The tax gap—the difference between taxes owed and those paid on time—has persisted for decades despite efforts by the Internal Revenue Service (IRS) and Congress to reduce it. IRS most recently estimated a tax gap of $450 billion for 2006. IRS eventually recovers part of the tax gap through enforcement actions and late payments; for 2006, it estimated it would recover $65 billion, resulting in a net tax gap of $385 billion.
The tax gap arises when taxpayers, whether intentionally or inadvertently, fail to accurately report tax liabilities on tax returns (underreporting), pay taxes due from filed returns (underpayment), or fail to file a required tax return altogether or on time (nonfiling). The tax gap is spread across the five types of taxes that IRS administers—individual income, corporate income, employment, estate, and excise taxes. As shown in the figure below, underreporting, particularly of individual income taxes, accounts for most of the tax gap.
Figure 1: Tax Gap Noncompliance
Given the tax gap has been persistent and dispersed across different types of taxes and taxpayers, coupled with tax code complexity and a globalizing economy, reducing the tax gap will not likely be achieved through a single solution. Rather, the tax gap must be attacked on multiple fronts and with multiple strategies, such as:
- enhancing information reporting by third parties;
- ensuring high-quality services to taxpayers;
- devoting additional resources to IRS enforcement;
- expanding compliance checks before IRS issues refunds;
- developing innovative compliance strategies;
- leveraging external resources, such as paid tax return preparers and whistleblowers;
- modernizing information systems; and
- simplifying the tax code.
For more information on efforts to reduce the tax gap, see the enforcement of tax laws area of the High Risk list.