Tax Gap Grows To $450 Billion, Compliance Rate Holds Steady

The "tax gap" climbed from $345 billion in tax year (TY) 2001 to $450 billion in TY 2006, the most recent year for which the necessary statistics were available, the IRS reported. The growth in the tax gap over five years was concentrated in underreporting and underpayment, which jointly accounted for nine out of 10 tax gap dollars, according to the agency.

The IRS also reported that despite the increase in the tax gap, the voluntary compliance rate for TY 2006 was statistically unchanged from TY 2001.

Background

The net tax gap, according to the IRS, is the amount of tax liability that is never collected. That is, the net tax gap consists of the amount of tax liability not paid on time (the gross tax gap) that is not collected subsequently, either voluntarily or as the result of enforcement activities. In TY 2001, the gross tax gap was $345 billion and the net tax gap was $290 billion. In TY 2006, the gross tax gap climbed to $450 billion and the net tax gap grew to $385 billion. The IRS reported that enforcement activities and late payments reduced the TY 2006 net tax gap by $65 billion, compared to $55 billion in TY 2001.

The overall voluntary compliance rate in TY 2006 was 83.1 percent compared to 83.7 percent in FY 2001. According to the IRS, the two rates are essentially the same because the TY 2006 rate is within the range of error of the TY 2001 rate.

Comment: The IRS explained that 2006 was the latest year in which all statistics that go into a tax gap computation were available, taking into account filing time, audit cycles and collection efforts. The IRS did not speculate on what an eventual examination of TY 2011 would reveal another five years from now. However, it did mention the attention that IRS Commissioner Shulman has given to the tax gap since taking office in 2008, emphasizing in FS-2012-6 that virtually all major initiatives launched by the IRS since then "have been designed to focus on the tax gap."

Underreporting

Underreporting of income remained the largest contributing factor to the tax gap, the IRS explained. Underreporting accounted for an estimated $376 billion (84 percent) of the $450 billion TY 2006 gross tax gap. Underreporting grew 32 percent between TY 2001 and TY 2006, the IRS reported.

Individuals. According to the IRS, individuals underreported by an estimated $235 billion in TY 2006 compared to $197 billion in 2001.

Corporations. The IRS estimated that the tax gap for large corporations (assets over $10 million) was $48 billion in TY 2006 and $19 billion for small corporations in TY 2006.

Employment taxes. Underreporting of self-employment taxes contributed $57 billion to the TY 2006 tax gap, the IRS reported. Taxpayers underreported FICA taxes by $14 billion in TY 2006.

Nonpayment

Nonfiling made up $28 billion of the TY 2006 gross tax gap, the IRS explained. Nonfiling by individuals accounted for nearly 90 percent of all nonfiling in TY 2006.

Hill Reaction

"In an era when we're squeezing the federal budget for every dollar of savings, we have to make every effort to recover these lost funds," Senate Finance Committee Chair Max Baucus, D-Montana, said in a statement. A spokesperson for House Ways and Means Chair Dave Camp, R-Mich., said that the tax gap study reinforced the need for tax reform.

Disclaimers