TREASURY INSPECTOR GENERAL FOR TAX
ADMINISTRATION
Some Concerns Remain About the Overall Confidence That Can Be Placed in Internal Revenue Service Tax Gap Projections
April 2006
Reference Number: 2006-50-077
This report has cleared the Treasury Inspector General for Tax Administration disclosure review process and information determined to be restricted from public release has been redacted from this document.
Phone Number |
202-927-7037
Email Address | Bonnie.Heald@tigta.treas.gov
Web Site |
http://www.tigta.gov
April 21, 2006
MEMORANDUM FOR DIRECTOR, OFFICE OF RESEARCH, ANALYSIS, AND STATISTICS
FROM: Michael R. Phillips /s/ Michael R. Phillips
Deputy Inspector General for Audit
SUBJECT: Final Audit Report – Some Concerns Remain About the Overall Confidence That Can Be Placed in Internal Revenue Service Tax Gap Projections (Project # 200650001)
This report presents the results of our review of whether the Internal Revenue Service’s (IRS) compliance efforts and strategies will enable it to achieve a 90 percent Voluntary Compliance Rate (VCR) by 2010.
Synopsis
In April 2004, the ranking member of the Senate Finance Committee, Senator Max Baucus, called for 90 percent voluntary tax compliance by 2010. Senator Baucus stated, in part, that “Today, I’m calling on the IRS to achieve a 90 percent voluntary compliance rate by the end of the decade, which would raise at least an additional $100 billion each year without raising taxes.”[1] Perhaps the greatest challenge facing the IRS is finding ways to improve the VCR.
Using different terms, Senator Baucus challenged the IRS to reduce what is commonly known as the tax gap. The IRS defines the gross tax gap as the difference between the estimated amount taxpayers owe and the amount they voluntarily and timely pay for a tax year. In February 2006, the IRS estimated the gross tax gap at $345 billion for Tax Year 2001.
To determine whether the IRS can achieve the VCR called for by Senator Baucus, we first evaluated the reliability of the IRS developed tax gap figures. We concluded the IRS still does not have sufficient information to completely and accurately assess the overall tax gap and voluntary compliance. The IRS has significant challenges in both obtaining complete and timely data and developing the methods for interpreting the data. However, it is important to tax administration and tax policy decision makers that an estimate be developed that is within tolerable parameters. Otherwise, inappropriate decisions can be made on how to address the tax gap. If one assumes that, in Tax Year 2010 the total tax liability is the same as it was in Tax Year 2001, noncompliant taxpayers would have to timely and voluntarily pay an additional $134 billion to achieve the Senator Baucus challenge to reach a 90 percent VCR by 2010.
Reliability of the Internal Revenue Service Developed Tax Gap Figure
Our analysis focused on whether there was sufficient,
complete, and accurate information to determine whether the composite tax gap
projections are reliable. We concluded
that, despite the significant efforts undertaken in conducting the individual
taxpayer National Research Program (NRP) for underreporting, the IRS still does
not have sufficient information to completely and accurately assess the overall
tax gap and the VCR. Our primary concerns are described in the
following areas of nonfiling, reporting compliance, and payments collected.
Nonfiling
In the pre-NRP tax gap map,[2] the IRS estimated the nonfiling gap to be $30.1 billion, which was comprised of $28.1 billion for individual income taxes and $2 billion for estate taxes. In February 2006, this estimate was updated to $25 billion for individuals. Supplementary data suggest that substantial amounts are not included in the estimates provided in the tax gap map projections. The maps described the nonfiling estimate as reasonable despite the missing segments of corporate income, employment, and excise taxes. These facts suggest the nonfiler estimate is incomplete and likely inaccurate.[3]
Reporting Compliance
The tax gap attributed to underreporting is by far the largest identified portion of the tax gap at an estimated $285 billion. Yet, this estimate may not be complete since there are at least four areas that suggest substantial amounts are not included in the tax gap map projections.
Payments Collected
The payment
information used to arrive at a net tax gap figure is shown as $55 billion in
recoveries or enforced collections and other late payments.[5] This
figure does not represent an actual amount but is an estimate based on formulas
devised from historical analyses. However,
the actual basis of these formulas seems to be very limited, as well as dated,
since IRS officials stated they were developed “quite some time ago.” Thus, these formulas most likely do not take
into account changes in the IRS’ ability to collect revenue. Furthermore, these collections have two basic
parts: voluntary payments received by
the IRS after the due date and payments received by the IRS as a result of some
type of IRS intervention. The IRS does
not currently correlate either type of payment to the applicable tax year and
thus does not determine actual collections.
Comparing Tax Gap Estimates to Independent Observations Presents
Difficult Challenges
In an effort to determine whether the tax gap projections developed by the IRS coincide with estimates developed by independent sources, we attempted to identify other estimates from independent sources. Although some outside studies exist, none provide sufficient information to allow close comparisons. However, one possible source of comparison is the annual Bureau of Economic Analysis estimate of the difference between its personal income figures and the IRS’ measure of Adjusted Gross Income to derive what is called an Adjusted Gross Income Gap. IRS Office of Research officials suggested this is a narrow definition of tax noncompliance based, in part, on IRS estimates. For Tax Year 2001, the Bureau of Economic Analysis reported an Adjusted Gross Income Gap of $834.4 billion.[6]
The private sector
has also developed some estimates of the tax gap. For example, in January 2005, financial analysts calculated the number of illegal
immigrants in the
Learning From
Previous Attempts to Reduce the Tax Gap and Increase Voluntary Compliance
In 1993, in concert with the Department of the Treasury and the Office
of Management and Budget, the IRS formed a task group that performed an
extensive review of the tax gap. The
resulting report addressed major areas of the tax gap and provided
recommendations that addressed multiple approaches to closing the tax gap. The recommendation that would have had the
most impact included various legislative changes.
Conclusion
The IRS’ ability to achieve 90 percent voluntary compliance by 2010 is a determination that cannot be made with the information currently available. Regardless of whether a 90 percent VCR can be achieved, the IRS faces formidable challenges in completely and accurately estimating the tax gap and finding effective ways to increase voluntary compliance. Overall strategies to decrease the tax gap, as well as major areas of noncompliance, were identified by the IRS more than a decade ago. Improvements can be realized; however, sufficient resources need to be provided to ensure tax administrators can effectively ensure compliance with the tax laws.
Recommendations
The Commissioner should continue to conduct NRPs on a regular cycle for the major segments of the tax gap. To augment the direct measurement approach, the IRS should devise indirect measurement methods to assist in quantifying the tax gap. In addition, the Commissioner should consider establishing a tax gap advisory panel that includes tax and economic experts to identify ways to improve the methods to measure voluntary compliance.
Response
The IRS agreed with our first recommendation, subject to resource availability, and agreed with our second recommendation. The IRS will conduct reporting compliance studies consistent with resource constraints, with a goal of covering all major taxes and taxpayer groups. The IRS will also explore incorporating indirect measurement methods where these can improve the precision of the resulting estimates. In addition, the IRS will look into establishing an advisory panel. Management’s complete response to the draft report is included as Appendix V.
Copies of this report are also being sent to
the IRS managers affected by the report recommendations. Please contact me at (202) 622-6510 if you
have questions or Philip Shropshire, Acting Director (Inspections and
Evaluations), at (215) 516-2341.
Comparing Tax Gap Estimates to Independent
Observations Presents Difficult Challenges
The Barriers Caused by Budget and Taxpayer
Burden Concerns Hamper Compliance Research
Learning From Previous Attempts to Reduce the
Tax Gap and Increase Voluntary Compliance
Appendices
Appendix I – Detailed Objective, Scope, and
Methodology
Appendix II – Major Contributors to This
Report
Appendix III – Report Distribution List
Appendix V – Management’s Response to the
Draft Report
The Federal income tax operates on a self-assessment basis. In general, taxpayers are responsible for determining their own tax liabilities. The success of the self-assessment system depends on the willingness of taxpayers to file tax returns when required, accurately report their tax liabilities, and timely pay their taxes.
The Internal Revenue Code system
of self-assessment places three basic obligations on taxpayers. Generally, taxpayers are required to: (1) file annual tax returns, on which
they (2) report the correct
amount of tax that they owe, and (3) pay
their tax on a timely pay-as-you-go basis. Tax noncompliance can therefore be categorized
into three corresponding categories: nonfiling,
underreporting, and underpayment. The total dollar value of noncompliance (for a
given tax year) is called the gross
tax gap. This is the estimated amount
of tax that is owed but is not paid voluntarily and timely.
The three components of the tax gap are defined as follows:
· The nonfiling gap is the tax that is owed but is not paid voluntarily and timely by those who do not file required returns by their due date (April 15 for most individual taxpayers). In this definition, the nonfiling gap is net of any tax paid by or on behalf of these taxpayers before the due date of the return (e.g., through withholding).
· The underreporting gap is the amount of tax that is owed, but not paid voluntarily and timely, by those who file their returns timely but do not fully report their tax obligations. This can be intentional or unintentional.
· The underpayment gap is the amount of tax that is reported on timely filed returns but not paid voluntarily and timely.
Most of the gross tax gap is essentially an estimate by the Internal Revenue Service (IRS) and is never assessed or paid. However, some of it is paid late either through IRS enforcement efforts or through late payments that precede these efforts. The portion of the gross tax gap that is not eventually collected is called the net tax gap. The percentage of tax dollars paid by taxpayers who voluntarily and timely comply with their tax obligations is called the Voluntary Compliance Rate (VCR). The most recent IRS estimates of these various tax gap figures are for Tax Year (TY) 2001.
After a long period of inactivity,[8] the IRS reinstated comprehensive compliance measurement with the initiation of the National Research Program (NRP) for TY 2001 individual income tax returns. Data from the NRP have been used to update the 2001 tax gap figures.
In April 2004, the ranking member of the Senate Finance Committee, Senator Max Baucus, called for 90 percent voluntary tax compliance by 2010. Senator Baucus stated, in part, that “Today, I’m calling on the IRS to achieve a 90 percent voluntary compliance rate by the end of the decade, which would raise at least an additional $100 billion each year without raising taxes.” [9] Perhaps the greatest challenge facing the IRS is finding ways to improve the VCR.
This evaluation was performed at the IRS Headquarters in Washington, D.C., in the Office of Research, Analysis, and Statistics during the period October 2004 through September 2005. Data in this report were subsequently updated to reflect revised information provided by the IRS in February 2006. The evaluation was performed in accordance with Quality Standards for Inspections. Detailed information on our evaluation objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II.
There is a critical issue the IRS needs to address before determining whether 90 percent voluntary compliance can be achieved. The IRS needs to ensure its estimates of the tax gap and the VCR are substantially complete and accurate.
Based upon the best information the IRS had available as of February 2006, the gross tax gap for TY 2001 was approximately $345 billion and the VCR was approximately 83.7 percent. Assuming, despite evidence to the contrary, the current IRS tax gap and VCR are complete and accurate, the compliance target set by Senator Baucus would present major challenges to tax administration. For example, if one assumes that, in TY 2010 the total tax liability is the same as it was in TY 2001, to reach a level of 90 percent voluntary compliance, noncompliant taxpayers would have to timely and voluntarily pay an additional $134 billion.[10]
The specific challenges confronting the IRS are discussed in the remainder of this report. Our analysis focused on whether there was sufficient, complete, and accurate information to determine whether the composite tax gap projections are reliable. Our purpose was not to be critical of the efforts the IRS took in reestablishing compliance measurement. On the contrary, we commend the IRS for restoring these critical measurements and for designing them to be much less burdensome to taxpayers than previous efforts. Our intent was to identify what the measurements included and excluded, what confidence can be ascribed to them, and what areas could be addressed to make the tax gap measurements more reliable and useful in determining an accurate VCR. Where appropriate, we have provided our recommendations for improvement.
In any discussion about whether a specific VCR goal can be met, the logical starting point would be an assessment of the data reliability of the measurement. To explore the views of IRS managers not directly involved in estimating the tax gap, we conducted a survey in which over 1,000 IRS managers expressed their opinions on the importance and reliability of tax gap issues and related NRP data.[11] The following are selected responses to our questions. Additional and more detailed response information can be found in Appendix IV.
· Approximately 95 percent cited the level of voluntary compliance as a major problem facing tax administration, believed the IRS should accurately measure it, and agree it is important in developing strategies and programs.
· Almost one-third of these managers think the IRS has insufficient data on the reasons for noncompliance.
· Fewer than 60 percent believe the NRP will provide accurate compliance-level estimates.
These survey results further clarify the importance of voluntary compliance and the accuracy of the measures associated with it. Consequently, an analysis of the IRS tax gap projections was required to determine its accuracy and completeness.
The IRS developed a chart called the tax gap map to graphically depict the gross tax gap for TY 2001, its components, and their relative sizes. The first iteration of the map was completed prior to the first phase of the NRP and is shown in Figure 1.
Figure 1: IRS Tax Gap Map – Before the NRP
Figure 1 was removed due to its size. To see Figure 1, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
The map attributes various certainties to the tax gap estimates representing the IRS’ confidence in the figures based on the quality and age of the estimates. We discuss the reasonableness of the certainty categorization in our evaluation of the estimates later in this report.
Subsequent to the NRP, the map was updated with preliminary figures in March 2005. After refinement of the NRP data, a third iteration was issued in February 2006. Figure 2 shows the most recent version of the tax gap map.
Figure 2:
IRS Tax Gap Map – After the NRP
Figure 2 was removed due to its size. To see Figure 2, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
As shown in the preceding tax gap maps, the IRS’ preliminary TY 2001 gross tax gap estimate for individual, employment, corporate, and other taxes was $310.6 billion with a VCR of 85.1 percent. However, the most recent gross tax gap estimate is $345 billion with a VCR of 83.7 percent based on updates using the NRP data.
In all three compliance
areas across the major tax gap segments, there are concerns about whether the
tax gap projections are complete and accurate.
Our primary concerns are described in the areas of nonfiling, underreporting,
and estimated payments that result in the difference between the gross and net
tax gaps.
In the pre-NRP tax gap map, the IRS estimated the nonfiling gap to be $30.1 billion, which was comprised of $28.1 billion for individual income tax and $2 billion for estate tax. In February 2006, this estimate was updated to $25 billion for individual income tax. The individual estimate was based on data provided by the United States Census Bureau. However, there are supplemental data that suggest substantial amounts are not included in the estimates provided in the tax gap map projections. The maps described the nonfiling estimate as reasonable despite the missing segments of corporate income, employment, and excise taxes. There are no definite plans to update the estate tax segment or to estimate the corporate, employment, and excise tax nonfiler segments. These facts suggest the nonfiler estimate is incomplete and likely inaccurate.
The IRS has shown concerns about the significance of nonfiling in the corporate segment. Although Headquarters Office of Research officials stated their belief that corporate nonfiling was not a significant issue because of corporate visibility, in July 2004, researchers in the Small Business/Self-Employed Division issued a report on business nonfilers recommending an enhanced system for creating and selecting inventory be designed and implemented. Subsequently, the Small Business/Self-Employed Division Research office developed a prototype that matched $4.6 trillion in transactions to over one-half of the business nonfilers for TY 2002, detecting approximately $1 trillion of apparent taxable income. This fact alone brings the $27 billion into question and demonstrates the need for more research to better estimate nonfiling for all tax segments.
Underreporting
The tax gap attributed to underreporting is by far the
largest identified portion of the tax gap at an estimated $285 billion. Yet, this estimate may not be complete since
there are at least four areas that suggest substantial amounts are not included
in the tax gap map projections. First, the business income portion of the
individual underreporting tax gap estimate is incomplete without information
from another NRP study that the IRS is undertaking on flowthrough returns[12] of Subchapter S corporations.[13] The
study will take 2 years to 3 years to complete from its inception in October
2005, which means information from these audits was not available for the
February 2006 updated TY 2001 tax gap estimates. Over 2.9 million Subchapter S Corporation
returns were filed in TY 2001 with over 5.3 million shareholders reporting
$187.7 billion in net income.
Second, the revised tax gap map lists the underreporting gap at $5 billion for small corporations and $25 billion for large corporations. These amounts are essentially carryovers from the previous estimate, including their weaker certainty status, since no new information was developed. For small corporations, the estimate is based on the 1980 TCMP survey. For large corporate underreporting, the previous estimates were not based on random TCMP audits but on operational audit coverage from the mid-1980s. These projections assume constant VCRs, yet current experience suggests compliance may not be constant. For example, in 2003, a contractor estimated the yearly tax gap arising from abusive corporate tax shelters alone was between $11.6 billion and $15.1 billion.[14]
Third, the revised map similarly categorized as reasonable a $4 billion figure for estate taxes and provided no estimate for excise taxes, yet the estate tax estimate was not updated during the current NRP. In addition, there are no firm plans for further studies or updates of these components.
Finally, in the employment tax component, the weaker
combined $15 billion Federal Insurance Contributions Act and unemployment tax gap
figure was also carried over and will not be further studied. Most of the employment tax component consists
of self-employment tax. Yet, like the
business income portion of the individual income tax gap, this too is incomplete without the flowthrough
data.
Payments collected
The IRS’ tax gap
maps, both before and after the NRP, list $55 billion as recoveries or enforced
collections and other late payments.[15] This
figure does not represent an actual amount but is an estimate projected from
historical information and formulas based on what is known about the amount of
collections on accounts over time. However,
the actual basis of these formulas seems to be very limited, as well as dated,
since IRS officials stated they were developed “quite some time ago.” Thus, these formulas most likely do not take
into account changes in the IRS’ ability to collect revenue.
To determine the
validity of the potential $55 billion in collections, we requested data on
actual collections to date for TY 2001 by year of collection. These collections have two basic
components: voluntary payments received
by the IRS after the due date and payments received by the IRS as a result of
some type of IRS intervention. The IRS
responded it does not currently correlate either type of payment to the
applicable tax year. Consequently, the
IRS has no means of determining whether the $55 billion is ever collected. While the IRS is currently working on
developing a table that will separate collections resulting from enforcement
actions into the related tax years, no similar data are being developed for
voluntary late payments. Unless the
latter data are categorized, the IRS will be unable to determine actual
collections or an accurate net tax gap.
Beyond the concerns about the completeness and accuracy of the current tax gap estimates, there are additional concerns about the samples and adjustments made to the estimates. Both sampling and adjustments can have a significant effect on the confidence that can be placed in the estimates.
The first concern about sampling for the NRP studies is
whether the sample sizes would affect
the usefulness, or perhaps accuracy, of the data. Performing the studies depends on limited
audit resources. Office of Research
officials described the problem as acute for the current flowthrough
study. The most recent TCMP survey of
partnerships, for example, involved a sample size that was significantly larger
than the present normal, or operational, audit coverage of partnership
returns. That sample size was
sustainable at the time of the TCMP survey, when the operational audit program
was much larger, but is not feasible now.
The same thing was true of the last TCMP survey of Subchapter S corporation
returns. The NRP Office proposed much
smaller sample sizes for its current surveys of flowthroughs, not because the
same sample sizes are no longer needed but because the resources necessary to
sustain the required number of random audits are not available.
Although the IRS Office of Research stated the sample size was not an issue for the individual income tax study, the size of the calibration sample[16] for the individual study was constrained by fewer resources than what would have been preferred. A consultant’s evaluation of the NRP’s sample design expressed concern that using the calibration audits to adjust the NRP could introduce considerable error into the adjusted estimates. An expert we consulted believed the appropriate size of the original NRP sample was an open question that needs addressing for future work. Furthermore, as a result of software issues and anomalies in the data, only about 37,000 of the original 46,000 cases in the original sample were used in the most recent tax gap estimate.
The second factor that affects the tax gap estimates is the use of the multipliers.[17] Using multipliers complicates the confidence in, and precision of, the estimates.
In summary, considering that much of the information remains dated, the new information is incomplete in several respects, and methodology differences create challenges, a somewhat different picture of the tax gap map emerges. We concluded that, despite the significant efforts undertaken in conducting the individual taxpayer NRP, the IRS still does not have sufficient information to completely and accurately assess the overall tax gap and the VCR. Although having new information about TY 2001 individual taxpayers is better when compared to the much older TY 1988 information from the last TCMP survey, some individual compliance information remains unknown. Additionally, although individuals comprise the largest segment of taxpayers and were justifiably studied first, no new information about employment, small corporate, large corporate, and other compliance segments is available. With no firm plans for further studies or updates in many areas of the tax gap, both the underreporting tax gap and the nonfiling gap will indefinitely leave an unfinished picture of the overall tax gap and compliance.
In an effort to determine whether the tax gap projections
developed by the IRS coincide with estimates developed by independent sources,
we attempted to identify other estimates from such sources. Although some outside studies exist, none
provide sufficient information to allow close comparisons. A few
States do a type of tax gap analysis, but most simply compare State taxes to the
IRS’ numbers and use a ratio. A paper by
the Organization for Economic Co-operation and Development[18] looked at compliance studies by other
countries, but the data were limited to small and mid-size businesses. The
One possible source of comparison is the annual Bureau of Economic Analysis estimate of the difference between its personal income figures and the IRS’ measure of Adjusted Gross Income (AGI) to derive what is called an AGI Gap. Although the IRS has used this measure in the past to provide an independent validity check on its unreported income estimates, IRS Office of Research officials suggested this is a narrow definition of tax noncompliance based, in part, on IRS estimates. Nonetheless, difficulties in reconciling personal income and AGI components make the AGI Gap a starting point for further analysis.[19] For TY 2001, the Bureau of Economic Analysis reported an AGI Gap of $834.4 billion.[20]
The private sector
has also developed some estimates of the tax gap. For example, in January 2005, financial analysts calculated the number of illegal
immigrants in the
While these
estimates may not be precisely comparable to the IRS tax gap estimate, they
employ indirect methods of economic measurement. If these estimates are closer to the actual
tax gap than the lower IRS developed estimates, this could have a significant
effect on tax policy and tax administration.
The Range of Additional Collections That Would Be Required to
Achieve Targeted Voluntary Compliance Goals
While we have concerns
about the overall reliability of the tax gap projections, the annual amounts
collected that reduce the net tax gap, and the VCR, it is instructive to
analyze what additional amounts the IRS would have had to collect to reach 90
percent voluntary compliance at different estimated intervals for TY 2001. Figure 3 shows what the range would have been
for TY 2001 based upon the total tax liability for TY 2001 as estimated in
February 2006. The IRS has proposed in
the Fiscal Year (FY) 2007 budget that the VCR will be raised from 83.7 percent
to 85 percent by 2009. Accordingly, if
the total tax liability remained constant, the IRS would have to collect, on a
voluntary and timely basis, $28 billion more in TY 2009, thus reducing the
gross tax gap to $317 billion. To reach
90 percent voluntary compliance by TY 2010,[22] the amount voluntarily and timely collected for TY 2010 would be an
additional $134 billion, thus reducing the gross tax gap to $211 billion if the
total tax liability remained constant.
Figure 3:
Additional Voluntary and Timely Payments
Required to Reach Specified VCR Levels[23]
Figure 3 was removed due to its
size. To see Figure 3, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.
Performing a compliance measurement program
is expensive and time consuming. The
estimated cost for performing the TY 2001 individual taxpayer NRP was
approximately $150 million. The IRS Office
of Research staff explained that resource constraints are a major driver in NRP
studies and will affect how often the NRP is updated. From FYs 1995 through 2004, the revenue agent workforce declined
by nearly 30 percent while the number of returns filed grew by over 9 percent. Additionally, operational priorities must be
balanced against research needs. This
shortfall in examiner resources makes conducting large-scale research studies
problematic.
The
IRS’ budget submission to the Department of the Treasury for FY 2007 requests
funding to support ongoing NRP reporting compliance studies. It requests funding for 268 Full-Time Equivalents[24]
and $45.9 million that will include 26 analytical and technical positions to
estimate reporting compliance for new segments of taxpayers (such as S corporations,
partnerships, and other business entities) and to update estimates of reporting
compliance for other segments. It also
requests 510 additional revenue agents to conduct reporting compliance research
examinations. The initiative seeks to
provide a foundation for conducting compliance studies and to limit the
diversion of resources to research audits from operational priorities. The IRS Oversight Board[25]
supports ongoing dedicated funding for compliance research. Unfortunately, funding for those resources in
previous fiscal years did not materialize.
It bears repeating that, without
a resource commitment to continually update the studies, the information will
continue to be stale and less useful in improving voluntary compliance.
In June 1993, IRS executives met with Department of the Treasury and Office of Management and Budget officials to discuss key issues for the FY 1995 budget. The issues facing the Federal Government were similar to the current issues: severe financial constraints and the desire for good tax administration. Consequently, both the Department of the Treasury and Office of Management and Budget agreed to work with the IRS on a comprehensive plan to reduce the tax gap.
The IRS formed a task group that performed an extensive review of the tax gap. The resulting task force report addressed the major areas of the tax gap and provided recommendations that addressed multiple approaches to close the tax gap. The report concluded:
We found it difficult to trace what became of the recommendations in the report. While it is likely that some of the recommendations were implemented, not all were. From the information we could obtain, the IRS did receive funding for about 5,000 additional compliance employees in the FY 1995 budget; however, there was a cut for about the same amount in the following year.
There
are likely to be more task groups and studies of the tax gap, although the
overall strategies to reduce the tax gap are already known. The largest areas of noncompliance are also
known. The changes needed could be
difficult and add to taxpayer burden.
However, 90 percent voluntary compliance and a significant reduction in
the $345 billion annual gross tax gap will not be achieved without a
multifaceted approach that includes the aforementioned conclusions and
recommendations.
Conclusion
The IRS’ ability to achieve 90 percent voluntary compliance by 2010 is a determination that cannot be made with current information. However, as illustrated in Figure 3 of this report, it is unlikely that such a massive change in voluntary and timely compliance can be achieved without significant changes to the entire system of tax administration. Regardless of whether a 90 percent VCR can be achieved, the IRS faces formidable challenges in completely and accurately estimating the tax gap and finding effective ways to increase voluntary compliance. Consequently, it is important to tax administration and tax policy decision makers that an estimate be developed that is within tolerable parameters. Otherwise, inappropriate decisions can be made on how to address the tax gap. Overall strategies to decrease the tax gap as well as major areas of noncompliance were identified by the IRS more than a decade ago. Improvements can be realized; however, sufficient resources need to be provided to ensure tax administration can effectively ensure compliance with the tax laws.
Recommendations
Recommendation 1: The Commissioner should continue to conduct NRPs on a regular cycle for the major segments of the tax gap. To augment the direct measurement approach, the IRS should devise indirect measurement methods to assist in quantifying the tax gap.
Management’s Response: The IRS agreed with our recommendation and, subject to available resources, will conduct reporting compliance studies on a regular basis for the foreseeable future. Management’s goal is to cover all major taxes and taxpayer groups over a period of years. Initially, they will focus on the most valuable and productive studies and will depend on the IRS Enforcement Committee to prioritize these efforts. As one step in estimating the tax gap, they use indirect methods as a check on their analytical work. They will continue to do so in the future and will explore the viability of incorporating indirect measurement methods where these can improve the precision of the resulting estimates. However, this may require an improvement in the quality and reliability of indirect methods.
Recommendation 2: The
Commissioner should consider establishing a tax gap advisory panel that
includes tax and economic experts to identify ways to better measure voluntary
compliance.
Management’s Response: The IRS agreed with this recommendation. IRS management will look into establishing such an advisory group with the intent of using it to validate and improve their estimation methods.
Appendix I
Detailed Objective, Scope, and Methodology
Our overall objective was to determine whether the Internal Revenue Service’s (IRS) compliance efforts and strategies will enable it to achieve a 90 percent Voluntary Compliance Rate by 2010. To accomplish our objective, we:
I. Evaluated voluntary compliance and the tax gap to establish the parameters and premises of the challenge to achieve a 90 percent Voluntary Compliance Rate by 2010.
A. Determined the IRS’ meanings for Voluntary Compliance Rate and tax gap.
B. Determined and analyzed the relationships between specific tax gap components and their impact on the gross and net tax gaps and assessed the reliability of the IRS’ Voluntary Compliance Rate and tax gap estimates.
C. Determined the potential effect of the National Research Program on improving voluntary compliance.
D. Reviewed IRS and other historical information to determine the continuing challenges to improving voluntary compliance.
II. Determined whether the IRS developed and communicated a viable strategy for improving voluntary compliance and reducing the gross tax gap.
A. Surveyed IRS compliance function executives and managers to determine their knowledge and opinions about the tax gap, the IRS’ strategic planning, and the IRS’ compliance efforts and to solicit their ideas for ways to reduce the tax gap and improve voluntary compliance.
Appendix II
Major Contributors to This Report
Philip
Shropshire, Acting Director, Inspections and Evaluations
Preston
Benoit, Audit Manager
Cynthia
Dozier, Senior Auditor
Richard
Hayes, Senior Auditor
Theodore
Lierl, Senior Auditor
Larry
Madsen, Senior Auditor
Bill
Russell, Senior Auditor
Karen
Stafford, Senior Auditor
Robert
Weiss, Senior Auditor
Appendix III
Commissioner C
Office of the Commissioner – Attn: Chief of Staff C
Deputy Commissioner, Small
Business/Self-Employed Division SE:S
Chief Counsel CC
National Taxpayer Advocate TA
Director, Office of Legislative Affairs CL:LA
Director, Office of
Program Evaluation and Risk Analysis
RAS:O
Office of
Management Controls OS:CFO:AR:M
Audit Liaisons:
Director, Office of Research, Analysis, and Statistics RAS
Commissioner, Small
Business/Self-Employed Division SE:S
Appendix IV
This appendix presents detailed information on the results of a survey of 1,033 Internal Revenue Service (IRS) managers conducted to solicit the views of managers who work closely with the most significant components of the IRS tax gap. Of the 1,033 managers, 838 identified themselves as first-line managers, 175 as second-line managers or above, and 20 as executives. Counting the 1,033 managers by IRS operating divisions, 249 were from the Large and Mid-Size Business Division and 784 were from the Small Business/Self-Employed Division. Counting the 1,033 managers by IRS function, 642 were involved with the Examination function, 288 were involved with the Collection function, and 103 listed their function as “other.”
The chart was removed due to its size. To see the chart, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
Appendix V
Management’s Response to the
Draft Report
The response was removed due to its
size. To see the response, please go to
the Adobe PDF version of the report on the TIGTA Public Web Page.
[1] United States Senate Committee on Finance News Release, April 13, 2004
[2] The tax gap map is an IRS developed chart that graphically depicts the tax gap along with its components and their relative sizes.
[3] There are no definite plans to update the estate tax segment or to estimate the corporate, employment, and excise tax nonfiler segment.
[4] This study is expected to take 2 years to 3 years to complete from its inception in October 2005.
[5] According to one IRS representative, these collections can take up to 10 years because of appeals and court decisions.
[6] This number is an income gap rather than a tax gap. Thus, it would have to be multiplied by a tax rate to determine the associated tax gap. Similarly, the $35 billion stated in the following paragraph could be significantly smaller, depending on whether some of these workers have actual filing obligations.
[7] Bear Stearns, The Underground Labor Force Is Rising To The Surface.
[8] Prior to the National Research Program, tax gap estimates were based on the results of the IRS Taxpayer Compliance Measurement Program, which was a systematic program of tax return examinations conducted to facilitate the compilation of compliance data. The last Taxpayer Compliance Measurement Program processed involved TY 1988 individual income tax returns.
[9] United States Senate Committee on Finance News Release, April 13, 2004.
[10] The IRS goal in the 2007 budget is to reach an 85 percent VCR by 2009.
[11] There were 2,075 surveys sent to 2,689 managers and 16 executives. The IRS selected the managers in the Small Business/Self-Employed and Large and Mid-Size Business Divisions. We received 1,033 responses to the survey.
[12] These include partnerships and Subchapter S corporations through which individual partners and shareholders, respectively, derive tax information from those entities. The flowthrough study covers only Subchapter S corporations and not partnerships. In 1958, Congress established Subchapter S of the Internal Revenue Code that enables small businesses, including sole proprietorships, to form corporations owned by 10 or fewer shareholders. Subsequently, the Code was revised to allow as many as 100 shareholders. Electing this form of business organization, commonly referred to as an S corporation, exempts the profits from corporate taxation and allows the profits to “pass through” to the shareholders who are then responsible for individual income taxes on the profits.
[13] The study began in October 2005 with audits of TY 2003 returns.
[14] The IRS has not developed a new estimate of this figure.
[15] According to one IRS representative, these collections can take up to 10 years because of appeals and court decisions.
[16] Without the intensive audits that characterized the TCMP, the NRP may obtain less complete information, possibly resulting in misstatement of tax liabilities. To address this potential bias, the NRP conducted more comprehensive line-by-line audits of a small calibration sample of 1,683 returns to provide a means of evaluating and, if necessary, correcting the full sample for this bias. The IRS Office of Research believes the quality level of the NRP is about the same as that for the TCMP.
[17] Multipliers are essentially methods used to estimate undetected additional taxable income.
[18] Organization for Economic Co-operation and Development Information Note: Compliance Risk Management – Use of Random Audit Programs, September 2004.
[19]
Edgar Feige, Defining And
Estimating Underground And Informal Economies: The New Institutional Economics Approach.
[20] This number is an income gap rather than a tax gap. Thus, it would have to be multiplied by a tax rate to determine the associated tax gap. Similarly, the $35 billion stated in the following paragraph could be significantly smaller, depending on whether some of these workers have actual filing obligations.
[21] Bear Stearns, The Underground Labor Force Is Rising To The Surface.
[22] This is the amount previously described in this report that was called for by Senator Baucus.
[23] Payment of the $55 billion estimated by the IRS as late or enforced payments does not affect the VCR. However, it does affect the total amount collected by the IRS. Therefore, we developed the Eventual Compliance Rate term that shows the effect of these payments when coupled with additional voluntary and timely payments that do affect the VCR.
[24] A measure of labor hours in which 1 Full-Time Equivalent is equal to 8 hours multiplied by the number of compensable days in a particular fiscal year. For FY 2005, 1 Full-Time Equivalent was equal to 2,088 hours.
[25] According to the IRS Oversight Board web site (irsoversightboard.treas.gov), it is an “independent body charged to oversee the IRS in its administration, management, conduct, direction, and supervision of the execution and application of the internal revenue laws and to provide experience, independence, and stability to the IRS so that it may move forward in a cogent, focused direction.”