Key Issues > Enforcement of Tax Laws - High Risk Issue
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Enforcement of Tax Laws - High Risk Issue

Addressing the tax gap—the difference between taxes owed and those paid on time—could help improve the government’s fiscal position.

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Enforcing tax laws helps the Internal Revenue Service (IRS) collect revenue from noncompliant taxpayers and, perhaps more importantly, promotes voluntary compliance by giving taxpayers confidence that others are paying their fair share. However, every year, taxpayers fail to pay hundreds of billions of dollars in taxes. This tax gap—the difference between tax amounts that taxpayers should pay and what they actually pay voluntarily and on time—has been a persistent problem for decades.

How big is the tax gap?

In 2016, IRS estimated that taxpayers voluntarily and timely paid about 81.7 percent of the taxes they should have for tax years 2008 to 2010, resulting in an average annual tax gap of $458 billion for those years. IRS estimated that through late payments and enforcement actions, it will collect an additional $52 billion annually for tax years 2008 to 2010.

The rest—$406 billion per year for those years—may never be collected.

Figure: IRS's Annual Average Tax Gap Estimate for Tax Years 2008-2010

IRS's Annual Average Tax Gap  Estimate for Tax Years 2008-2010

The tax gap arises when taxpayers, whether intentionally or inadvertently, fail to accurately report tax liabilities on tax returns (underreporting), fail to 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.

The latest gross tax gap estimate has increased from past estimates, in nominal terms. However, when adjusted for inflation (using fiscal year 2016 dollars), the 2008-2010 estimate is slightly lower than the 2006 estimate. Differences in tax gap estimates across years may be the result of

  • changes in taxpayer behavior (voluntary compliance),
  • IRS enforcement activities,
  • new tax gap components and updated methods for estimating the tax gap,
  • changes in economic activity, or
  • changes in tax law and administration.

The overall voluntary compliance rate—the percentage of owed tax for a given year that is paid voluntarily and timely—has decreased slightly over time.

Figure: Tax Gap Comparison, Tax Year 2001 to Tax Years 2008-2010

Tax Gap Comparison, Tax Year  2001 to Tax Years 2008-2010

Note: This graphic does not include excise taxes, which accounted for less than 0.2 percent of each gross tax gap estimate. When the gross tax gap figures are inflated to fiscal year 2016 dollars, the figures are $460 billion in 2001, $530 billion in 2006, and $509 billion in 2008-2010.
aThe 2008-2010 tax gap estimate is an average of all 3 years.

What accounts for the largest part of the tax gap?  

Underreporting accounted for most of the tax gap estimate for tax years 2008-2010, making up 84 percent of the entire estimated gross tax gap. Individual income taxes made up the largest portion of underreporting, followed by employment taxes and corporation income taxes.

Figure: Estimated Average Annual Gross Tax Gap by Type of Noncompliance and Tax (Tax Years 2008-2010)

Estimated Average Annual Gross Tax Gap by Type of  Noncompliance and Tax (Tax Years 2008-2010

Note: Data may not sum to totals because of rounding. Individual income tax includes individual business income tax. Estate tax underreporting noncompliance is not shown in this graphic because it represents less than one-half percent of total underreporting noncompliance. Excise tax is not shown in this graphic because IRS does not have excise tax underreporting noncompliance or nonfiling noncompliance estimates, and its estimate for excise tax underpayment noncompliance represents less than one-half percent of total underpayment noncompliance. In addition, IRS does not have a corporation income tax estimate for nonfiling noncompliance.

Individual taxpayers more accurately report their income on tax returns if the income is also reported to them and to IRS by third parties. For example, financial institutions generally report interest and dividends to taxpayers and IRS on information returns. According to 2008-2010 IRS data, individual taxpayers accurately reported most of their income from interest and dividends on their own tax returns. In contrast, taxpayers misreported over half of those types of income for which there is little or no third-party information reporting, such as business income.  Likewise, for types of income with third-party information reporting, IRS can use automated processes to address noncompliance. For items with little to no third-party information reporting, IRS has to rely on more resource-intensive methods, such as correspondence or face-to-face examinations, to address noncompliance.

Figure: Effect of Third-Party Information Reporting on Net Misreporting Percentage, Tax Years 2008-2010

Effect of Third-Party Information Reporting on  Net Misreporting Percentage, Tax Years 2008-2010

Note: Net misreporting percentage is the sum of the net misreported amount divided by the absolute values (over or underreported) of the amounts that should have reported, expressed as a percentage.
aIRS receives information from third parties that it uses to verify income or deduction amounts that taxpayers report on their tax returns. IRS categorized various line items on the individual income tax return into 4 different groupings of third-party reporting in IRS Publication 5161, Estimation of the Underreporting Tax Gap for Tax years 2008-2010: Methodology Research, Analysis and Statistics Technical Paper, September 2016. However, IRS did not provide a scale to define the differences between substantial, some, and little or no third party information reporting. 

How can the tax gap be reduced?

Given that 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, IRS must attack the tax gap on multiple fronts and with multiple strategies, such as:

  • continuing to develop and implement a long-term strategy to address the efficiency of its programs, processes, and structure amidst an uncertain budget environment;
  • determining resource allocation strategies for its enforcement efforts;
  • collecting more data on noncompliance;
  • assessing the performance of its information technology (IT) investments;
  • strengthening referral/whistleblower programs; and
  • enhancing taxpayer services.

Further, reducing the tax gap may also require targeted legislative actions, such as:

  • enhancing and expanding third-party information reporting,
  • enhancing electronic filing,
  • expanding math error authority,
  • regulating paid preparers, and
  • simplifying and reforming 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.

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