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1 1 (January 4, 2023)

handle is hein.crs/govekal0001 and id is 1 raw text is: Congressional Research Service Informing the legislative debate since 1914 Updated January 4, 2023 Federal Tax Gap: Size, Contributing Factors, and the Debate over Reducing It Federal Tax Gap The federal tax gap is a measure of taxpayer noncompliance. The Internal Revenue Service (IRS) provides two estimates of the gap: a gross measure and a net measure. The former is the difference between the total amount of federal individual and corporate income, employment, and estate and gift taxes owed in a year and the total amount of those taxes paid voluntarily on time. The net tax gap is the difference between all taxes owed and taxes paid after accounting for late taxpayer payments and taxes collected through IRS enforcement actions. In effect, it represents the amount of federal taxes that never will be paid or collected. The federal tax gap may concern policymakers for several reasons. First, the gap represents uncollected revenue that the federal government could use for many purposes, such as reducing the budget deficit or paying for new programs. Second, the gap imposes costs on compliant taxpayers that are not borne to the same extent by noncompliant taxpayers (e.g., higher taxes in the future, cutbacks in beneficial government programs, and interest payments on federal debt to finance budget deficits). Third, sustained growth in the tax gap may undermine public confidence in the fairness and integrity of the federal tax system. Estimating the Federal Tax Gap The IRS has been estimating the size and composition of the tax gap since 1979. Pre-1989 estimates were based on compliance data obtained through the Taxpayer Compliance Measurement Program (TCMP). The data were based on comprehensive in-person audits done by IRS examination officers. Audited taxpayers had to provide documents supporting every tax return item. Many found these audits burdensome. Congressional opposition to the TCMP's audits led the IRS to adopt, in 2000, a different method of collecting compliance data known as the National Research Program (NRP). To estimate compliance with the individual income tax, the NRP uses a random sample of audits of about 13,000 taxpayers deemed representative of the entire filing population. Random sampling has the advantage of providing information on both compliant taxpayers and noncompliant taxpayers who otherwise might be difficult to identify using the IRS's income detection tools. To estimate other components of the tax gap (e.g., corporate income and employment taxes), the IRS relies on a variety of data sources and empirical methods. Size of the Tax Gap The most recent tax gap study by the IRS covers the years 2014 to 2016. According to the study, the average annual gross gap totaled $496 billion in that period, or about 15% of total average annual federal taxes owed. Late payments and IRS enforcement actions produced a net gap of $428 billion. This estimate does not consider the effect of IRS enforcement on taxpayer noncompliance. As Table 1 shows, between 2001 and 2016, the net federal tax gap (2021 dollars) reached its lowest level in 2001 ($444 billion) and its highest level in 2006 ($516 billion), and then trended downward to 2016. Similarly, the net taxpayer noncompliance rate rose 2.6 percentage points from 2001 to 2008-2010 and then fell 3.3 percentage points by 2014-2016. Table 1. Net Federal Tax Gap Estimates from 2001 to 2016 ($ billions) Net Taxpayer Current 2021 Noncompliance Year(s) Dollars Dollars Ratea (%) 2001 $290 $444 13.7% 2006 $385 $516 14.5% 2008- $406 $508 16.3% 2010 20113 $380 $450 14.2% 2014- 2016 $428 $488 13.0% Source: Internal Revenue Service, Tax Gap Estimates; and Bureau of Labor Statistics, Annual Average Consumer Price Indexes. a. The percentage of federal taxes owed in a year that were not paid on time, after IRS enforcement actions and late taxpayer payments. Sources of the Federal Tax G ap The federal tax gap has three main sources: (1) understatement of tax liability through unreported income or overstated deductions, credits, and other income adjustments; (2) failure to pay taxes owed on time; and (3) failure to file a return on time, or nonfiling.

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