IRS Data Show Tax Gap Has Reached $458 Billion

Source: AccountingWEB

April 29, 2016

By Jason Bramwell

The difference between taxes owed and taxes paid on time – known as the tax gap – increased to an estimated $458 billion during the period from 2008 to 2010, according to a report the IRS released on April 28. 

The last time the IRS released a tax gap analysis was in January 2012, when it studied tax year 2006. Estimates put the tax gap at $450 billion at that time.

“Many factors contribute to differences over time in both the gross tax gap and the voluntary compliance rate,” the report states. “These include factors such as the overall level of economic activity, changes in the composition of economic activity with shifts toward those with higher or lower compliance rates, changes in tax law and administration, updated data and improved methodologies, and changes in underlying compliance behavior on the part of taxpayers and preparers. Since the tax gap typically moves with the economy, the December 2007 through June 2009 recession and the weak recovery that followed contributed to the gross tax gap remaining substantially unchanged from the previously released tax year 2006 estimate.”

The agency estimated that the average annual voluntary compliance rate for 2008 to 2010 was 81.7 percent, which is down from the 83.1 percent estimate for tax year 2006. 

“About half of the 1.4 percentage-point difference is attributable to the updated methods,” the report states. “Given the challenges in estimating the tax gap and given the many factors that contribute to differences over time, the remaining 0.7 percentage-point difference from the tax year 2006 estimate does not support concluding that noncompliance has increased.”

Of that $458 billion, $32 billion is due to nonfiling, $387 billion is due to underreporting, and $39 billion is due to underpayment, the report shows. 
Here’s the breakdown by type of tax: $319 billion for individual income tax, $44 billion for corporate income tax, $91 billion for employment tax, and a combined $4 billion for estate and excise taxes.

The IRS expects that $52 billion of the $458 billion will eventually be collected, resulting in a net tax gap of $406 billion.

For the first time, the IRS provided estimates of the net tax gap by type of tax. The estimated net tax gap is $291 billion for individual income tax, $35 billion for corporate income tax, $79 billion for employment tax, and $1 billion combined for estate and excise taxes.

“We need to keep in mind several facts when considering this data,” Robert Kerr, senior director of government relations for the National Association of Enrolled Agents, said in a written statement. “The first is that IRS takes years to estimate the tax gap, so the newest data considered is from tax years 2008 to 2010, before IRS’s budget took an approximately $1 billion hit annually and before staffing dropped by some 16,000 or so. Let’s not conclude that a flat tax gap indicates tax compliance hasn’t taken a hit because of reduced IRS resources. We won’t know that for years.

“The second fact is that even though many Americans are completely compliant – they file timely, accurate tax returns and pay taxes due – the net tax gap is enormous; a bit over $400 billion annually, which, roughly speaking, is nearly large enough to fund all nondefense federal discretionary spending,” Kerr continued. “The third fact, and I believe [IRS] Commissioner [John] Koskinen has made this observation, is that it is practically speaking impossible to eliminate the tax gap altogether. We wouldn’t want to live in a country that had 100 percent compliance. The apparatus to get there would be far too oppressive.”

Responding to the tax gap analysis, Sen. Ron Wyden (D-OR), the top Democrat on the Senate Finance Committee, emphasized that the IRS needs to put a system in place that identifies 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 10 years from corporations dodging their tax payments,” Wyden said in a written 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.”