Wednesday, September 27, 2006

Closing the Tax Gap

Yesterday the Treasury Department’s Office of Tax Policy published a report, “A Comprehensive Strategy for Reducing the Tax Gap”. (I got my copy from the BNA Daily Tax Report. I expect an online copy will soon be available free for the public at the treasury website, found here:

Treasury estimates the “tax gap” for FY 2001 at about $290 billion, for a compliance rate of about 86 percent. This takes into account some collection and enforcement actions since that date, so the actual gap in a given fiscal year’s discrete collections will be greater. 86 percent is pretty good – that would translate, on roughly $2.2 trillion of revenues for the current year, that we are losing roughly $350 billion in the current year – enough to erase the current deficit. Given declining deficit figures in future periods, this means we could erase deficits without raising taxes if we are able to collect the taxes we assess now. That, of course, can be a tall order.

According to the report, the biggest contributor to the tax gap is underreporting of income by individuals. Individual tax underpayments total about 71 percent of the tax gap on a “gross” basis (before taking into account those extra collection efforts), while corporate underreporting is only about 9 percent of this total. Employment tax amounts make up the remainder.

As Ronald Reagan once said, “Trust, but verify.” That statement about treaty compliance is also apparently true in the context of tax compliance. The report suggests that the biggest source of noncompliance is among those who are not subject to information reporting. Underreporting of business income by individuals, by either not reporting receipts or overstating deductions, amounts to 40 percent of the total.

There are problems out there with noncompliant persons who decide to cheat. True enough, the tax laws are sufficiently complex so that honest persons of good will might make a mistake that could understate taxes. However, there are also dishonest persons who do not report taxable income, or who overstate deductions in order to escape their share of the tax burden. Some people may think this is ok as long as they are “starving the government.” But it is not ok when others of us have to pay.

There are some folks out there who want to abolish the IRS. They are fooling themselves. As long as human beings are not angels (and I can attest to the truth of that assertion from personal experience), we need law enforcement. So, thank your local IRS agent for doing his or her job. (A special thanks goes to my friend Patty who does this work, and very fairly and competently I’m sure.)


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