Why This Area Is Important
The Internal Revenue Service (IRS) has estimated that the gross tax gapthe difference between taxes owed and taxes paid on timewas $450 billion for tax year 2006 (the most recent year for which data were available). IRS estimated that it would eventually recover about $65 billion of this amount through late payments and enforcement actions, leaving a net tax gap of $385 billion. Federal deficits and long-term fiscal challenges have heightened the importance of reducing the tax gap. To help reduce the tax gap, in fiscal year 2012, Congress appropriated $5.3 billion to IRS for its enforcement activities to support approximately 48,000 staff. Congress also appropriated $2.2 billion to IRS for its taxpayer service activities to support 30,500 staff. IRSs enforcement of the tax laws contributes to voluntary compliance by giving all taxpayers a sense that their neighbors and business competitors are paying their fair share. Notwithstanding IRSs enforcement and service programs, the net tax gap remains large. Accordingly, tax law enforcement is on GAOs high-risk list.
For the most current high-risk report, see GAO, High-Risk Series: An Update, GAO-13-283 (Washington, D.C.: Feb. 14, 2013).
What GAO Found
Since last reporting on cost savings and revenue collection opportunities related to IRSs enforcement efforts in February 2012, GAO has identified several areas where IRS can further improve its programs and collect billions of dollars in tax revenue, reduce its costs, and facilitate voluntary compliance. These include the following:
- Using return on investment (ROI) and similar analyses to better target its resources. Resource limitations prevent IRS from examining more than a small fraction of individual tax returns filed. In its December 5, 2012, report, GAO estimated that modest reallocations of IRSs examination resources might raise billions of dollars in direct revenue with little, if any, decline in voluntary compliance. For example, a hypothetical shift of a relatively small share of resources (about $124 million) from examinations of less productive groups of tax returnsspecifically, lower-income returns with the earned income tax credit and lower-income business returnsto more productive groups of tax returnsspecifically, higher-income returns and lower-income nonbusiness returns without the earned income tax creditcould have increased direct revenue collection by an estimated $1 billion over the $5.5 billion per year IRS actually collected from its examination activities in fiscal years 2007 and 2008. Additionally, in June 2012, GAO reported that providing return on investment estimates or other economic analyses, such as cost-effectiveness analyses, in its budget requests for new investment initiatives could aid in making decisions about budget and resource allocations. When comparisons of alternative investments do not consider costs, budget decision makers cannot be assured that alternatives were fully evaluated and the best alternative was selected. Finally, in that same report, GAO stated that although IRS tracks the schedule and cost performance of its information technology investments, it does not have a similar quantitative measure to determine the extent to which these investments are delivering planned functionality. Without a quantitative measure, budget decision makers lack information about how well IRS is managing its information technology investment projects.
- Using more risk-based approaches to aid in earlier and less costly collection of balances due. In our December 18, 2012, report, GAO reported that taxpayers filed 3.8 million individual income tax returns with self-acknowledged balances due totaling $13.8 billion for tax year 2010 (the most recent year for which data were available). The majority of this amount is either fully paid or accounted for through installment agreements during IRSs notice phase, when it sends letters to taxpayers telling them how to pay their balances. However, at least $4.4 billion remained uncollected after IRS sent as many as four notices to the taxpayer. These amounts become subject to more costly collection actions, such as face-to-face contact, if they remain uncollected. Best practices, such as risk-based approaches where contacts are tailored based on characteristics of the taxpayer, have helped increase collections in states such as California. IRS has developed an analytics plan and uses some risk-based processes to identify which notices taxpayers will receive, but has not yet implemented the plan, and management responsibilities are unclear. As a result, IRS has not tested more advanced risk-based approaches. Using more risk-based approaches, including implementation of its data analytics plan, may increase revenue collections by a portion of the $4.4 billion that either moves to more expensive collection methods or ultimately goes uncollected.
- Using Small Employer Health Insurance Tax Credit examination results to more efficiently allocate resources. The Small Employer Health Insurance Tax Credit was established to help eligible small businesses or tax-exempt entities provide health insurance for employees. In May 2012, GAO reported that although fewer small employers claimed the tax credit in tax year 2010 than were estimated to be eligible, IRS could better use the enforcement resources devoted to the program. GAO found that IRS does not systemically analyze examination results related to the credit to understand the types of errors being made and whether examinations are the best way to ensure compliance. As an example of potentially inefficient resource use, over half of the completed small business health insurance claim examinations for tax year 2010 found no errors. By contrast, for examinations of business entities as a whole, IRS is better able to target its resources with errors found at much higher rates. By analyzing small employer health insurance claims examination results, IRS would be better able to decide how much in examination resources should be invested in verifying those claims. In commenting on GAOs May 2012 report, IRS stated that although its information systems do not capture adjustments by issue, it would leverage existing information systems and manually analyze exam results if necessary to optimize its compliance efforts. Any examination resources saved on this credit could be shifted to other priorities and potentially increase revenue collected.
- Using third-party information reporting to enforce compliance for reporting international income. Given the mobility of money and proliferation of foreign financial institutions, the potential for U.S. taxpayers to evade taxes on funds held in offshore accounts is greater than ever. In 2010, Congress passed the Foreign Account Tax Compliance Act as part of the Hiring Incentives to Restore Employment Act of 2010. The Act requires certain U.S. taxpayers to report to IRS their overseas assets and requires U.S. entities to withhold a portion of certain payments made to foreign financial institutions that have not entered into an agreement with IRS to report certain information with respect to the institutions U.S. accounts. The Act is an effort to reduce tax evasion by creating greater transparency and accountability with respect to offshore accounts and entities held by U.S. taxpayers and providing IRS with tools to further enforce tax laws and collect additional revenue. On April 16, 2012, GAO reported that although IRS had begun discussing how it will use this information to improve compliance, it had not yet completed or fully documented a strategy for doing so. IRS has not developed key timelines for accomplishing the tasks necessary to enable it to use this information to improve taxpayer compliance. IRS has also not developed performance measures to assess the cost and benefits of its compliance efforts. If IRS does not have a broad strategy, it risks negatively affecting implementation of the Act.
- Reversing declines in taxpayer service can benefit voluntary compliance. IRS interacts with millions of taxpayers by processing tax returns, issuing refunds, answering telephone calls and correspondence, and providing other services, including those on its website. Providing taxpayer services can promote voluntary compliance for taxpayers who wish to comply with tax laws but do not understand their obligations. On December 18, 2012, GAO reported that IRS has realized efficiency gains and provided alternative types of services, including more automated services. Notwithstanding these efforts, IRS has not kept up with the demand for service. Key indicators of its taxpayer service performance have continued to declinethe percentage of taxpayers seeking live telephone assistance who receive it has decreased, and telephone wait times and the percentage of paper correspondence IRS did not address within 45 days have increased. While IRS plans to continue to pursue efficiency gains, its strategy for future years does not specifically address how it plans to manage these negative trends. Managing the declines in telephone and correspondence services may require IRS to consider difficult trade-offs, such as reassessing which phone calls IRS should answer with a live assister. If the declines in taxpayer service are not effectively managed, voluntary compliance could be affected.
GAO has long reported that a broader opportunity to address the tax gap involves simplifying the tax code, as complexity can cause taxpayer confusion resulting in unintentional noncompliance as well as provide opportunities to hide willful noncompliance. GAO reiterated this point in testimony on April 19, 2012, and in its February 2013 high-risk report. Fundamental tax reform could result in a smaller tax gap if the new system has fewer tax preferences or complex tax code provisions, reducing IRSs enforcement challenges and increasing public confidence in the fairness of the tax system. Short of fundamental reform, targeted simplification opportunities exist. For example, GAOs May 2012 report on higher education credits shows how changing tax laws to include more consistent definitions across tax provisions could help taxpayers better understand how to claim these tax benefits. Similarly, in September 2011, GAO reported that the complexity of tax rules for derivatives and other financial instruments makes proper reporting of taxes difficult.
GAOs December 5, 2012, report also describes limitations of this estimate. Specifically, exam resource reallocation can also affect tax collections indirectly by influencing the voluntary compliance of nonexamined taxpayers. These indirect effects are difficult to estimate, and IRS has no empirical evidence that would allow it to say whether overall voluntary compliance would increase or decrease as a result of specific resource allocations.
IRSs return on investment calculations have limitations that reflect the challenges of estimating ROIs. For example, they do not include benefits of improved voluntary compliance. In addition, the investment, or costs, should ideally recognize not just IRS costs, but any costs borne by others. IRSs return on investment estimates provide useful information, but given the limits of current data, are not complete estimates of benefits and costs.
Pub. L. No. 111-147, Title V, subtitle A, 124 Stat. 71, 97 (2010).
Policymakers may find GAO reports issued in September 2005 and November 2012 helpful when considering changes to the tax laws. See GAO, Understanding the Tax Reform Debate: Background, Criteria, & Questions, GAO-05-1009SP (Washington, D.C.: September 2005), and Tax Expenditures: Background and a Guide for Evaluation Criteria and Questions, GAO-13-167SP (Washington, D.C.: Nov. 29, 2012).
Since last reporting on cost savings and revenue-raising opportunities related to IRSs enforcement efforts in February 2012, GAO made additional recommendations to reduce the tax gap and improve taxpayer service in five reports issued April 16, May, June, December 5, and December 18, of 2012. Specifically, GAO recommended that the Commissioner of the IRS take the following seven actions:
- determine whether IRS has a basis for adjusting its allocation of enforcement resources each year;
- ensure cost-effectiveness analyses are conducted for future significant initiatives/investments;
- develop a quantitative measure of scope, at a minimum, for its major information technology investments to have information on the performance of these investments;
- pilot more risk-based approaches for contacting taxpayers who have a balance due, which could include implementing its data analytics plan;
- use Small Employer Health Insurance Tax Credit examination results more efficiently by analyzing results from examinations of credit claimants and using those results to identify and address any errors through alternative approaches;
- complete a broad strategy, including a timeline and performance measures, for how IRS intends to use information collected based on the Foreign Account Tax Compliance Act requirements to improve tax compliance; and
- develop a strategy that defines appropriate levels of telephone and correspondence service and wait time and lists specific steps to manage service based on an assessment of time frames, demand, capabilities, and resources.
These actions should either generate cost savings from applying more rigorous analyses, achieving program efficiencies, and improving resource allocations or they should increase revenue collections through better enforcement of tax laws and services designed to facilitate voluntary compliance.
How GAO Conducted Its Work
The information contained in this analysis is based on findings from the products in the related GAO products section. GAO analyzed agency documents and interviewed officials from the Department of the Treasury, IRS, and other parties. GAO analyzed fiscal year 2011 and fiscal year 2012 budget data from IRS and related budget documents. GAO also analyzed relevant federal laws, regulations, and procedures.
Agency Comments & GAO Contact
In commenting on the reports cited under related GAO products, IRS agreed with six of the recommendations discussed in this analysis but did not state whether it agreed or disagreed with a seventh. For those six it agreed with, IRS said it is taking action to address them. For example, in its response to GAOs recommendation to pilot approaches for contacting taxpayers with a balance due, including implementing its data analytics plan, IRS said that its plan has been finalized and is under consideration for funding. In the event that full funding is not available, IRS will evaluate the effectiveness of incremental development and deployment of its plan. IRS did not agree or disagree with GAOs recommendation to develop a strategy that defines appropriate levels of taxpayer service. IRS said it already had an objective of providing taxpayers with access to accurate services while managing demand by improving efficiency. However, although IRS has realized efficiency gains and provided more automated services, its efforts to date have not reversed these declines.
GAO provided a draft of this report section to IRS for review and comment. IRS provided additional comments in response to three of GAOs recommendations. To ensure that cost-effectiveness analyses are conducted for future significant initiatives/investments, IRS said it is developing procedures to use cost-effectiveness analyses in its budget formulation processes where appropriate. To use Small Employer Health Insurance Tax Credit examination results more efficiently, IRS said it is reviewing a sample of closed cases and plans to use the results to consider alternative approaches to address compliance. To use Foreign Account Tax Compliance Act information to improve tax compliance, IRS said it formed a working group to respond to the recommendation. IRS did not provide comments on GAOs other four recommendations presented in this report section.
For additional information about this area, contact James R. White at (202) 512-9110, or email@example.com.
2012 Tax Filing
IRS 2013 Budget
Small Employer Health Tax Credit
Foreign Account Reporting Requirements