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Congressional Budget Office:
United States Government Accountability Office: 
Joint Committee on Taxation: 

June 2008: 

Highlights of the Joint Forum on Tax Compliance: 

Options for Improvement and Their Budgetary Potential: 

GAO-08-703SP: 

GAO Highlights: 

Highlights of GAO-08-703SP, a CBO, GAO and JCT forum. 

Why CBO, GAO and JCT Convened This Forum: 

The tax gap—the difference between the tax amounts taxpayers pay 
voluntarily and on time and what they should pay under the law—has been 
a long-standing problem in spite of many efforts to reduce it. When 
some taxpayers fail to comply, the burden of funding the nation’s 
commitments falls more heavily on compliant taxpayers. Reducing the tax 
gap would help improve the nation’s fiscal stability. For example, each 
1 percent reduction in the net tax gap would likely yield $3 billion 
annually. Most recently, the Internal Revenue Service (IRS) estimated 
it would recover $55 billion of this gap, resulting in a net 2001 tax 
gap of $290 billion. 

The Congressional Budget Office (CBO), GAO, and the Joint Committee on 
Taxation (JCT) convened this forum on September 6, 2007, to discuss tax 
compliance and the options to close the tax gap. Participants were a 
select group of individuals drawn from the federal tax policy community 
and state revenue offices. This forum was designed for the participants 
to discuss these issues openly and without individual attribution in 
order to facilitate a rich and substantive discussion. Therefore, 
comments expressed do not necessarily represent the views of any one 
participant or the organizations that these participants represent, 
including CBO, GAO and JCT. 

What Participants Said: 

Forum participants discussed numerous areas relating to the tax gap and 
gave suggestions for what types of approaches and actions might be 
effective in bridging the tax gap. Specifically the forum focused on 
the extent of noncompliance and the accuracy of the tax gap estimates; 
the extent to which enforcement actions, taxpayers service and tax code 
simplification might increase the compliance rate; and the most 
important initiatives the Congress and IRS could take to help close the 
tax gap. 

As might be expected in a forum of this nature, the discussions 
included a mix of ideas that had been previously raised and newer ideas 
for helping IRS close the tax gap. The following are highlights which 
stood out from these discussions: 

* Although valuable, tax gap estimates have limitations and serious 
efforts to reduce the tax gap should not be delayed while waiting for 
more precise estimates. 

* The IRS enforcement strategy should focus on large entities 
regardless of the type – S-corporations, C-corporations, partnerships 
or large sole proprietorships. 

* IRS workforce challenges may have affected the quality of IRS’s 
audits. 

* Improvements to compliance may come from partnering with the states 
to share more data. 

* Little data exist to show that taxpayer services increase voluntary 
compliance with the tax laws. 

* Many Americans are not directly affected by tax code complexity 
because they are insulated from such complexity, at least somewhat, by 
either paid preparers or through the use of tax preparation software. 

Participants also discussed the most important initiatives to undertake 
to reduce the tax gap. Some participants suggested increasing 
information reporting by enacting a proposal in the 2008 and 2009 
President’s budget that requires information reporting on merchant 
payment card reimbursements. Other participants recognized pilot 
compliance programs at the state level that have been effective in 
reducing noncompliance. For example, one state sent letters to 
taxpayers who were suspected in engaging in unlawful activities and 
offered the taxpayers a way to avoid penalties by filing amended 
returns and paying the taxes due. In most cases, taxpayers filed 
amended returns thus reducing the state’s caseload. Furthermore the 
state was able to increase its revenue collected by $1.4 billion. 
Finally, participants also noted that providing incentives to improve 
compliance and extending or eliminating the statute of limitations on 
enforcement actions would help IRS improve compliance. 

To view the full product, including the scope and methodology, click on 
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-703SP]. For more 
information, contact CBO, Thomas Woodward at (202) 226-2687 or 
TomW@cbo.gov; GAO, Michael Brostek at (202)512-9110 or 
brostekm@gao.gov; JCT, Edward D. Kleinbard at (202) 225-3621 or 
Edward.Kleinbard@mail.house.gov. 

[End of section] 

Contents: 

Letter: 

Introduction: 

Tax Compliance: Highlights of Forum Discussion: 

Background: 

Tax Gap Estimates Are Useful but Have Limitations and Are Likely 
Understated: 

Tax Gap Reductions Are More Likely to Come from Strengthening 
Enforcement Than Improving Taxpayer Service or Simplifying the Tax 
Code: 

Proposals May Make Progress in Closing the Tax Gap, but Improvements 
Will Be Incremental: 

Appendix I: Forum Participants: 

Appendix II: IRS's Tax Gap Map for 2001 and 2001 Individual Income Tax 
Underreporting Gap and Net Misreporting Percentage: 

Appendix III: Contacts: 

Bibliography: 

Tables: 

Table 1: IRS's Tax Year 2001 Gross Tax Gap Estimates by Type of 
Noncompliance and Type of Tax: 

Table 2: Individual Income Tax Underreporting Gap Estimates and Net 
Misreporting Percentage, Tax Year 2001: 

Figure: 

Figure 1: The Tax Gap Map for Tax Year 2001: 

[End of section] 

United States Government Accountability Office: 
Washington, DC 20548: 

Introduction: 

On September 6, 2007, the Congressional Budget Office (CBO), the U.S. 
Government Accountability Office (GAO), and the Joint Committee on 
Taxation (JCT) convened the Forum on Tax Compliance: Options for 
Improvement and Their Budgetary Potential. This report summarizes the 
forum discussion as well as subsequent comments received from the 
participants based on a draft of this report. 

The forum was intended to expand the dialogue on increasing voluntary 
tax compliance and reducing the tax gap. In particular, the forum 
sought to identify possible approaches and strategies that could 
enhance understanding of the tax gap and options available to the 
Congress and the Internal Revenue Service (IRS) for reducing it. The 
forum focused on (1) the extent of noncompliance and the accuracy of 
tax gap estimates; (2) the extent to which enforcement actions, 
taxpayer service, and tax code simplification might increase the 
compliance rate; and (3) the most important initiatives the Congress 
and IRS could take to help close the tax gap. 

We thank all of the participants for the generous contribution of their 
time and the constructive exchange of views and ideas during the Forum. 
The participants were a select group of individuals drawn from the 
federal tax policy and administration community and state revenue 
offices. They discussed numerous tax gap issues and suggested 
approaches and actions that might be effective in reducing the tax gap. 
This forum was designed for the participants to discuss these issues 
openly and without attribution in order to facilitate a rich and 
substantive discussion. Therefore, the report does not necessarily 
represent the views of any one participant or the organizations they 
represent, including CBO, GAO, and JCT. Appendix I provides a list of 
the participants. Appendix II provides the Tax Gap Map for 2001 and the 
2001 individual income tax underreporting gap estimates and net 
misreporting percentage. This report also includes a bibliography that 
lists products issued on the tax gap and tax compliance. This report is 
available at no charge on GAO's Web site at [hyperlink, 
http://www.gao.gov]. 

For additional information on CBO, GAO, and JCT work related on the tax 
gap and tax compliance, please contact the following senior staff: at 
CBO, Thomas Woodward at (202) 226-2687 or at TomW@cbo.gov; at GAO, 
Michael Brostek or James White at (202) 512-9110 or at brostekm@gao.gov 
or whitej@gao.gov; at JCT, Edward D. Kleinbard at (202) 225-3621 or at 
Edward.Kleinbard@mail.house.gov. 

Signed by: 

Peter Orszag: 
Director: 
Congressional Budget Office: 

Signed by: 

Gene L. Dodaro: 
Acting Comptroller General of the United States: 

Signed by: 

Edward D. Kleinbard: 
Chief of Staff: 
Joint Committee on Taxation: 

[End of letter] 

Tax Compliance: Highlights of Forum Discussion: 

On September 6, 2007, the Congressional Budget Office (CBO), the U.S. 
Government Accountability Office (GAO), and the Joint Committee on 
Taxation (JCT) hosted a forum to discuss tax compliance and options to 
close the tax gap. The participants discussed the accuracy of the 
Internal Revenue Service's (IRS) current tax gap estimates, the effect 
of enforcement, taxpayer service, and tax code simplification on 
compliance, and the most important initiatives for closing the tax gap. 

Background: 

The tax gap is an estimate of the difference between the taxes-- 
including individual income, corporate income, employment, estate, and 
excise taxes--that should have been paid voluntarily and on time and 
what was actually paid for a specific year. IRS estimated the tax gap 
on multiple occasions between 1979 and 1988, relying on its Taxpayer 
Compliance Measurement Program (TCMP). IRS did not implement any TCMP 
studies after 1988 because of concerns about costs and burdens on 
taxpayers. 

Recognizing the need for more current compliance data, IRS implemented 
a new compliance study called the National Research Program (NRP) to 
produce such data for individual taxpayers for tax year 2001 while 
minimizing taxpayer burden. The 2001 estimate revealed that taxpayers 
paid about 84 percent of the taxes that should have been paid on time 
under the law, resulting in an estimated gross tax gap of $345 billion. 
IRS estimated that it would eventually recover around $55 billion of 
the 2001 tax gap through late payments and IRS enforcement actions, 
leaving a net tax gap of $290 billion.[Footnote 1] 

The tax gap estimate is an aggregate of estimates for the three primary 
types of noncompliance: (1) underreporting of tax liabilities on tax 
returns, (2) underpayment of taxes due from filed returns, and (3) 
nonfiling, or the failure to file a required tax return altogether or 
on time.[Footnote 2] IRS's tax gap estimates for each type of 
noncompliance include estimates for some or all of the five types of 
taxes that IRS administers. As shown in table 1, underreporting of tax 
liabilities accounted for most of the tax gap estimate for tax year 
2001. IRS recognizes that the tax gap estimate is uncertain, in part, 
because some areas of the estimate rely on old data, IRS has no 
estimates for other areas of the tax gap, and it is inherently 
difficult to measure some types of noncompliance. The limitations of 
the estimates were discussed by the participants; more detailed 
information is available in the following section. 

Table 1: IRS's Tax Year 2001 Gross Tax Gap Estimates by Type of 
Noncompliance and Type of Tax: 

Type of noncompliance: Underreporting; 
Type of tax: Individual income tax: $197 billion; 
Type of tax: Corporate income tax: $30 billion; 
Type of tax: Employment tax: $54 billion; 
Type of tax: Estate tax: $4 billion; 
Type of tax: Excise tax: No estimate; 
Type of tax: Total: $285 billion. 

Type of noncompliance: Underpayment; 
Type of tax: Individual income tax: $23 billion; 
Type of tax: Corporate income tax: $2 billion; 
Type of tax: Employment tax: $5 billion; 
Type of tax: Estate tax: $2 billion; 
Type of tax: Excise tax: $1 billion; 
Type of tax: Total: $34 billion. 

Type of noncompliance: Nonfiling; 
Type of tax: Individual income tax: $25 billion; 
Type of tax: Corporate income tax: No estimate; 
Type of tax: Employment tax: No estimate; 
Type of tax: Estate tax: $2 billion; 
Type of tax: Excise tax: No estimate; 
Type of tax: Total: $27 billion. 

Type of noncompliance: Total; 
Type of tax: Individual income tax: $244 billion; 
Type of tax: Corporate income tax: $32 billion; 
Type of tax: Employment tax: $59 billion; 
Type of tax: Estate tax: $8 billion; 
Type of tax: Excise tax: $1 billion; 
Type of tax: Total: $345 billion. 

Source: IRS. 

Note: Figures may not sum to totals because of rounding. 

[End of table] 

IRS used data from NRP to estimate individual income tax underreporting 
and the portion of employment tax underreporting attributed to self- 
employed individuals. The underpayment segment of the tax gap is not an 
estimate, but rather represents the actual tax amounts that taxpayers 
reported on time but did not pay on time. 

Because of taxpayer noncompliance, the burden of funding the nation's 
commitments falls more heavily on taxpayers who willingly and 
accurately pay their taxes. Based on IRS's estimate, each 1 percent 
reduction in the net tax gap would yield nearly $3 billion annually. 
The tax gap has been a persistent problem in spite of efforts to reduce 
it, as the estimated rate at which taxpayers voluntarily comply with 
our tax laws has changed little over the past three decades.[Footnote 
3] Globalization and the ever-increasing tax code complexity add to 
IRS's tax administration challenges. 

Tax Gap Estimates Are Useful but Have Limitations and Are Likely 
Understated: 

[Although valuable, tax gap estimates have limitations and serious 
efforts to reduce the tax gap should not be delayed while waiting for 
more precise estimates]. 

The participants generally agreed that although the tax gap estimates 
are valuable, they have limitations and are likely understated. The 
participants recognized that the current estimates provide IRS with 
useful information for evaluating options to reduce the tax gap. Some 
participants said the gap remains unacceptably large and serious 
efforts to reduce the tax gap should not be delayed while waiting for 
more precise estimates. 

The participants cited several reasons why the current estimates are 
limited or understated, but other reasons may exist. Tax gap estimates 
do not include all areas of the economy, such as illegal activity. 
Illegal activity is not part of the tax gap for two main reasons. 
Philosophically, it is excluded because some believe the government 
should be trying to stop illegal activity not tax it, and therefore it 
should not be considered part of taxable activities. Furthermore, it is 
not practical for IRS to try to measure illegal activity. The 
underground economy is different from illegal activity in that income 
from the underground economy may not be reported to IRS but was gained 
in legal transactions--this is otherwise known as the cash economy. 

The age of the data underlying some components of the tax gap estimate 
is a weakness. The participants noted that the tax gap estimates for 
corporations and partnerships are especially weak because compliance 
behavior may have changed markedly since the 1980s--the last time IRS 
collected data on corporations or partnerships. The participants also 
noted that changes in the global economy have affected the business 
environment over the past few decades, specifically with regard to 
business categorization and the very large amounts of money exchanged 
among related business entities. For example, since 1985, S-corporation 
[Footnote 4] return filings have increased dramatically. In that year, 
over 700,000 Forms 1120S (U.S. Income Tax Return for an S-Corporation) 
were filed. In 2004, that number had grown by nearly five times to over 
3.6 million, while other corporate returns declined by approximately 
500,000 for the same period. According to a participant, S-corporations 
generate huge sums of money but have not been getting a proportionate 
amount of audit attention. IRS has recognized the need to update these 
data and is completing a study of S-corporations. IRS plans to have the 
study results available by the end of 2008. 

The participants also emphasized that tax gap estimates for individuals 
are based on examiners' reviews of a sample of tax returns, so errors 
may be introduced when calculating the tax gap. Tax returns selected 
for an in-person audit are assigned to an examiner who is trained to 
look for underreporting of income. Since the examiner is human, errors 
are inevitably introduced. Because IRS knew that not all examiners 
would be equally able to detect all underreporting noncompliance, it 
multiplied the detected amounts of underreporting to reflect what the 
"best examiners" likely would have found. This was intended to yield a 
more accurate total estimate for underreported individual income tax. 
However, some participants noted that the multipliers IRS used have 
their own likely inaccuracy, thus the tax gap estimates are best 
interpreted as broad indications of the amount of noncompliance with 
fairly large confidence intervals around those estimates. Also, some 
participants noted that although agents are trained throughout their 
careers to detect noncompliance, they may not be equally attentive to 
errors in the taxpayers' favor. However, others thought taxpayers' self-
interest in minimizing the tax they pay somewhat offsets this possible 
measurement bias. 

Tax Gap Reductions Are More Likely to Come from Strengthening 
Enforcement Than Improving Taxpayer Service or Simplifying the Tax 
Code: 

The forum participants also discussed actions that the Congress or IRS 
could take to improve taxpayer compliance via enhanced enforcement 
activities, increased taxpayer services, and tax code simplification. 
The participants also discussed long-term plans for identifying areas 
where progress can be made in reducing the tax gap. 

Enforcement May Yield the Greatest Impact but Is Not Going to Close the 
Tax Gap: 

The participants generally agreed that heightened enforcement of tax 
laws is the best way to bring about improvements in the tax gap but 
noted that increasing audits is not the only way to address the tax 
gap. The participants generally agreed that the following enforcement 
strategies may help IRS increase the amount of tax collected. 

* Increase the number of audits performed per year. The participants 
agreed that a gradual increase in auditing over time will lower the tax 
gap and that audits have a direct effect on reducing the level of 
noncompliance. However, a participant stated that "even by doubling the 
number of audits, the IRS will not be able to audit itself out of the 
tax gap." The participant noted that compliance efforts have a ripple 
effect on future compliance, both for the individual taxpayer who was 
the subject of the enforcement as well as others who become aware of 
his or her experience. One participant thought that this ripple effect 
may have a larger impact on compliance than the actual audits. 
Furthermore, the participant said that the rate of return on audit 
expenditures is from 3:1 to 5:1. Similarly, an IRS official previously 
testified that based on over 10 years of data, IRS receives a 4:1 
return on investment, not counting indirect compliance effects on 
taxpayers. 

[The IRS enforcement strategy should focus on large entities regardless 
of the type--S-corporations, C-corporations, partnerships or large sole 
proprietorships--as these entities can control large amounts of money. 
Noncompliance among these entities can be found in individual and 
corporate segments of the tax gap]. 

* Focus audits where noncompliance is the greatest. Some participants 
thought that IRS needs to conduct more audits where the risk of 
noncompliance is the greatest. Using the discriminate function (DIF) 
[Footnote 5] scores, which are derived from tax gap data, IRS should be 
able to focus the selection process for audits on higher-return-on-
investment cases. The participants also suggested focusing more audit 
resources on the business income tax area regardless of the type--S-
corporations, C-corporations, partnerships or sole proprietorships. As 
mentioned above, they noted that very large amounts of money are 
controlled by some businesses and flow among some of the large 
businesses and related entities. To effectively audit these large 
organizations, some participants thought that IRS needs new methods. 
For example, one participant suggested that to address the corporate 
income tax gap more efficiently, IRS could supplement companies' tax 
return data with publicly available financial statements. Another 
participant suggested that IRS study the individual taxpayers' 
relationships with their businesses, for example, matching revenue from 
an individual return with revenue reported on an S-corporation return. 
According to the participant, both individuals and business entities 
have developed into complex webs of relationships with other entities 
and use these relationships to minimize their taxes both legally and 
illegally. To truly understand the accuracy of an individual or 
entity's tax return requires analyzing these interrelationships. 

[IRS workforce challenges may affect the quality of IRS's audits]. 

* Improve the quality of audits. One participant observed that the 
quality of audits varies significantly. This may be attributed to 
changes in IRS's workforce. According to one IRS executive, a 
significant number of employees have less than 3 years of experience 
and historically examiners needed 3 years of experience in order to 
work on the more complicated corporate returns. According to a 
participant, improving examiner training may help to improve the 
quality of audits. Furthermore, ensuring that examiners are given 
audits with complexity commensurate with their training will help to 
ensure more consistent, high-quality audits. 

[Improvements to compliance may come from partnering with the states to 
share more data]. 

* Increase data sharing and partnering with the states. Exchanging 
information between the states and IRS could be an effective tool for 
reducing the tax gap. According to one participant, the data sharing 
between California and IRS allows California's Franchise Tax Board to 
collect an additional $300 million to $500 million in taxes per year. A 
state official noted that state-level audit information could be better 
shared by the states and IRS. For example, Minnesota's Department of 
Revenue has a program that allows the department to notify the state 
licensing authority to stop license issuance or renewal or to revoke a 
license at any time if, among other things, the business or person owes 
at least $500 in tax, penalty, interest, or debt to another agency. IRS 
could make use of information about these actions by the state because 
they may indicate a problem with the taxpayer's federal tax return. One 
impediment to efficient data sharing between the states and IRS is the 
pledges made to taxpayers that their electronic returns would not be 
used any differently than returns filed on paper. A fairness issue is 
raised if information about electronic filers, which is easily 
transferred, is shared between states and IRS but paper filers' 
information is not. 

While agreeing that enhanced enforcement is important, the participants 
also cited several reasons why enforcement should not be the only 
method of addressing the tax gap. For example, the participants noted 
that low-dollar noncompliance can be expensive to address. Although a 
small portion of taxpayers owe large amounts because of noncompliance, 
much of the tax gap is made up of small amounts of noncompliance by 
large numbers of taxpayers.[Footnote 6] When this latter type of 
noncompliance can only be addressed on a case-by-case basis it becomes 
very expensive for IRS to pursue. As one participant observed, IRS 
knows that about half of all returns have some mistake on the return, 
some in the taxpayers' favor and some in the government's favor. Errors 
tend to be distributed such that there are many small errors, but the 
errors that yield the largest dollar amounts often are fewer in number 
(falling in one "tail" of the distribution). Furthermore, another 
participant questioned whether the complexity of the tax code raises 
the noncompliance rate by providing "gray space"--where whether an 
action or transaction is noncompliant is open to interpretation--and 
making it more difficult to audit tax returns. 

The participants also noted that IRS faces challenges in the corporate 
income tax area. They said that aggressive use of tax shelters and the 
complex nature of the corporate tax returns in general make it 
difficult for IRS to identify noncompliance, and that when IRS 
identifies noncompliance these factors create fertile ground for 
litigation over IRS's interpretation of the tax law. The participants 
also noted that it is hard to know what is economically recoverable 
from corporate taxes. The cost of pursuing litigation with corporations 
can be high and not all of the cases are won in part because of the 
complexity and differing interpretations of the law. 

Better Taxpayer Services May Increase Compliance, but It Is Hard to 
Quantify the Effect: 

The participants provided a range of opinions regarding the 
effectiveness of trying to improve taxpayer service as a means to 
improve compliance. Although the participants said they were unaware of 
any quantifiable estimates that measure the effect of taxpayer service 
on compliance, a number of participants noted it is still important to 
provide taxpayers the best possible tools to help them comply with the 
tax code. 

[Little data exist to show that taxpayer services increase voluntary 
compliance with the tax laws]. 

Better taxpayer services may have different effects on different groups 
of taxpayers. According to one participant, two classes of people do 
not pay their taxes. One is made up of those taxpayers who 
intentionally evade paying taxes. According to participants, education 
and improved service are much less likely to improve tax compliance for 
this population because these taxpayers are trying to circumvent tax 
laws. The second group includes those taxpayers who do not understand 
the tax code but are trying to comply. The participants thought that 
improved taxpayer services may help this population comply with tax 
laws. For example, one component of this group includes the immigrant 
population, which may face cultural and language barriers. California 
publishes tax forms in five foreign languages to help these immigrant 
populations comply with tax laws. California is also conducting 
outreach to many immigrant populations who typically distrust the 
government and whose businesses deal mostly with cash. Minnesota has 
outreach units that work with banks and other community service 
organizations that work with immigrant populations, among others, in an 
effort to educate these groups about tax compliance. These taxpayer 
services and outreach efforts allow the taxpayers to better understand 
the tax laws and thereby comply with them. One participant noted that 
education and improved taxpayer services may decrease the amount some 
taxpayers pay if they had been previously overpaying their taxes. 

Increased taxpayer services may not help increase compliance when paid 
tax preparers are involved. As a participant noted, paid tax preparers 
are "a mixed bag;" some help taxpayers avoid noncompliance, for 
example, by using their expertise to help ensure that complex laws are 
understood, but others add to noncompliance by either introducing their 
own mistakes or guiding taxpayers to underreport their tax liability. 
For example, a limited GAO investigation in 2006 found that for the 19 
tax preparers GAO visited, all 19 made some mistake, with tax 
consequences that were sometimes significant.[Footnote 7] During this 
investigation, several paid preparers gave the GAO undercover 
investigators incorrect information, such as that reporting cash income 
was the taxpayer's decision because IRS would not know of it unless the 
taxpayer reported it. Another preparer told the investigator that she 
did not have to report such income unless it was over $3,200. Other 
preparers overclaimed the Earned Income Tax Credit (EITC) by reporting 
an ineligible child, despite being told by the GAO investigator that 
the child did not live with her. Therefore, IRS cannot fully rely on 
paid tax preparers to increase compliance with the laws. 

One participant noted that if additional requirements are established 
for tax preparers, the tax preparer community might take compliance 
issues more seriously and therefore increase compliance. One 
participant noted that practitioners should face consequences for not 
complying with the laws, even when the practitioners are erroneously 
applying the tax law. However, another participant asked, can the IRS 
encourage such "surrogate" tax administration? If IRS makes tax 
practitioners guilty of perjury if they falsify a tax return, would 
this increase compliance or lead to unanticipated undesirable 
reactions? Noncompliance on a prepared return may be the result of the 
taxpayer misinforming or lying to the preparer. In a circumstance like 
this, is it fair to ask the preparer to be an agent of IRS and look for 
noncompliance, or penalize the preparer if he or she doesn't realize 
the taxpayer is trying to be noncompliant? 

Many Americans Are Not Directly Affected by Tax Code Complexity: 

[Since over 80 percent of Americans have help preparing their 
individual tax returns, either from paid preparers or through the use 
of tax preparation software, taxpayers are insulated, at least 
somewhat, from tax code complexity]. 

A participant noted that between paid tax return preparers and the use 
of software to self-prepare returns, over 80 percent of individual 
taxpayers have help in preparing their tax returns and therefore are 
insulated, at least somewhat, from tax code complexity. Software 
companies often act as surrogate tax administrators in that they keep 
abreast of tax law changes and tend to submit tax returns that have 
fewer math errors. 

The participants said that another group whose compliance may not be 
affected much by simplifying the tax code is small business taxpayers. 
Small businesses contribute a large proportion of the tax gap because 
of underreporting of income. Since the requirement to report all income 
is fairly straightforward, tax code simplification may not do much to 
help decrease underreporting in this area. Further, a participant noted 
that all tax systems have noncompliance. For example, a retail sales 
tax could be simpler than the current income tax system, but states 
nevertheless must maintain robust programs to address compliance 
problems. 

On the other hand, the participants recognized that some taxpayers may 
benefit from tax code simplification. For instance, low-income 
taxpayers face an array of complicated issues on their tax returns, 
such as claiming the EITC. Anecdotal evidence suggests that simplifying 
the tax laws can lead to an increase in compliance. For example, 
taxpayers may unintentionally claim the wrong amount of EITC because 
they do not understand the complex rules governing eligibility for 
claiming the credit. Both Congress and the administration have long 
been concerned with the complexity of the EITC qualifications, 
including the definition of a qualifying child. The administration's 
proposed fiscal year 2008 budget suggested legislative language to 
simplify eligibility requirements for the credit as well as to further 
clarify the uniform definition of a qualifying child. Making 
definitions consistent across code provisions may reduce taxpayer 
errors because dissimilar definitions may increase the likelihood of 
taxpayer errors and increase taxpayer frustration. 

One participant also noted that because the tax code is used as a 
vehicle for so many policy initiatives and programs other than 
collecting revenue, simplifying the tax code may not be as easy as it 
sounds. For example, the purpose of the EITC is not to collect revenue 
but is to offset the burden of Social Security taxes and provide a work 
incentive for low-income taxpayers. Similar non-revenue-generating 
policy purposes exist for tax preferences in the tax code. The trade- 
off between tax administration and tax policy considerations is 
something the Congress must consider, and in some cases the tax system 
may be the preferred way to accomplish social policies even though the 
tax code is made more complex. 

A Long-term Plan Should Guide Efforts at IRS to Develop a Strategic 
Approach to Addressing the Tax Gap: 

The participants noted that for many years IRS has implemented short 
range plans to address the tax gap, but many also agreed that IRS needs 
a long-term strategy for addressing the tax gap. They said that the 
strategy should focus audits on taxpayers who are noncompliant and, to 
the extent possible, on those who can pay the tax assessments. The plan 
will have to be implemented over a number of years, possibly as long as 
a decade, and will have to be properly funded. One participant noted 
that if IRS wants to approach the tax gap intelligently, officials 
should develop a 10-year plan focusing on four areas: 

(1) Investing in technology (making better use of information 
resources, such as data matching or data mining). 

(2) Increasing staffing. 

(3) Increasing information reporting. 

(4) Addressing emerging issues caused by the global economy. 

Other participants noted that IRS should think primarily about 
deterring aggressive tax avoidance, designing a credible enforcement 
strategy to accompany its information technology modernization efforts, 
and obtaining additional resources over a period of time to reduce the 
tax gap. Since much of the debate on the tax gap is focused on the 
amount of tax IRS can collect, IRS should apply the resources it 
already has more effectively by focusing on initiatives with higher 
return on investment. However, as a participant noted, basing 
enforcement activities solely on return on investment is risky because 
some enforcement actions may have low returns on investment, such as 
many criminal prosecutions, but nevertheless be necessary both for 
fairness and to encourage voluntary compliance. 

Some participants were concerned that the Congress is too focused on 
the 1-year budget cycles. The participants said that IRS does not seem 
to get the resources it needs unless there is a major budget crisis and 
the Congress sees the need to heighten enforcement to collect more 
taxes. They also generally agreed that IRS will need an increased 
budget over a number of years to execute a meaningful long-term plan. 
They also noted, however, that even a substantial budget increase for 
several years would not eliminate the tax gap. The problem, they said, 
is that a multiyear plan seems to run contrary to the usual legislative 
process, which is based on 1-year budgets. Some participants thought 
that a consensus needs to be reached on creating a program that will 
last for multiple years and that there needs to be leadership from the 
White House, the U.S. Department of the Treasury, IRS, and CBO. 

Proposals May Make Progress in Closing the Tax Gap, but Improvements 
Will Be Incremental: 

The participants discussed the most important initiatives to undertake 
to reduce the tax gap. The participants generally agreed that new 
initiatives are needed to help IRS close the tax gap and discussed a 
variety of proposals, which are summarized below. Many of these 
proposals would require enacting legislation. 

* Increase information reporting. Information reporting tends to lead 
to high levels of compliance because the income taxpayers earn is 
transparent both to taxpayers and to IRS. Individuals subject to 
substantial information reporting and withholding are 99 percent 
compliant, whereas self-employed individuals who are subject to little 
or no information reporting and withholding are 46 percent compliant. 
[Footnote 8] Specific suggestions for increasing information reporting 
were as follows: 

- Enact the proposals in the 2008 and 2009 President's budgets to 
require information reporting on merchant payment card reimbursements 
and brokers to report the basis of security sales. One participant 
noted that the merchant payment proposal may not result in a large 
increase in direct enforcement revenue, but may have a large impact on 
voluntary compliance. Nevertheless, one participant had concerns about 
this proposal, saying that (1) the industry needs time to implement it, 
(2) it could be a big burden, (3) IRS is not prepared to use the data, 
and (4) IRS will not be able to use the resulting data to do 
information matching but will only be able to profile merchants for 
audit selection. Another participant did not think the proposal would 
be as large a burden as some were claiming, and noted that this 
proposal would provide a new source of data for IRS to use. 

- Leverage more data to identify capital gains income. For example, 
Form 1099 is not currently required for the sale of buildings. This is 
an area where states and the federal government could work together 
since counties have access to information on the value of the real 
estate when properties change hands. 

* Increase compliance through waivers of penalties and other 
techniques. An example of a compliance program at the state level was 
California sending letters to taxpayers who were suspected of engaging 
in unlawful activities and offering the taxpayers a way to avoid 
penalties by filing amended returns and paying the taxes due. In most 
cases, taxpayers filed amended returns and thus reduced the state's 
caseload. Furthermore, California received $1.4 billion in revenue from 
the amnesty program after originally estimating it would bring in $90 
million. In another example, California piloted a program with the 
intent of encouraging self-compliance by first educating taxpayers and 
then giving them an opportunity to correct any filing errors rather 
than undergo the more traditional audit. The state mailed self- 
compliance letters to taxpayers who claimed the car and truck expense. 
The letters explained the expense deduction rules and provided 
worksheets to calculate the amount to claim. About 80 percent of those 
letter recipients filed amended returns. 

* Provide incentives to improve compliance. Some participants noted 
that giving taxpayers an incentive to comply may be an underused 
strategy. For example, one participant noted a Customs and Border 
Protection (CBP) program that fast-tracks goods into the country. CBP 
is to review companies' self-policing procedures and how effective they 
are. According to the participant, if a company is diligent in its self-
policing, it has an opportunity to fast-track its goods into the 
country. If CBP finds a company's not diligent in self-policing, the 
company loses the opportunity to fast-track its goods into the country. 
IRS uses similar techniques in some cases, but some participants 
thought more could be done. For example, the Compliance Assurance 
Process, an IRS pilot program, has been used by about two dozen large 
corporations. Under this program, IRS works with large businesses to 
identify and resolve issues prior to the filing of a tax return. The 
objective of the program is to reduce taxpayer burden and uncertainty 
while assuring IRS of the accuracy of tax returns prior to filing, 
thereby reducing or eliminating the need for postfiling examinations. 

* Extending or eliminating the statute of limitations on enforcement 
actions. Some participants said IRS is confined by time limitations in 
assessing taxes owed by a taxpayer who filed a return and thereafter 
(1) in collecting of the tax, (2) penalizing of the taxpayer, and (3) 
subsequently prosecuting the taxpayer if necessary. Extending or 
eliminating these time limitations may allow IRS to recover some 
additional taxes that it would currently be barred from pursuing but 
this could also raise fairness issues. 

[End of section] 

Appendix I: Forum Participants: 

Facilitators: 

Peter Orszag: 
Director: 
Congressional Budget Office. 

David M. Walker: 
Comptroller General of the United States[A]: 
U.S. Government Accountability Office: 

Thomas Barthold: 
Acting Chief of Staff[A]: 
Joint Committee On Taxation: 

Participants: 

James Alm: 
Dean of Andrew Young School of Policy Studies: 
Georgia State University: 

Gary Bornholdt: 
Legislation Counsel: 
Joint Committee on Taxation: 

Kevin Brown: Acting Commissioner[A]: 
Internal Revenue Service: 

Brian Erard: 
B. Erard and Associates. 

Russell George: 
Inspector General for Tax Administration: 
Treasury Inspector General for Tax Administration: 

Lawrence Gibbs: 
Member: 
Miller & Chevalier Chartered: 

Rafael Ixta: 
Individual Income Tax Audit, Bureau Director: 
California Franchise Tax Board: 

Matt Knittel: 
Financial Economist: 
U.S. Department of the Treasury: 

Mark Mazur: 
Director, Office of Research, Analysis and Statistics: 
Internal Revenue Service: 

John McClelland: 
Financial Economist[A] 
U.S. Department Of The Treasury: 

Charles Rossotti: 
Senior Advisor The Carlyle Group: 

Linda Stiff: 
Deputy Commissioner for Operations Support[A]: 
Internal Revenue Service: 

Eric Toder: 
Senior Fellow Urban Institute: 

Mike Udell: 
Economist: 
Joint Committee on Taxation: 

Carole Wald: 
Assistant Commissioner for Individual Taxes: 
Minnesota Department of Revenue: 

[A] Title as of date of forum, September 6, 2007. 

[End of table] 

[End of section] 

Appendix II: IRS's Tax Gap Map for 2001 and 2001 Individual Income Tax 
Underreporting Gap and Net Misreporting Percentage: 

Figure 1 is taken from the IRS report Reducing the Federal Tax Gap 
[Footnote 9] and summarizes the key components of the tax gap and how 
they relate to one another. It has come to be known as the Tax Gap Map. 
As the map indicates, IRS estimates that for tax year 2001 
approximately $55 billion of the gross tax gap will eventually be paid 
though enforcement or other late payments, leaving a net tax gap of 
about $290 billion. This projection of what will eventually be paid is 
based on fiscal year tabulations of past enforcement revenue and on 
prior studies of amounts that are paid late without enforcement 
efforts. This estimate of enforcement revenues and other late payments 
is necessarily subject to some uncertainty. 

Further, the report noted that the Tax Gap Map distinguishes between 
"good" and "weak" estimates. For example, the corporation income tax 
estimates are acknowledged as weak because compliance behavior may have 
changed since the mid-1980s, which is the last time IRS collected data 
on corporate compliance. Moreover, the underreporting tax gap is 
estimated as the difference between true tax liability and reported 
amounts. Determining true tax liability for large multinational 
corporations can be difficult, given the complexity of the tax law, 
economic activities undertaken by these taxpayers, and the difficulty 
of making any kind of statically valid assumptions based on a limited 
population of taxpayers. Weaknesses in general arise from two causes: 
using old data and using data and methods that do not adequately 
reflect the full extent of noncompliance. 

Figure 1: The Tax Gap Map for Tax Year 2001: 

[See PDF for image] 

This figure is a complex illustration of the Tax Gap Map for Tax Year 
2001, as follows: 

Tax Gap Map for Tax Year 2001 (in $ Billions): 

Tax Paid Voluntarily & Timely: $1,767 billion. (Voluntary Compliance 
Rate: VCR= 83.7%)(reasonable estimate) 

Gross Tax Gap: $345 billion (Noncompliance Rate: NCR = 16.3%) (weaker 
estimate) [Estimates Have Been Updated Based on Detailed TY01 NRP 
Results]: 
Minus: 
Enforced & Other Late Payments, $55 billion[A] (reasonable estimate): 
Equals: 
Net Tax Gap (Tax Not Collected), $290 billion (weaker estimate) 
[Estimates Have Been Updated Based on Detailed TY01 NRP Results]. 

Total Tax Liability: $2,112 billion. 

Components of the Gross Tax Gap: 

* Underreporting: $285 billion (weaker estimate); 
- Individual Income tax [Estimates Have Been Updated Based on Detailed 
TY01 NRP Results]: $197 billion: (Non-business income: $56 billion; 
Business income: $109 billion; Adjustments, deductions, exemptions: $15 
billion; Credits: $17 billion)(reasonable estimate). 
- Corporate Income Tax: $30 billion; (Small corporations, under $10 
million: $5 billion; Large corporations, over $10 million: $25 billion) 
(weaker estimate). 
- Employment tax: $54 billion (reasonable estimate)[Estimates Have Been 
Updated Based on Detailed TY01 NRP Results]; (FICA, $14 billion (weaker 
estimate); Self-employment tax, $39 billion (reasonable estimate) 
[Estimates Have Been Updated Based on Detailed TY01 NRP Results]; 
Unemployment tax, $1 billion) (weaker estimate). 
- Estate Tax: $4 billion (reasonable estimate); 
- Excise tax: [B]. 

* Nonfiling[C]: $27 billion; 
- Individual Income tax[C]: $25 billion (reasonable estimate); 
- Corporate Income Tax: [B] (weaker estimate); 
- Employment tax: [B] (weaker estimate); 
- Estate Tax: $2 billion (reasonable estimate); 
- Excise tax: [B] (weaker estimate). 

* Underpayment: $33.3 billion (actual amount); 
- Individual Income tax[C]: $23.4 billion (actual amount); 
- Corporate Income Tax: $2.3 billion (actual amount); 
- Employment tax: $5.0 billion (actual amount); 
- Estate Tax: $2.1 billion (actual amount); 
- Excise tax: $0.5 billion (actual amount). 

Source: Internal Revenue Service. 

[A] IRS will continue to collect late payments for TY01 for years to 
come. This category includes tax paid late by taxpayers without IRS 
enforcement action. For comparison, $24.3B of tax was collected solely 
through enforcement in FY2001. 

[B] No estimates available. 

[C] Updated using Census tabulations. 

[End of figure] 

The individual income tax underreporting gap can be broken out by the 
various line items on a typical return--income sources, offsets to 
income, and offsets to tax. Table 2 provides updated estimates of both 
the tax gap arising from misreporting on each line item and the 
corresponding net misreporting percentage (NMP).[Footnote 10] These 
estimates are based on thorough audits of a representative sample of 
returns, but they also account for underreporting that is not detected 
in those audits. 

Table 2: Individual Income Tax Underreporting Gap Estimates and Net 
Misreporting Percentage, Tax Year 2001 (Dollars in Billions): 

Type of Income or Offset: Total Underreporting Gap; 
Tax Gap: $197; 
Net Misreporting Percentage[A]: 18%. 

Type of Income or Offset: Underreported Income; 
Tax Gap: $166; 
Net Misreporting Percentage[A]: 11. 

Type of Income or Offset: Non-Business Income; 
Tax Gap: $56; 
Net Misreporting Percentage[A]: 4. 

Type of Income or Offset: Non-Business Income; Wages, salaries, tips; 
Tax Gap: $10; 
Net Misreporting Percentage[A]: 1. 

Type of Income or Offset: Non-Business Income; Interest income; 
Tax Gap: $2; 
Net Misreporting Percentage[A]: 4. 

Type of Income or Offset: Non-Business Income; Dividend income; 
Tax Gap: $1; 
Net Misreporting Percentage[A]: 4. 

Type of Income or Offset: Non-Business Income; State income tax 
refunds; 
Tax Gap: $1;
Net Misreporting Percentage[A]: 12. 

Type of Income or Offset: Non-Business Income; Alimony income; 
Tax Gap: less than $0.5 billion; 
Net Misreporting Percentage[A]: 7. 

Type of Income or Offset: Non-Business Income; Pensions and annuities; 
Tax Gap: $4; 
Net Misreporting Percentage[A]: 4. 

Type of Income or Offset: Non-Business Income; Unemployment 
compensation; 
Tax Gap: less than $0.5 billion; 
Net Misreporting Percentage[A]: 11. 

Type of Income or Offset: Non-Business Income; Social Security 
benefits; 
Tax Gap: $1; 
Net Misreporting Percentage[A]: 6. 

Type of Income or Offset: Non-Business Income; Capital gains; 
Tax Gap: $11; 
Net Misreporting Percentage[A]: 12. 

Type of Income or Offset: Non-Business Income; Form 4797 Sales of 
Business Property; 
Tax Gap: $3; 
Net Misreporting Percentage[A]: 64. 

Type of Income or Offset: Non-Business Income; Other income; 
Tax Gap: $23; 
Net Misreporting Percentage[A]: 64. 

Type of Income or Offset: Business Income; 
Tax Gap: $109; 
Net Misreporting Percentage[A]: 43. 

Type of Income or Offset: Business Income; Nonfarm proprietor income; 
Tax Gap: $68; 
Net Misreporting Percentage[A]: 57. 

Type of Income or Offset: Business Income; Farm income; 
Tax Gap: $6; 
Net Misreporting Percentage[A]: 72. 

Type of Income or Offset: Business Income; Rents and royalties; 
Tax Gap: $13; 
Net Misreporting Percentage[A]: 51. 

Type of Income or Offset: Business Income; Partnerships, S-corporation, 
Estate, Trust, etc.; 
Tax Gap: $22; 
Net Misreporting Percentage[A]: 16. 

Type of Income or Offset: Overreported Offsets to Income; 
Tax Gap: $15; 
Net Misreporting Percentage[A]: 4. 

Type of Income or Offset: Overreported Offsets to Income; Adjustments; 
Tax Gap: -$3; 
Net Misreporting Percentage[A]: -21. 

Type of Income or Offset: Overreported Offsets to Income; Adjustments; 
Self-employed tax deduction[B]; 
Tax Gap: -$4; 
Net Misreporting Percentage[A]: -51. 

Type of Income or Offset: Overreported Offsets to Income; Adjustments; 
All other adjustments; 
Tax Gap: $1; 
Net Misreporting Percentage[A]: 6. 

Type of Income or Offset: Overreported Offsets to Income; Deductions; 
Tax Gap: $14; 
Net Misreporting Percentage[A]: 5. 

Type of Income or Offset: Overreported Offsets to Income; Exemptions; 
Tax Gap: $4; 
Net Misreporting Percentage[A]: 5. 

Type of Income or Offset: Credits; 
Tax Gap: $17; 
Net Misreporting Percentage[A]: 26. 

Type of Income or Offset: Net Math Errors (non-Earned Income Tax 
Credit); 
Tax Gap: less than $0.5 billion; 
Net Misreporting Percentage[A]: [Empty]. 

Source: IRS. 

[A] The amount of income or offset misreported divided by the amount 
that should have been reported. The National Research Program contains 
an adjustment for income amounts that were underreported, but does not 
have a corresponding adjustment for offset amounts that were not 
claimed. 

[B] Taxpayers understate this adjustment because they understate their 
self-employment income and, thereby, their self-employment tax. 
Therefore, the gap associated with this item is negative. 

[End of table] 

[End of section] 

Appendix III: Contacts: 

Contacts: 

Thomas Woodward at (202) 226-2687 or at TomW@cbo.gov: 

Michael Brostek (202) 512-9110 or at Brostekm@gao.gov: 

Edward D. Kleinbard at (202) 225-3621 or at 
Edward.Kleinbard@mail.house.gov. 

[End of section] 

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[End of section] 

Footnotes: 

[1] Throughout this report, references to the tax gap refer to the 
gross tax gap unless otherwise noted. 

[2] Taxpayers who receive filing extensions, pay their full tax 
liability by payment due dates, and file returns prior to extension 
deadlines are considered to have filed on time. 

[3] IRS's tax gap estimation methodology changed over time, so 
estimates from different years are not entirely comparable. 

[4] Generally, S-corporations are not subject to federal income tax 
other than tax on certain capital gains and passive income. Instead, an 
S-corporation's shareholders are taxed on their portion of the 
corporation's taxable income, regardless of whether they receive a cash 
distribution. 

[5] Some returns are selected for examination on the basis of computer 
scoring. Computer programs give each return numeric "scores." The DIF 
score rates the potential for change, based on IRS experience with 
similar returns. 

[6] For example, GAO reported [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-07-1014] that small proportions of sole proprietors, but 
still a significant number, have relatively large amounts of unpaid 
taxes. 

[7] GAO, Paid Tax Return Preparers: In a Limited Study, Chain Preparers 
Made Serious Errors, [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-
06-563T] (Washington, D.C.: Apr. 4, 2006). 

[8] According to IRS data, for wages and salaries, which are subject to 
substantial information reporting and tax withholding, the percentage 
of income that taxpayers misreport has consistently been measured at 
around 1 percent over time. Further, those taxpayers who are subject to 
little or no information reporting misreport their income 54 percent of 
the time. 

[9] Internal Revenue Service, Reducing the Federal Tax Gap: A Report on 
Improving Voluntary Compliance (Washington, D.C.: Aug. 2, 2007). 

[10] The NMP is the net amount of income misreported divided by the sum 
of the absolute values of the amounts that should have been reported. 
The NMP measures provide insights into the extent of noncompliance for 
any given provision. However, caution should be applied when comparing 
NMPs across tax provisions. First, a provision may have a large NMP but 
contribute only slightly to the tax gap (e.g., the total true tax 
liability for a particular item is relatively small). Second, the NMP 
contains an adjustment for income amounts that were underreported but 
does not have a corresponding adjustment for offset amounts that were 
not claimed. 

[End of section] 

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