Reducing the Tax Gap: The Illusion of Pain-Free Deficit Reduction

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Abstract

IRS recently estimated a gross tax gap of $345 billion, or 16 percent of tax liability, for tax year 2001. The gross tax gap is the difference between estimated tax liability in any year and the amount of tax that is paid voluntarily and on time. The tax gap could be reduced by expanding the scope of information reporting, as the current Administration and some Members of Congress have proposed, or increasing resources for IRS enforcement. Potential budgetary gains from these measures are modest, however, and will not enable politicians to avoid hard choices about future tax and spending levels.

Introduction and Summary

The gross tax gap is the difference between tax liability in any year and the amount of tax that is paid voluntarily and on time. The IRS recently estimated a gross tax gap for tax year 2001 of $345 billion, just over 16 percent of tax liability for that year.

The tax gap is once again a high profile political issue, as politicians and some economists see measures to close the tax gap as a key component of a deficit reduction strategy. This attention paid to the tax gap is the latest iteration of a cyclical pattern in which politicians alternatively call for increased IRS enforcement and then complain about the burdens the IRS imposes on the citizenry.

For example, in the 1988 presidential campaign, Democratic candidate Michael Dukakis called for more tax enforcement as a means of reducing the budget deficit and cited his success in improving tax compliance in Massachusetts as a model of what might be accomplished at the Federal level. In the mid-1990s, however, politicians competed with each other to denounce alleged heavy-handed IRS enforcement tactics. Congress enacted a new Taxpayer Bill of Rights, placed new restrictions on IRS activities, and mandated a re-organization of the IRS in the Internal Revenue Restructuring Act of 1998. Throughout the second half of the 1990s, IRS spending on enforcement activities declined dramatically, as budgetary resources shifted from enforcement to taxpayer service. Since 2001, however, IRS enforcement activities have gradually increased and, today, narrowing the tax gap is again a priority.

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The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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