The Internal Revenue Service reported that the average annual tax gap has increased to $458 billion for tax years 2008-2010, compared to $450 billion for tax year 2006.
The voluntary compliance rate was 81.7 percent for tax years 2008-2010, compared to 83.1 percent in tax year 2006. The IRS periodically estimates the tax gap, which provides a broad view of compliance with federal tax laws. The report found there has been no significant change in the amount of the tax gap or the rate of compliance since the last report was issued for tax year 2006.
“The figure of $458 billion doesn’t account for the revenue brought in through enforcement activities, such as audits and document matching,” IRS Commissioner John Koskinen said during a conference call with reporters Thursday. “After factoring in those activities, the average net tax gap for this period is estimated to be $406 billion per year. This continues to show that both solid taxpayer service and effective enforcement are needed for top-notch tax administration.”
Koskinen noted that factors such as third-party information reporting and withholding tend to increase the compliance rate. “The compliance rate is very high for income that is subject to third-party information reporting, and higher still when you also have withholding,” he said. “The study found that when there is information reporting, such as 1099s, income is underreported only about 7 percent of the time. That number drops to 1 percent for income subject to both third-party reporting and withholding. But the number jumps to 63 percent for income not subject to any third-party reporting or withholding.”
The small increase in the estimated size of the tax gap and small decrease in the voluntary compliance rate are largely attributable to improvements in the tax gap estimation methodology, and do not represent a significant change in underlying taxpayer behavior, according to the IRS. The changes also reflect the overall decline in the nation’s tax revenues due to the severe recession during the time period covered by the study, as well as changes in the mix of income sources that have different compliance rates.
Koskinen acknowledged there has been a small drop in the voluntary compliance rate for 2008-2010 since the earlier study for 2006, but the IRS doesn’t believe this represents a change in underlying taxpayer behavior.
“Instead, this likely reflects factors such as the overall decline in the nation’s tax revenues due to the severe recession, as well as improved estimation techniques,” he said. “I would note that since the last tax gap estimates for 2006, new data have become available, and these have been used in developing the current estimates. So the measurement methods are improving.”
However, Koskinen pointed out that the IRS is continuing to look for other ways to keep the voluntary compliance rate high. “These include such things as our educational efforts aimed at preparers and taxpayers; ongoing efforts to improve compliance in the international tax arena; and working with businesses on employment tax issues,” he said. “The IRS also continues to work with Congress on providing new tools to help address compliance issues, such as the legislation enacted last year to provide W-2s to us earlier in the filing season.”
He believes those initiatives will help the IRS collect the correct amount of tax and encourage voluntary compliance. “The importance of voluntary compliance cannot be overstated,” said Koskinen. “A one-percentage-point increase in the level of voluntary compliance brings in about $30 billion in tax receipts. So it’s critical for us to do everything we can to maintain a high level of voluntary compliance with our tax laws, to help ensure taxpayer faith and fairness in the tax system. Those who don’t pay what they owe ultimately shift the tax burden to those who properly meet their tax obligations.”
Koskinen acknowledged that it is impossible to completely eliminate the tax gap. “Even with these and other efforts, I would note that it is not possible to eliminate the tax gap completely. In designing enforcement programs, we must take into account both the burden on taxpayers and the limits of our resources,” he said. “Getting to 100 percent tax compliance would require a huge increase in audits, and significantly greater third-party reporting and withholding than we have now. Realistically, that wouldn’t work, because the burden on taxpayers and the strain on IRS resources would be too great.”
Koskinen also warned that cuts in the IRS budget are likely to exacerbate the tax gap in reports to come. The IRS endured five years of budget cuts until it received an increase for this year earmarked toward improving taxpayer service and cybersecurity and fighting identity theft, but the agency has been forced to reduce its enforcement personnel.
“While we continue to pursue many different angles to address the tax gap, reductions to the IRS budget over the last several years have had a negative impact on these efforts,” he said. “Our funding is now $900 million below what it was in 2010, and we have 15,000 fewer full-time employees. Additional resources are essential for us to continue making progress in reducing the tax gap.”
He warned that the impact of the underfunding might not show up until the IRS releases a tax gap study for tax years 2011-2013 in 2019, and by then it might be too late. “I’ve tried to get Congress to understand we’re playing with fire when we underfund the agency so we provide less effective taxpayer service and less effective enforcement,” he said.
The tax gap study basically aids the IRS and the federal government in planning for future tax revenues.
“Understanding the tax gap and its components helps government make better decisions about tax policy and the allocation of resources to tax administration,” said Koskinen. “Research on the extent of noncompliance and its sources helps the IRS devise cost-effective ways to increase compliance with our tax laws. For example, it helps us improve our audit-selection tools. We are committed to applying our limited resources where they are useful in reducing noncompliance while ensuring fairness, observing taxpayer rights, and reducing the burden on taxpayers who comply.”
Koskinen explained how the IRS needs time to process the tax collection numbers so the study does not take into account the impact of more recent initiatives such as matching of information from credit and debit card transactions on Form 1099-K information returns, as well as the various Offshore Voluntary Disclosure Programs and FATCA, the Foreign Account Tax Compliance Act, which was included as part of the HIRE Act of 2010.
“The voluntary disclosure program has operated primarily after this period,” he said in response to a question from Accounting Today. “About 55,000 people have paid us about $8 billion. To the extent that we wouldn’t have collected that $8 billion, that’s going to have an impact. We think with FATCA, it’s like the 1099-K. The fact that people now know we’ve had all this settlement with the Swiss banks and 220,000 foreign financial institutions are sharing with us information about Americans’ bank accounts, it should have an impact. We already can see a substantial increase in the filing of foreign asset-holding account reports, the FBARs as they’re called. We’ve tracked that once FATCA passed and once we were negotiating agreements with Swiss banks, we in some cases got twice as many information returns about people revealing foreign accounts that they held. I would think in the next report from ’11 to ’13 we would hope to see the impact of the 1099-K information returns and the impact of FATCA.”
In reaction to the tax gap report, Senate Finance Committee ranking member Ron Wyden, D-Ore., urged the IRS to put a system in place to identify the sources of corporate tax avoidance, evasion and noncompliance.
“It is absolutely unacceptable that the country has lost more than $400 billion dollars over the past ten years from corporations dodging their tax payments,” said Wyden in a statement. “This is money that could be put to good use shoring up critical programs such as Medicare. It’s time the IRS put an effective tracking and auditing system in place to locate this lost money.”