliance where further research could
provide information on how to address noncompliance. However, IRS cannot
maximize the value of information it collects through NRP if it cannot
locate or efficiently access examination case files.
Recommendation for Executive Action
To ensure that IRS maximizes its return on investment from future NRP
studies, IRS should develop a plan for capturing complete NRP examination
case files that
^4GAO, Capital Gains Tax Gap: Requiring Brokers to Report Securities Cost
Basis Would Improve Compliance if Related Challenges Are Addressed,
GAO-06-603 (Washington, D.C.: June 13, 2006).
(1) determines the most cost effective means for capturing information
electronically and (2) lays out a schedule for when it will begin to
capture information electronically.
Agency Comments and Our Evaluation
In commenting on a draft of this report, the Commissioner of Internal
Revenue concurred with our recommendation (see enclosure II for the full
text of IRS's comments). IRS also provided separate comments on several
technical issues, which we incorporated into this report 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 issue date. At that time, we will send copies to the Chairman and
Ranking Minority Member, House Committee on Ways and Means; the Secretary
of the Treasury; the Commissioner of Internal Revenue; and other
interested parties. We will also make copies available to others upon
request. In addition, this letter will be available at no charge on the
GAO Web site at http://www.gao.gov.
If you or your staff have any questions, please contact me on (202)
512-9110 or [email protected]. Contact points for our offices of
Congressional Relations and Public Affairs may be found on the last page
of this letter. Individuals making key contributions to this report are
listed in enclosure III.
James R. White
Director, Tax Issues
Strategic Issues Team
Enclosures
Enclosure I
Congressional Briefing on NRP Data
Enclosure II
Comments from the Internal Revenue Service
Enclosure III
Contact and Staff Acknowledgments
GAO Contact
James R. White, (202) 512-9110 or [email protected]
Staff Acknowledgments
In addition to the contact named above, David Lewis,
Assistant Director; Jeff Arkin; John Mingus; Karen O'Conor; Cheryl
Peterson; Jeff Procak; and Sam Scrutchins made key contributions to this
report.
Related GAO Products
Tax Compliance: Multiple Approaches Are Needed to Reduce the Tax Gap.
GAO-07-488T. Washington, D.C.: February 16, 2007.
Tax Compliance: Multiple Approaches Are Needed to Reduce the Tax Gap.
GAO-07-391T. Washington, D.C.: January 23, 2007.
Tax Compliance: Opportunities Exist to Reduce the Tax Gap Using a Variety
of Approaches. GAO-06-1000T. Washington, D.C.: July 26, 2006.
Tax Compliance: Challenges to Corporate Tax Enforcement and Options to
Improve Securities Basis Reporting. GAO-06-851T. Washington, D.C.: June
13, 2006.
Capital Gains Tax Gap: Requiring Brokers to Report Securities Cost Basis
Would Improve Compliance if Related Challenges Are Addressed. GAO-06-603.
Washington, D.C.: June 13, 2006.
Tax Gap: Making Significant Progress in Improving Tax Compliance Rests on
Enhancing Current IRS Techniques and Adopting New Legislative Actions.
GAO-06-453T. Washington, D.C.: February 15, 2006.
Tax Gap: Multiple Strategies, Better Compliance Data, and Long-Term Goals
Are Needed to Improve Taxpayer Compliance. GAO-06-208T. Washington, D.C.:
October 26, 2005.
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.
Tax Compliance: Reducing the Tax Gap Can Contribute to Fiscal
Sustainability but Will Require a Variety of Strategies. GAO-05-527T.
Washington, D.C.: April 14, 2005.
Tax Administration: IRS Is Implementing the National Research Program as
Planned. GAO-03-614. Washington, D.C.: June 16, 2003.
Tax Administration: New Compliance Research Effort Is on Track, but
Important Work Remains. GAO-02-769. Washington, D.C.: June 27, 2002.
Tax Administration: Status of IRS' Efforts to Develop Measures of
Voluntary Compliance. GAO-01-535. Washington, D.C.: June 18, 2001.
Taxpayer Compliance: Analyzing the Nature of the Income Tax Gap.
GAO/T-GGD-97-35. Washington, D.C.: January 9, 1997.
Tax Administration: Alternative Strategies to Obtain Compliance Data.
GAO/GGD-96-89. Washington, D.C.: April 26, 1996.
Tax Administration: Information on IRS' Taxpayer Compliance Measurement
Program. GAO/GGD-96-21. Washington, D.C.: October 6, 1995.
Other Income Reporting. GAO/GGD-95-199R. Washington, D.C.: July 19, 1995.
Tax Compliance: 1994 Taxpayer Compliance Measurement Program.
GAO/T-GGD-95-207. Washington, D.C.: July 18, 1995.
Reducing the Tax Gap: Results of a GAO-Sponsored Symposium.
GAO/GGD-95-157. Washington, D.C.: June 2, 1995.
Tax Compliance: Status of the Tax Year 1994 Compliance Measurement
Program. GAO/GGD-95-39. Washington, D.C.: December 30, 1994.
Tax Gap: Many Actions Taken, But a Cohesive Compliance Strategy Needed.
GAO/GGD-94-123. Washington, D.C.: May 11, 1994.
Tax Administration: IRS' Plans to Measure Tax Compliance Can Be Improved.
GAO/GGD-93-52. Washington, D.C.: April 5, 1993.
IRS' Compliance Programs to Reduce the Tax Gap. GAO/T-GGD-91-11.
Washington, D.C.: March 13, 1991.
IRS Can Use Tax Gap Data to Improve Its Programs for Reducing
Noncompliance. GAO/T-GGD-90-32. Washington, D.C.: April 19, 1990.
Tax Administration: Profiles of Major Components of the Tax Gap.
GAO/GGD-90-53BR. Washington, D.C.: April 4, 1990.
(450510)
Congressional Briefing on NRP Data
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