Reducing the Tax Gap: Results of a GAO-Sponsored Symposium (Letter
Report, 06/02/95, GAO/GGD-95-157).
GAO presented the results of its symposium on key taxpayer compliance
issues.
GAO found that: (1) the federal tax system does not ensure uniform
compliance among various groups of taxpayers; (2) major modifications in
the current tax system would be required to substantially improve
taxpayer compliance with tax laws, such as reducing tax law complexity
and extending income tax withholding requirements; (3) the Internal
Revenue Service (IRS) could improve taxpayer compliance by expanding
compliance techniques, addressing unreported income, improving the
utility of compliance data, and improving its ability to resolve
taxpayer compliance problems promptly; and (4) IRS officials must
determine the acceptable levels of compliance and tax system
intrusiveness to promote compliance for each type of taxpayer.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-95-157
TITLE: Reducing the Tax Gap: Results of a GAO-Sponsored Symposium
DATE: 06/02/95
SUBJECT: Tax administration
Reporting requirements
Noncompliance
Income taxes
Tax administration systems
Taxpayers
Tax returns
Tax law
Tax nonpayment
IDENTIFIER: IRS Taxpayer Compliance Measurement Program
Earned Income Tax Credit
IRS Business Master Plan
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Cover
================================================================ COVER
Report to the Joint Committee on Taxation, U.S. Congress
June 1995
REDUCING THE
TAX GAP - RESULTS OF A
GAO-SPONSORED SYMPOSIUM
GAO/GGD-95-157
Tax Gap Symposium
Abbreviations
=============================================================== ABBREV
IRS - Internal Revenue Service
TCMP - Taxpayer Compliance Measurement Program
Letter
=============================================================== LETTER
B-260255
June 2, 1995
The Honorable Bill Archer
Chairman, Joint Committee on Taxation
The Honorable Bob Packwood
Vice-Chairman, Joint Committee on Taxation
United States Congress
As part of our continuing effort to improve the administration of the
nation's tax laws, we have been examining the overall issue of
taxpayer compliance. Available Internal Revenue Service (IRS) data
indicate that taxpayers do not pay (either voluntarily or after IRS
compliance efforts) about 13 percent of the federal income taxes due
on their income from legal sources. Such an estimated shortfall in
tax revenue has been a long-standing and seemingly intractable
problem.
SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :1
To explore innovative and practical means for increasing taxpayer
compliance, we sought the views of experts in the field. On January
12, 1995, we sponsored a symposium that brought together well-known
tax authorities with congressional, IRS, and GAO staff (see app. I
for a listing of the panelists).
The starting point for the symposium panel discussion was our May
1994 overview report, which highlighted the changes that IRS and
Congress need to consider given the body of work we had already
completed.\1
This report discusses the key issues raised during the January 1995
GAO symposium. The views expressed by the panelists are not
necessarily the views of GAO. Also, the views are those that were
voiced at the session, but not every panelist commented on every
issue and not all panelists were present for all of the
discussions.\2 In developing this report, we provided each panelist
the opportunity to comment on its contents and incorporated the views
of those who responded in the final product.
--------------------
\1 See Tax Gap: Many Actions Taken, But a Cohesive Compliance
Strategy Needed (GAO/GGD-94-123, May 11, 1994).
\2 Seven of the eight panelists were available for the duration of
the symposium. Because of scheduled congressional deliberations,
Senator Dorgan participated during part of the discussions.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :2
Analyses of IRS compliance data show that the federal tax system does
not ensure uniform compliance among various groups of taxpayers,
e.g., between wage earners and the self-employed. Given such
differences and the persistent level of noncompliance as indicated by
IRS' statistics, the panelists who participated in GAO's 1995
symposium agreed that major modifications in the current tax system
would be required to substantially improve taxpayer compliance with
the nation's tax laws.
In general, the panelists identified a number of objectives that, if
met, could help to bring about such change: (1) reduce tax law
complexity and make results more certain; (2) extend the reach of tax
requirements, such as income tax withholding, that promote taxpayer
compliance; (3) expand the compliance techniques available to IRS;
(4) adjust the focus of IRS' compliance efforts to address more
aggressively the largest aspect of noncompliance, i.e., unreported
income; (5) improve the utility of IRS' compliance data; and (6)
improve IRS' ability to resolve taxpayer compliance problems quickly,
before the problems become serious.
But, as the panelists recognized, any change that extends the reach
of the tax system also increases the extent to which the tax system
intrudes into taxpayers' affairs and needs to be carefully
considered. Thus, the bottom-line decision on whether to extend the
reach of the tax system to recover additional revenues due the
government under current law involves determining the right mix
between (1) the acceptable level of compliance for each type of
taxpayer and (2) the acceptable level of tax system intrusiveness to
promote compliance within each category of taxpayer.
NONCOMPLIANCE: A SIGNIFICANT
AND LONG-STANDING PROBLEM
------------------------------------------------------------ Letter :3
The size of the gross tax gap (the difference between what taxpayers
owe and what they do not voluntarily pay) has increased significantly
from that first estimated by IRS in 1973.\3 But the relative
magnitude of the tax gap, when compared with total income taxes due
the federal government, has remained comparatively constant over the
intervening years. The estimated amount of taxes not voluntarily
paid (about $28 billion to $32 billion in 1973 versus $110 billion to
$127 billion in 1992) has hovered around 17 percent of total federal
income taxes due each year, according to IRS.
In addition to receiving voluntary tax payments, IRS collects about 4
percent of total income taxes due the federal government in any
particular tax year as a result of its enforcement efforts, according
to IRS. Thus, overall compliance (as measured by taxes paid relative
to taxes owed) tends to reach about 87 percent for any given tax
year. But, because of the time- consuming nature of IRS' enforcement
activities and subsequent appeals and litigation, it may take a
number of years to reach the 87-percent compliance level.
The largest component of noncompliance known to IRS involves
taxpayers who do not report all taxable income on their tax returns.
The size and characteristics of this aspect of noncompliance as well
as a breakdown of the other major types of noncompliance that
represent IRS' $127-billion gross tax gap estimate for 1992 are as
follows:
24 percent is attributable to sole proprietors (self-employed
individuals) who do not report all income subject to taxation;
24 percent is attributable to other individuals who do not report
all taxable income (excluding wages and salaries subject to
withholding);
19 percent is attributable to large corporations (i.e., those with
assets of $10 million or more) that understate their tax
liability;
9 percent is attributable to individuals who do not remit all taxes
reported due on their returns;
8 percent is attributable to individuals who do not file a return;
6 percent is attributable to individuals who take excessive
deductions;
6 percent is attributable to small corporations (i.e., those with
assets of less than $10 million) that understate their tax
liability; and
4 percent is attributable to all other reasons, such as
corporations not remitting all taxes reported due on their
returns.
Appendix II provides additional data on IRS' tax gap estimates. As
the appendix shows, much more is known about the noncompliance
attributable to individuals than to corporations or other business
entities.
--------------------
\3 IRS' tax gap estimates (an annual series, 1973 through 1992) have
been largely developed from the results of periodically scheduled
audits of randomly selected tax returns done under IRS' Taxpayer
Compliance Measurement Program (TCMP). These TCMP audits of
individuals were done for tax years 1973, 1976, 1979, and 1982. For
small corporations, the TCMP audits involved tax years 1977 and 1980.
Rather than using TCMP audits to measure compliance of large
corporations, IRS has used the results of regular examinations.
Also, other TCMP audits of individuals for tax years 1985 and 1988
and small corporations for 1987 have been completed, but the results
have not yet been fully incorporated into the tax gap estimates.
IMPROVING TAXPAYER COMPLIANCE:
VIEWS OF SYMPOSIUM PANELISTS
------------------------------------------------------------ Letter :4
Analyses of the tax gap and other compliance data show the degree to
which the current tax system does not ensure uniform compliance. The
panelists identified certain tax system features that tend to promote
high levels of compliance for some groups and features that tend to
predict noncompliance for other groups. Given such relationships,
the panelists identified a number of objectives that, if met, could
enhance the effectiveness of the existing system in promoting
compliance.
PROMOTING TAX LAW SIMPLICITY
AND CERTAINTY
---------------------------------------------------------- Letter :4.1
As discussed by the panel members, the simpler the tax code and the
more certain the results in applying it, the fewer the opportunities
for disagreements over the "fine points" of tax law and the greater
the likelihood of voluntary compliance. For example, on the basis of
audit results for tax year 1992, IRS estimated that large
corporations owed about $142 billion in taxes. In contrast, those
corporations set their tax liability at about $118 billion. The
difference (about $24 billion) is substantial and, in large part,
attributable to ambiguity and complexity in tax law.
Our prior work has shown that resolving disputes arising from tax law
ambiguities frequently involves rather lengthy appeals and
litigation.\4 In some instances, appeals and litigation have delayed
the settlement of tax disputes for years. For example, analyses of
IRS data indicate that hundreds of tax disputes between IRS and large
corporations remain unsettled for 10 or more years, and some as long
as 30 years. Using the results of IRS' audits of 1,700 of the
nation's largest corporations, we estimated that for each $1 of IRS'
proposed audit assessments, IRS ultimately collected about 22 cents
as the full amount due to settle the tax liability.\5
Tax law complexity may stem from a number of different causes. In
part, complexity arises from the attempt to treat all taxpayers
fairly. For example, IRS has adopted lengthy rules to enforce
general concepts embodied in tax law.
It has 261 pages of regulations clarifying the "arm's-length
standard" for valuing intercompany transactions to ensure that
multinational corporations doing business in the United States
pay their fair share of taxes. In general, the panelists were
skeptical that IRS has a good measure of the extent of
noncompliance by these corporations. But, some panelists
thought that IRS' $2-billion to $3-billion estimate
significantly understated the extent to which these corporations
have tended to annually underpay their U.S. federal income tax.
It has 20 factors for determining who should be treated as an
employee or as an independent contractor (i.e., a self-employed
individual who provides services). IRS compliance data on the
nonfarm self-employed indicated that income tax losses amounted
to about $34 billion in 1992.
The panelists also indicated that other complexities arise from
congressional decisions to use the tax code to resolve social
problems through tax preferences. Currently, tax preferences not
only amount to about $450 billion of forgone annual taxes but also
add to tax administration complexity by increasing the volume of
transactions or activities that could result in tax noncompliance.
These preferences thereby increase the number of transactions that
IRS may need to audit or otherwise oversee to ensure compliance.
For example, recent IRS analysis of one tax preference (the Earned
Income Tax Credit)\6 showed that 29 percent of returns filed during a
2-week period in January 1994 claimed too large a tax credit.\7
Earlier IRS estimates had indicated that about 42 percent of the
taxpayers who claimed the credit in 1988 received too large a credit,
and, because of the complexity of the tax law, many who were entitled
to the credit did not claim it. Both circumstances required action
on the part of IRS.\8
To help simplify and make tax collection results more certain, the
panelists identified a number of specific changes relating to the
taxation of corporations that warranted consideration.
Most panelists favored IRS moving away from the traditional
approach for pricing intercompany transactions to determine
taxable income of multinational corporations. But their views
on solutions differed.
Some panelists favored replacing the traditional approach with a
formulaic one, e.g., allocating multinational corporate income
among tax jurisdictions according to the proportion of certain
factors, such as the amount of payroll in each jurisdiction.
According to these panelists, the formulaic approach is easy to
administer and has been successfully adopted by states (e.g.,
California) to compute corporate income attributable to
corporate operations within a state.
Other panelists, however, believed that the institution of a
formulaic approach by one country and not others would lead to
double taxation problems. They noted that without international
harmonization of tax rules, an attempt by one country to tax
business income that a multinational company attributes to
operations in another country could lead to taxation of that
income by each of the countries involved. Given the views
expressed by foreign officials, however, these panelists
recognized that international harmonization of tax laws to
support a formulaic approach would be unlikely.
Instead, these other panelists favored the negotiated pricing
agreement concept that IRS has begun to pursue. Under the
advance pricing agreement concept, a taxpayer(s) may ask IRS to
approve ahead of time the methodology to be used to arrive at
taxable income. The agreements could be based on traditional
arm's-length standard practices for pricing intercompany
transactions or a more formulaic method of splitting profits, if
warranted. Thus, according to these panelists, the agreements
could reap the benefits of a formulaic approach while minimizing
the possibility of double taxation since the affected parties
would be engaged in the negotiated agreements. On the other
hand, some panelists objected to this approach because the
negotiations could be done in private, i.e., without public
oversight.
Given the difficulties in identifying taxable income of
multinational businesses, the panelists recognized that
consideration could be given to establishing a minimum tax on
businesses. For example, among Latin American countries it is
not uncommon for businesses to be taxed on the basis of asset
size, and among African countries on the basis of gross
turnover. Such tax arrangements avoid the technical and
seemingly unadministerable rules associated with computing
profits of multinationals on a case-by-case arm's-length basis.
Instead, the tax systems presume that the businesses are
realizing some economic gains--otherwise, the business activity
would not be occurring--and therefore should be subject to some
level of taxation.
Some panelists also suggested that consideration be given to
abolishing the corporate income tax. The rationale for such a
change was largely based on the (1) relatively small
contribution corporate taxes make--about 10 percent--to the
overall funding of the federal government, (2) difficulties IRS
has in administering the corporate tax provisions as indicated
by the significant difference between tax assessments proposed
by IRS and the final tax settlements reached with large
corporations, and (3) potential adverse consequences that
corporate noncompliance rates may have on the willingness of
noncorporate taxpayers to voluntarily pay what they owe. On the
other hand, some panelists suggested that exempting corporations
from federal income tax might have a more detrimental impact on
individual noncompliance than public knowledge of corporate
noncompliance rates.
The panelists also noted that, given the extent of noncompliance
associated with the use of the 20 factors for classifying individual
taxpayers as employees or independent contractors, a tax system
change was warranted. The change involves an extension of income tax
withholding requirements and is discussed in the following section.
--------------------
\4 See Tax Administration: Compliance Measures and Audits of Large
Corporations Need Improvement (GAO/GGD-94-70, Sept. 1, 1994).
\5 As specified in the report, given the complexity of tax law and
administration, GAO does not know what the proper amount of tax
assessment or collection should be but believes that it is reasonable
to assume that collecting 22 cents per dollar leaves room for
improvement either in the audit recommendation process or the appeals
process, or both.
\6 The Earned Income Credit is a major federal effort to assist the
working poor. The estimated $22 billion in tax credits in 1995 are
intended to (1) offset the amount of Social Security taxes on
low-income workers and (2) encourage low-income workers to seek
employment rather than welfare.
\7 See Earned Income Credit: Targeting to the Working Poor
(GAO/T-GGD-95-136, April 4, 1995).
\8 See Tax Policy: Earned Income Tax Credit: Design and
Administration Could Be Improved (GAO/GGD-93-145, Sept. 24, 1993).
EXTENDING THE REACH OF TAX
SYSTEM REQUIREMENTS KNOWN TO
PROMOTE COMPLIANCE
---------------------------------------------------------- Letter :4.2
As the panelists discussed, the greater the visibility of income to
IRS, the higher the rate of timely payment of taxes without IRS
intervention. For wages earned by individual tax return filers whose
salaries are subject to tax withholding (the most visible form of
income to IRS), IRS estimates voluntary reporting compliance to be
over 99 percent. In comparison, for interest and dividend income
earned by individual tax return filers, which for the most part is
subject to tax information reporting\9 but not tax-withholding
requirements, income-reporting compliance is about 95 percent.
In contrast, for self-employed tax return filers such as independent
contractors whose income is neither subject to withholding nor
necessarily covered by information-reporting requirements, IRS
estimates income-reporting compliance to be about 41 percent. And,
for self-employed individuals who have adopted an informal business
style\10 and thus are even less likely to have income reported to IRS
on information returns, compliance is estimated to be about 13
percent. In addition, for every $3 of reported earnings by these
self-employed filers, another $1 of earnings is not reported by
self-employed nonfilers of tax returns.
To better promote compliance, the panelists identified a number of
specific changes that warranted consideration.
Most panelists generally favored extending tax-withholding
requirements to certain income currently not subject to such
requirements, i.e., business payments to independent
contractors. The panelists noted that extending withholding
would not be inconsistent with international practices.
As part of the withholding discussion, the panelists questioned the
existing practice of attempting to resolve the noncompliance of
independent contractors by clarifying the definition of
"independent contractor." Instead, panelists offered withholding
on income as an appropriate alternative. They recognized that
factors outside the realm of tax law (e.g., potential liability
for judgments under civil law, responsibility for benefits, and
flexibility of working arrangements) may cause employers and
workers to seek "independent contractor" status and thereby help
to explain the vocal, and effective, resistance to IRS
reclassification of "independent contractors" to "employees."
But, absent withholding, the panelists were skeptical that IRS
compliance efforts could effectively reduce the relatively high
degree of noncompliance among independent contractors.\11
Accordingly, the panelists tended to favor some withholding on
the basis of payments made by business entities rather than on
the employment status of the worker.
In general, the panelists tended to support changes that would make
income-related information more visible to IRS. This view stems, in
part, from IRS' experience over the last 15 years or so. Over that
period of time, audit coverage has dropped substantially, yet
compliance rates have remained relatively stable. The generally
accepted explanation for such seemingly contradictory occurrences is
the expansion of information- reporting requirements and the use of
that information by IRS.
During the panel discussion, the individual tax return (Form 1040)
was identified as a means to enhance information reporting to IRS.
For example, a panelist indicated that the tax return could be
modified to ask individual taxpayers whether they employed a domestic
worker (e.g., provide a name and Social Security number). Panelists
indicated that such a change could potentially yield tens of millions
of dollars in additional tax revenues annually. Consideration of
such a change could also prompt questions about whether tax return
reporting could be adopted to help reduce noncompliance attributable
to other self-employed individuals who provide services to
nonbusiness taxpayers (e.g., self-employed individuals who provide
home repair services to households).
Nonetheless, the panelists recognized that any change that would
extend the reach of the tax system also would increase the extent to
which the tax system would intrude into taxpayers' affairs and would
need to be carefully considered. On the one hand, the panelists
recognized that something less than total compliance has the
potential to erode future voluntary compliance. On the other hand,
the panelists also recognized that if a system becomes too intrusive
and burdensome, it also has the potential to erode future compliance.
Thus, the bottom-line decision on whether to extend the reach of the
tax system involves determining the right mix between the acceptable
level of noncompliance for each type of taxpayer and the acceptable
level of tax system intrusiveness to promote compliance among those
taxpayers. For the most part, the panelists did not believe that the
optimum balance had yet been reached with respect to tax withholding
requirements.
--------------------
\9 In general, certain third parties (e.g., businesses and banks but
not individuals such as homeowners) are required to make annual
information filings with IRS to report various payments made to
unincorporated individuals, such as payments for services rendered
and interest and dividends. The information is also reported to the
individuals receiving the payments.
\10 These informal suppliers are individuals (sole proprietors) who
provide products or services through informal arrangements that
frequently involve cash-related transactions. In this category IRS
includes roadside or sidewalk vendors, moonlighting craftsmen or
mechanics, and similar operators with informal business styles,
including some auto repair shops, beauty shops, and used car dealers.
\11 For additional discussion of options, see Tax Administration:
Approaches for Improving Independent Contractor Compliance
(GAO/GGD-92-108, July 23, 1992).
EXPAND THE COMPLIANCE
TECHNIQUES AVAILABLE TO IRS
---------------------------------------------------------- Letter :4.3
As some panelists pointed out, tax collectors in a number of foreign
countries have access to information produced in connection with the
administration of tax laws other than those applicable to income
(e.g., sales and value-added taxes). The nationwide information
produced in connection with these other taxes can be used to track
potential sources of unreported income.
The United States has no value-added tax, and taxes based on sources
other than income are generally administered by state and local
governments. Accordingly, making optimum use of information from
disparate sources is an enormous challenge. The panelists encouraged
IRS to continue to explore ways to share information from the states.
Panelists believed the need for such information has become
particularly evident as IRS has begun to refocus its enforcement
efforts on detecting unreported income.
Also, over the past 10 to 15 years, penalties for noncompliance have
been stiffened, but the panelists recognized that little information
is available on the efficacy of the changes.
MORE AGGRESSIVELY FOCUS
COMPLIANCE EFFORT ON
UNREPORTED INCOME
---------------------------------------------------------- Letter :4.4
Given that the bulk of noncompliance that is known to IRS stems from
unreported income, particularly by the self-employed, the panelists
believed that IRS needed to deal with this issue more directly. IRS
traditionally had focused on the validation of information reported
on the return (e.g., deductions) and not necessarily on searching for
information omitted from the return.
IRS has recently announced the development of an audit approach
geared to identifying unreported income. Under this approach,
referred to as "economic reality" audits, IRS auditors will use
available information to evaluate taxpayers' financial status and
compare it with information reported on their returns, i.e., to
determine whether the reported income could sustain the apparent
expenses. If the preliminary determination is no, then the IRS
auditors would begin expanding their search for leads of unreported
income (e.g., using third-party data, such as business licenses,
building permits, and other information that may be available from
other federal, state, and local agencies as well as private firms
such as credit bureaus).
As we have previously reported, this audit technique may require more
time than simply auditing the tax return, as has been done in the
past.\12 However, IRS officials believe that the benefits from
identifying more unreported income will more than offset the cost
associated with increased audit time.
Most panelists generally supported refocusing IRS audits toward
identifying unreported income. But given the early stage of the
refocusing, it is too soon to predict what the results will be. As
explained in our 1994 report on tax compliance measurement, we
believe that finishing IRS auditor training before the audits start
and ensuring that auditors appropriately follow the approach will
improve the likelihood of achieving the desired benefits.
Also, some panelists were concerned that an expansion of IRS' debt
collection role could dilute the focus of IRS from assessing and
collecting the appropriate amount of taxes, including taxes due on
unreported income. These panelists recognized that IRS already
collects some nontax government debts through a program to offset tax
refunds. But, they expressed concern over what they saw as
indications that IRS may become the collection agent for additional
nontax debts. They also questioned the appropriateness of extending
IRS' extraordinary tax collection powers to routine business
transactions involving the federal government. Accordingly, the
panelists generally favored in-depth research of the possible impacts
on the tax system before such action is taken.
--------------------
\12 Tax Compliance: Status of the Tax Year 1994 Compliance
Measurement Program (GAO/GGD-95-39, Dec. 30, 1994).
IMPROVE IRS' COMPLIANCE DATA
---------------------------------------------------------- Letter :4.5
While the panelists saw the tax gap as a problem serious enough to
warrant a change in the tax system, they viewed the present tax gap
data as having limited value for planning compliance activities.
Further, some panelists believed that the estimates of the tax gap,
if left unchanged, had the potential to negatively influence the
willingness of the nation's taxpayers to voluntarily comply with
federal tax laws. Although taxpayers' continued cooperation is the
underpinning to the nation's voluntary tax system, the current tax
gap data could mislead some taxpayers into trying to exploit
opportunities for paying less than what is owed. These concerns
tended to stem from the following issues:
Much of the data on the tax gap is based on IRS' proposed
assessments, not final assessments. Thus the estimates may bear
little or no similarity to the gap between voluntary payment and
final settlement of the tax liability. For example, the
panelists referred to our 1994 report, which indicated that for
every $1 of proposed assessments made to very large
corporations, only about 22 cents is ultimately determined to be
due the federal government and collected by IRS.\13
Much of the data is aggregated at such a general level that they
provide little useful information for discerning underlying
compliance problems warranting IRS attention. For example,
little is known about noncompliance trends encapsulated under
the umbrella categories such as "large corporation," "sole
proprietor," or "informal supplier."
The data provide a gross estimate of taxpayer noncompliance without
considering the permissible limits of intrusiveness imposed on
the current system of taxation. Thus, for example, the tax gap
estimate includes taxes that are effectively out of IRS reach
because of congressionally determined limits on record keeping,
withholding, or information-reporting requirements.
The panelists discussed ways in which to improve the tax gap data,
such as assigning research responsibility to an agency other than
IRS. But after deliberations, the panelists tended to conclude that
the estimating methodology needed further study and that IRS'
research staff should be amply supported to make such changes. The
panelists were also concerned that IRS' tax gap measures do not cover
employment taxes. Efforts to measure this tax gap have not, as yet,
been completed.
--------------------
\13 See footnotes 4 and 5.
IMPROVE IRS' ABILITY TO
RESOLVE COMPLIANCE PROBLEMS
QUICKLY
---------------------------------------------------------- Letter :4.6
As the panelists noted, taxpayer compliance is prompted by a wide
spectrum of IRS activities, such as tax audits, outreach efforts, and
education. The key is for IRS to tailor its efforts to the needs of
the situation and to act appropriately and on a timely basis. The
longer it takes to reach a taxpayer, whether by computer matching,
examining records, prosecuting a case, or collecting a tax debt, the
less likely that IRS will achieve a favorable outcome.
For example, after much prodding by GAO and Congress to explore the
feasibility of using telephone contacts in the tax collection
process, IRS tests show that early telephone contact with delinquent
taxpayers can yield better results than the cumbersome time-consuming
process of mailing a series of notices and letters.\14 IRS is
revising its collection process along these lines.
IRS' automated systems, however, were not originally designed to
support prompt intervention. They are a patchwork of information
systems that are not integrated. They are not capable of readily
interchanging information among various systems that support each IRS
function (e.g., examination and collection). Moreover, the systems
were not designed to provide IRS with detailed information on which
to assess compliance problems. They were designed to facilitate the
processing of tax returns and the scheduling and managing of IRS
compliance efforts.
IRS is currently engaged in a long-term, multibillion-dollar effort
to redesign its systems to take advantage of new technology. The
panelists recognized that major systems redesign initiatives are
needed for IRS to (1) develop detailed information on compliance
patterns of taxpayers; and (2) extend its early intervention
strategy, e.g., resolve taxpayers' problems on initial contact. They
encouraged IRS to finish its computer modernization and related
changes to operating systems as soon as possible.
--------------------
\14 See Tax Administration: New Delinquent Tax Collection Methods
for IRS (GAO/GGD-93-67, May 11, 1993); and Tax Administration: Tax
Compliance Initiatives and Delinquent Taxes (GAO/T-GGD-95-74, Feb.
1, 1995).
GAO OBSERVATIONS ON THE
CHALLENGE FOR THE FUTURE
------------------------------------------------------------ Letter :5
IRS has set an overall goal of achieving 90-percent compliance with
the nation's tax laws by 2001. On the surface, reaching this goal
would appear to be a modest accomplishment (i.e., reducing the
difference between what taxpayers owe but do not pay from about 13
percent to 10 percent over a 7-year period). But, as indicated by
the tax gap data developed by IRS over the past 20 years, such a
change would constitute a rather significant departure from past
experience. By IRS' reckoning in its 3-year operational plan
(Business Master Plan), the change would generate about $6.7 billion
more tax revenue in 1997 than in 1994.
In summary, the near-term revenue gain of $6.7 billion from IRS'
planned improvements is modest when compared to current projections
of over $100-billion annual tax gaps. Accordingly, absent
significant tax system changes, Congress should not expect much
additional tax revenues. This report has provided the viewpoints of
a number of tax experts on what those changes could entail.
But, as indicated before, any change that would extend the reach of
the tax system also would increase the extent to which the tax system
would intrude into the public's affairs and would need to be
carefully considered. Thus, the bottom-line decision on whether to
broaden the reach of the tax system to recover additional revenues
due the government under current law would involve determining the
right balance between (1) the acceptable level of compliance for each
type of taxpayer and (2) the acceptable level of tax system
intrusiveness to promote compliance.
---------------------------------------------------------- Letter :5.1
We are sending copies of this report to the Senate Finance Committee,
House Committee on Ways and Means, Senate Committee on Governmental
Affairs, House Committee on Government Reform and Oversight, House
and Senate Appropriations Committees, the Commissioner of Internal
Revenue, symposium panelists, and other interested parties. We will
make copies available to others on request.
This report was prepared under the direction of Natwar M. Gandhi,
Associate Director. Other major contributors to this report are
listed in appendix III. If you have any questions concerning this
report, please contact me at (202) 512-5407.
Jennie S. Stathis
Director, Tax Policy
and Administration Issues
PANELISTS IN GAO'S TAX GAP
SYMPOSIUM
=========================================================== Appendix I
Mr. Phil Brand
Chief Compliance Officer
Internal Revenue Service
Ms. Milka Casanegra de Jantscher
Assistant Director and Chief, Tax Administration Division
International Monetary Fund
Former Tax Commissioner, Chile
Senator Byron L. Dorgan
Former State Tax Commissioner, North Dakota
Mr. Kenneth W. Gideon
Wilmer, Cutler and Pickering
Former Assistant Secretary of the Treasury (Tax Policy)
Former Chief Counsel, Internal Revenue Service
Mr. Fred T. Goldberg Jr.
Skadden, Arps, Slate, Meagher and Flom
Former Commissioner of Internal Revenue
Former Assistant Secretary of the Treasury (Tax Policy)
Former Chief Counsel, Internal Revenue Service
Mr. G. Alan Hunter
Assistant Executive Officer for Compliance
California Franchise Tax Board
Mr. Herbert J. Lerner
National Director of Tax Policy and Standards, Ernst & Young
Former Chairman, American Institute of
Certified Public Accountants, Tax Division
Mr. Ronald A. Pearlman
Covington and Burling
Former Chief of Staff, Joint Committee on Taxation
Former Assistant Secretary of the Treasury (Tax Policy)
Note: The panel discussion was moderated by Mr. Natwar M. Gandhi,
Associate Director of GAO's Tax Policy and Administration Issue Area.
Other GAO participants in the panel discussions are listed in
app.III.
SELECTIVE TAX GAP SUMMARY
STATISTICS
========================================================== Appendix II
Table II.1
Gross Tax Gap Estimates for Tax Years
1981 and 1992, in Nominal Dollars
(Dollars in millions)
Percen
t
1981 tax 1992 tax increa
Source of tax gap gap amount gap amount se
---------------------------- ---------- ---------- ------
Individual tax gap $61,900 $93,994 51.8
Unreported income 40,433 62,759 55.2
Sole proprietors 18,714 30,173 61.2
All other income 21,719 32,586 50.0
Overstated deductions\a 7,449 8,081 8.5
Individual nonfiler 5,231 10,233 95.6
Individual remittance gap 8,300 11,400 37.3
Math errors 487 1,521 212.3
Corporate tax gap 14,066 33,135 135.6
Small corporations 4,461 6,999 56.9
Large corporations 8,638 23,716 174.6
Others\b 167 420 151.5
Corporate remittance gap 800 2,000 150.0
============================================================
Total tax gap\c $75,966 $127,129 67.2
------------------------------------------------------------
\a Includes subtractions for erroneous deductions, exemptions,
credits, and other adjustments.
\b Includes unreported income and overstated deductions for exempt
organizations' unrelated business income and for fiduciaries.
\c As shown in Table II.3, the gross tax gap in 1992 dollars
increased from $117 billion in 1981 to $127 billion in 1992--about
8.7 percent.
Sources: Income Tax Compliance Research, IRS Publication 1415
(7-88); and Income Tax Compliance Research: Net Tax Gap and
Remittance Gap Estimates, IRS Publication 1415 (4-90).
Table II.2
Gross Tax Gap Estimates by Source for
1981 and 1992, in Nominal Dollars
(Dollars in millions)
1981 tax 1992 tax
Description gap amount gap amount
------------------------------------ ---------- ----------
Individual tax gap $61,900 $93,994
Wages and salaries 2,378 1,919
Interest 1,969 1,891
Dividends 2,075 2,142
State tax refund 127 102
Alimony 124 253
Capital gains 1,822 11,535
IRS Form 4797 217 1,264
Pensions and annuities 456 144
Taxable unemployment 107 388
Farm income 2,350 1,909
Partnership income 2,755 2,246
Small business corporation 912 729
Estates and trusts 49 73
Rents and royalties 2,012 4,481
Nonfarm sole proprietors 18,714 30,173
Other income 4,366 3,465
Taxable Social Security 0 44
Adjustments to income 752 694
Deductions 3,540 3,889
Exemptions 1,844 2,224
Credits 1,313 1,274
Math errors 487 1,521
Nonfiler 5,231 10,233
Nonremittance 8,300 11,400
Corporate tax gap 14,066 33,135
Small corporations 4,461 6,999
Large corporations 8,638 23,716
Unrelated business income 56 218
Fiduciary 111 202
Nonremittance 800 2,000
============================================================
Total tax gap\a $75,966\b $127,129
------------------------------------------------------------
\a Totals may not add due to rounding.
\b As shown in Table II.3, the 1981 gross tax gap in 1992 dollars was
$117 billion.
Source: Income Tax Compliance Research, IRS Publication 1415 (7-88).
Table II.3
Gross Tax Gap Estimates for Tax Years
1981 and 1992, in 1992 dollars
(Dollars in millions)
Percen
t
1981 tax 1992 tax increa
Source of tax gap gap amount gap amount se
---------------------------- ---------- ---------- ------
Individual tax gap $94,851 $93,994 -0.9
Unreported income 61,956 62,759 1.3
Sole proprietors 28,676 30,173 5.2
All other income 33,280 32,586 -2.1
Overstated deductions\a 11,414 8,081 -29.2
Individual nonfiler 8,016 10,233 27.7
Individual remittance gap 12,718 11,400 -10.4
Math errors 746 1,521 103.9
Corporate tax gap 21,552 33,135 53.7
Small corporations 6,836 6,999 2.4
Large corporations 13,236 23,716 79.2
Others\b 256 420 64.1
Corporate remittance gap 1,226 2,000 63.1
============================================================
Total tax gap\c $116,988 $127,129 8.7
------------------------------------------------------------
\a Includes subtractions for erroneous deductions, exemptions,
credits, and other adjustments.
\b Includes unreported income and overstated deductions for exempt
organizations' unrelated business income and for fiduciaries.
\c Totals may not add due to rounding.
Sources: Income Tax Compliance Research, IRS Publication 1415
(7-88); and Income Tax Compliance Research: Net Tax Gap and
Remittance Gap Estimates, IRS Research Division, Publication 1415
(4-90).
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix III
GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C.
Lynda Willis, Associate Director, Tax Policy and Administration
Issues
Tom Short, Assistant Director, Tax Policy and Administration Issues
Ralph Block, Assistant Director, Tax Policy and Administration Issues
Thomas Richards, Senior Evaluator