What is the tax gap?
Every year, hundreds of billions of dollars of taxes that are owed are not collected. The "tax gap"--the difference between what individuals and businesses owe and what they pay-–stood at an estimated $345 billion in 2001 and remains a serious problem.
There are three ways in which individuals and businesses escape paying what they should: not reporting the full amount of their income or overstating deductions and credits; not paying the tax they owe in a timely manner; and not filing tax returns at all. The Internal Revenue Service (IRS) estimates that approximately 84 percent of taxes owed are voluntarily paid. Wage-earning Americans, whose taxes are regularly reported and subject to withholding, generally report well over 90 percent of their income. But business owners and investors, whose earnings are not reported by any third party, report less than half of what they take in.
What's at stake?
Failing to collect taxes that are owed is unfair to Americans who pay their taxes. Indeed, the National Taxpayer Advocate estimates that tax evasion puts an extra burden of $2,680 on every household in America. Billions could be collected from tax cheats each year if the IRS had the right resources and tools, increasing the fairness of the tax system and providing additional revenues to meet critical needs. And that estimate does not include the potential gains from closing down legal but dubious tax shelters and tax loopholes for corporations and very wealthy individuals.
Starting in 2011, companies that process credit or debit card payments for merchants have to report those transactions to both the merchants and the IRS, and brokerage firms have to file similar information reports on financial transactions. These changes will help reduce nonpayment of taxes due, but much more remains to be done.
Where things stand on the Hill
Congress is expected to fully fund President Obama’s FY 2010 request for increased funding for IRS enforcement efforts. Those efforts will address underreporting of offshore income by corporations, offshore tax evasion by wealthy individuals, and other measures that will narrow the gap between what is owed and what is paid. The House passed its financial services and general government appropriations bill (H.R. 3170) on July 16. A similar bill has passed the Senate Appropriations Committee and should be voted on by the full Senate soon.
Information & Resources:
Update on Reducing the Federal Tax Gap and Improving Voluntary Compliance, U.S. Department of the Treasury (July 8, 2009).
The Tax Gap: What is the Tax Gap?, Tax Policy Center (January 3, 2008).
Tax Compliance: Businesses Owe Billions in Federal Payroll Taxes, Government Accountability Office (July 2008).
Cayman Islands: Business and Tax Advantages Attract U.S. Persons and Enforcement Challenges Exist, Government Accountability Office (July 2008).
Tax Gap and Tax Enforcement, Congressional Research Service (February 16, 2007).