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Tax Gap

The average American spends 26.4 hours and $207 preparing his or her taxes. But not everyone pays every dollar owed the government or pays it on time. That difference between taxes owed and taxes paid is the tax gap, a measure of noncompliance. More IRS audits and increased reporting requirements for taxpayers and businesses could help close some of that gap but are unlikely to pull in large amounts of additional revenue. So while stronger enforcement will help, it won’t allow the next Congress and administration to avoid the hard budget decisions that expected future deficits will force them to make.

Urban Institute researchers can provide facts and nonpartisan perspectives about the tax gap. Read more in the reports linked below and listen to Senior Fellow Eric Toder’s “Sound Policy” recording on the right.

KEY FACTS

• Over the past 30 years, the gross tax gap has ranged from 16 to 20 percent of total tax liability.
• According to the latest Internal Revenue Service estimates, the 2001 gross tax gap was $345 billion, of which $55 billion will eventually be recovered through late payments, leaving a net tax gap of $290 billion. The gap for 2006 could be as high as $400 billion, assuming that it grows proportionally with tax liability.
• Most of the tax gap, 68 percent in 2001, stems from underreporting on individual income tax returns. Nonfiling and underpayment of reported taxes account for less than 20 percent of the gap.
• More than 60 percent of underreported individual tax is for income from small businesses, partnerships, and self-employment, all of which the IRS has no easy way to verify independently.
• Despite widely publicized stories of corporate tax shelters, corporate income tax accounted for only 10.5 percent of the underreporting gap in 2001; the estate tax and excise taxes accounted for 1.4 percent.
• The IRS enforces payment through collection programs and audits. IRS data suggest that about four dollars, on average, is recovered in direct enforcement revenue per additional dollar spent on enforcement.
• IRS enforcement resources declined in the late 1990s, as funding shifted toward taxpayer service. Enforcement spending has increased in the past few years, but so too has the number of tax returns and the complexity of the tax law.
• Proposals to expand the information reported to the IRS could ultimately raise around $3–4 billion per year. More could be raised by sustained increases in IRS enforcement spending. But these changes would still leave a substantial tax gap.

Additional analysis is available in UI reports:

• What Is the Tax Gap?—Eric Toder
• Reducing the Tax Gap: The Illusion of Pain-Free Deficit Reduction—Eric Toder
• Tax Policy Briefing Book entries—Urban-Brookings Tax Policy Center staff

Decision Points '08 is published weekly by the Urban Institute, a nonpartisan social and economic research organization.
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