More on the tax gap

Last weekend I was with “my people” in Vancouver, B.C. for a meeting of the ABA Section of Taxation. The “Tax Gap” was among the topics of discussion.

Those with long memories will recall prior discussions of the tax gap on this blog. See http://economictrends.blogspot.com/2006/09/closing-tax-gap.html (including a link to the 2006 Treasury Study discussing the topic.) Basically, the tax gap represents the difference between what taxes are collected and what taxes are owed if the law was correctly applied and taxpayers complied with those laws.

Bridging the tax gap sounds like a politically popular activity. After all, it means some folks are cheating (or just getting the law wrong), and the rest of us are picking up the full tab for the government. If we had full compliance, we would collect more than $300 billion, generating a budget surplus, rather than the small deficit we are currently running. (Some will quibble with “small” when the total is $275 billion. However, as compared with revenues of 2.28 billion (FY 07) and with total GDP, this is not very large. The latest Treasury report can be found here: http://www.fms.treas.gov/mts/mts0807.pdf)

However, closing the tax gap has costs, both political and economic, that also need to be taken into account. First, there are political costs. We know that small business owners are among the most significant contributors to the tax gap. Whether due to challenges of compliance, the need for capital for expansion, or simply a desire to self-engineer their own means of tax reduction (i.e., cheating), small businesses, especially those dealing with cash, are prone to cause some “leakage” in the tax system. All cash-based transactions are problematic, to the extent they may not leave an electronic or other trail that can be tracked by government sleuths. However, I don’t see us moving to electronic money altogether in the near future. Moreover, small business is also touted as the growth engine for jobs and economic development. No politician wants to be known as targeting the small business community. That makes any change here tough.

Underreporting of basis on sales of stock is also a problem. The matter of having brokers report basis on taxpayers has been discussed for a while, and this past week there was some additional discussion of this possibility. Some commentators believe that this will be accomplished. Though brokers may complain, but they have the technology, they have the erector set (wait- that is a spoof of the bionic broker). This may save the treasury a few dollars.

The second dimension of the tax gap that need to be considered is the compliance cost. The cost of collecting a tax, including costs of compliance by taxpayers, can be significant. Instead of investing in new technology, new goods, or new services to improve our lives, spending it on compliance with rules or protecting ourselves from government penalties is less than ideal, to say the least. Query: what effects will policy efforts designed to close the tax gap have on compliance costs? Will they be worth the effort? Stay tuned.

EAM