Tax Gap
Multiple Strategies, Better Compliance Data, and Long-Term Goals Are Needed to Improve Taxpayer Compliance Gao ID: GAO-06-208T October 26, 2005Long-term budget simulations by GAO and others show that we face large and growing structural deficits due primarily to known demographic trends and rising health care costs. Reducing the annual tax gap--the difference between what taxpayers timely and accurately pay in taxes and what they should pay under the law--could help the nation cope with these long-term fiscal challenges. The tax gap arises through the underreporting of tax liabilities, underpayment of taxes due or "nonfiling" of required tax returns. This testimony discusses the findings of GAO's recent tax gap report. It addresses the significance of reducing the tax gap, measuring the extent of the tax gap, collecting data on reasons why noncompliance occurs, and the Internal Revenue Service's (IRS) strategies for reducing the tax gap.
IRS's recent estimate of the tax gap in 2001 ranged from $312 billion to $353 billion. IRS estimates it will eventually recover some of this tax gap, resulting in a net tax gap of $257 billion to $298 billion. Reducing the tax gap will be challenging given persistent levels of noncompliance. Still, given its size, even small or moderate reductions in the net tax gap could yield substantial returns, which could improve the government's fiscal position. For example, based on IRS's most recent estimate, each 1 percent reduction in the net tax gap would likely yield more than $2.5 billion annually. Thus, a 10 percent to 20 percent reduction of the net tax gap would translate into from $25 billion to $50 billion or more in additional revenue annually. The tax gap must be attacked on multiple fronts and with multiple strategies over a sustained period of time. These strategies could include simplifying the tax code, providing quality service to taxpayers, and enhancing enforcement of tax laws by using tools such as tax withholding and information reporting. Regularly measuring compliance is also critical to IRS's ability to reduce the tax gap. A significant part of IRS's tax gap estimate is based on recently collected data on individual income tax reporting compliance. However, other areas of the tax gap rely on old data and outdated methodologies. IRS does not have approved plans, with one exception, to collect more current compliance data covering the various components of the tax gap. Although it can be challenging to develop, data on the reasons why taxpayers do not comply with the tax laws could help IRS more effectively tailor its efforts to reduce noncompliance. IRS has begun to capture data on the reasons for noncompliance, but it has concerns with the data. Although IRS is developing a system intended to capture better examination data, it does not have specific plans to develop better data on the reasons for noncompliance. IRS's strategies for reducing the tax gap involve improving taxpayer service and enforcing tax laws, but do not have a clear focus on quantitative long-term goals or results measurement. Establishing clear goals and measuring progress toward them would be consistent with results-oriented management principles and would provide IRS with a solid base upon which to develop a more strategic approach to reducing the tax gap.
GAO-06-208T, Tax Gap: Multiple Strategies, Better Compliance Data, and Long-Term Goals Are Needed to Improve Taxpayer Compliance
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Testimony:
Before the Subcommittee on Federal Financial Management, Government
Information, and International Security, Committee on Homeland Security
and Governmental Affairs, U. S. Senate:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 2:30 p.m. EDT:
Wednesday, October 26, 2005:
Tax Gap:
Multiple Strategies, Better Compliance Data, and Long-Term Goals Are
Needed to Improve Taxpayer Compliance:
Statement of Michael Brostek, Director, Strategic Issues:
GAO-06-208T:
GAO Highlights:
Highlights of GAO-06-208T, a testimony before the Subcommittee on
Federal Financial Management, Government Information, and International
Security, Committee on Homeland Security and Governmental Affairs, U.S.
Senate:
Why GAO Did This Study:
Long-term budget simulations by GAO and others show that we face large
and growing structural deficits due primarily to known demographic
trends and rising health care costs. Reducing the annual tax gap”the
difference between what taxpayers timely and accurately pay in taxes
and what they should pay under the law”could help the nation cope with
these long-term fiscal challenges.
The tax gap arises through the underreporting of tax liabilities,
underpayment of taxes due or ’nonfiling“ of required tax returns.
This testimony discusses the findings of GAO‘s recent tax gap report.
It addresses the significance of reducing the tax gap, measuring the
extent of the tax gap, collecting data on reasons why noncompliance
occurs, and the Internal Revenue Service‘s (IRS) strategies for
reducing the tax gap.
What GAO Found:
IRS‘s recent estimate of the tax gap in 2001 ranged from $312 billion
to $353 billion. IRS estimates it will eventually recover some of this
tax gap, resulting in a net tax gap of $257 billion to $298 billion.
Reducing the tax gap will be challenging given persistent levels of
noncompliance. Still, given its size, even small or moderate reductions
in the net tax gap could yield substantial returns, which could improve
the government‘s fiscal position. For example, based on IRS‘s most
recent estimate, each 1 percent reduction in the net tax gap would
likely yield more than $2.5 billion annually. Thus, a 10 percent to 20
percent reduction of the net tax gap would translate into from $25
billion to $50 billion or more in additional revenue annually.
The tax gap must be attacked on multiple fronts and with multiple
strategies over a sustained period of time. These strategies could
include simplifying the tax code, providing quality service to
taxpayers, and enhancing enforcement of tax laws by using tools such as
tax withholding and information reporting.
Regularly measuring compliance is also critical to IRS‘s ability to
reduce the tax gap. A significant part of IRS‘s tax gap estimate is
based on recently collected data on individual income tax reporting
compliance. However, other areas of the tax gap rely on old data and
outdated methodologies. IRS does not have approved plans, with one
exception, to collect more current compliance data covering the various
components of the tax gap.
Although it can be challenging to develop, data on the reasons why
taxpayers do not comply with the tax laws could help IRS more
effectively tailor its efforts to reduce noncompliance. IRS has begun
to capture data on the reasons for noncompliance, but it has concerns
with the data. Although IRS is developing a system intended to capture
better examination data, it does not have specific plans to develop
better data on the reasons for noncompliance.
IRS‘s strategies for reducing the tax gap involve improving taxpayer
service and enforcing tax laws, but do not have a clear focus on
quantitative long-term goals or results measurement. Establishing clear
goals and measuring progress toward them would be consistent with
results-oriented management principles and would provide IRS with a
solid base upon which to develop a more strategic approach to reducing
the tax gap.
What GAO Recommends:
GAO‘s July 2005 report recommended that IRS develop plans to
periodically measure tax compliance; take steps to improve its data on
the reasons why taxpayers do not comply; and establish long-term
quantitative goals on voluntary compliance levels, starting with
individual income tax underreporting and total tax underpayment.
In commenting on a draft of the report, IRS agreed with GAO‘s
recommendations.
www.gao.gov/cgi-bin/getrpt?GAO-06-208T.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Michael Brostek at (202)
512-9110 or brostekm@gao.gov.
[End of section]
Mr. Chairman and Members of the Subcommittee:
I appreciate this opportunity to discuss the annual tax gap--the
difference between what taxpayers timely and accurately pay in taxes
and what they should pay under the law--and how reducing that gap can
help the nation cope with its large and growing long-term fiscal
challenges. Most recently, the Internal Revenue Service (IRS) estimated
a gross tax gap from $312 billion to $353 billion for tax year
2001.[Footnote 1] IRS estimated that it would eventually recover some
of this amount through late payments and IRS enforcement actions,
resulting in an estimated "net" tax gap for 2001 from $257 billion to
$298 billion.[Footnote 2] The tax gap arises when taxpayers
intentionally or unintentionally fail to comply with the tax laws.
Their failure to pay taxes increases the burden of funding the nation's
commitments on those taxpayers who voluntarily pay their taxes.
Mr. Chairman, as I know you and the Comptroller General have discussed
in the past, confronting the nation's long-term fiscal challenge will
require nothing less than a fundamental review, reexamination, and
reprioritization of all major spending and tax policies and programs
that may take a generation or more to resolve. Simply put, our nation's
fiscal policy is on an imprudent and unsustainable course. Long-term
budget simulations by GAO, the Congressional Budget Office (CBO), and
others show that over the long term we face large and growing
structural deficits due primarily to known demographic trends and
rising health care costs. Continuing on this unsustainable fiscal path
will gradually erode, if not suddenly damage, our economy, our standard
of living, and ultimately our national security. Our current path also
will increasingly constrain our ability to address emerging and
unexpected budgetary needs and increase the burdens that will be faced
by our children, grandchildren, and future generations. While our long-
term fiscal imbalance cannot be eliminated with a single strategy,
reducing the tax gap should be one part of a broader effort to repair
the nation's fiscal health.
My remarks are based on our previous work on a variety of issues, in
particular the Comptroller General's recent testimony and our report on
reducing the tax gap.[Footnote 3] These efforts were conducted in
accordance with generally accepted government auditing standards.
Let me begin by highlighting four major points:
* Reducing the current tax gap would contribute to our fiscal
sustainability while simultaneously improving fairness for those
citizens who fully and timely meet their tax obligations but must be
done with multiple strategies over a sustained period.
* Regularly measuring the extent and nature of noncompliance is
critical to effective efforts to reduce the tax gap given changes in
the economy and tax law, but IRS does not have approved plans, with one
exception, for obtaining and maintaining more current compliance data
covering the various components of the tax gap beyond tax year 2001.
* Collecting data on the reasons why noncompliance occurs can help IRS
more effectively tailor its efforts to improve compliance. However, IRS
has no specific plans to gather better data than it already collects.
* Finally, IRS's strategies for improving compliance do not have the
clear focus on quantitative long-term goals and results measurement
that are associated with high-performing organizations and that are
incorporated into the statutory management framework Congress has
adopted.
In our July 2005 report on reducing the tax gap, we made
recommendations that IRS develop plans to periodically measure tax
compliance, take steps to improve its data on the reasons why taxpayers
do not comply, and establish long-term, quantitative goals for
voluntary compliance levels with an initial focus on individual income
tax underreporting and total tax underpayment. Taken together, these
steps can help IRS build a foundation to understand how its taxpayer
service and enforcement efforts affect compliance, improve the efforts,
and make progress on reducing the tax gap. The Commissioner of Internal
Revenue agreed with our recommendations, highlighted challenges
associated with them, and commented on various steps IRS would take to
implement each recommendation.
Background:
The tax gap is an estimate of the difference between the taxes--
including individual income, corporate income, employment, estate, and
excise taxes--that should have been timely and accurately paid and what
was actually paid for a specific year. The estimate is an aggregate of
estimates for the three primary types of noncompliance: (1)
underreporting of tax liabilities on tax returns; (2) underpayment of
taxes due from filed returns; and (3) nonfiling, which refers to the
failure to file a required tax return altogether or timely.[Footnote 4]
Estimates for each type of noncompliance include estimates for some or
all of the five types of taxes that IRS administers.
IRS develops its tax gap estimates by measuring the rate of taxpayer
compliance--the degree to which taxpayers fully and timely complied
with their tax obligations. That rate is then used, along with other
data and assumptions, to estimate the dollar amount of taxes not timely
and accurately paid. For instance, IRS recently estimated that for tax
year 2001, from 83.4 percent to 85 percent of owed taxes were paid
voluntarily and timely, which translated into an estimate gross tax gap
ranging from $312 billion to $353 billion.
IRS has estimated the tax gap on multiple occasions, beginning in 1979,
relying on its Taxpayer Compliance Measurement Program (TCMP). IRS did
not implement any TCMP studies after 1988 because of concerns about
costs and burdens on taxpayers.[Footnote 5] Recognizing the need for
current compliance data, in 2002 IRS implemented a new compliance study
called the National Research Program (NRP) to produce such data for tax
year 2001 while minimizing taxpayer burden.[Footnote 6]
IRS has a strategic planning process through which it supports
decisions about strategic goals, program development, and resource
allocation. Under the Government Performance and Results Act of 1993
(GPRA),[Footnote 7] agencies are to develop strategic plans as the
foundation for results-oriented management.
Reducing the Tax Gap Could Improve the Nation's Fiscal Position but
Will Require Multiple Strategies:
Given its size, even small or moderate reductions in the net tax gap
could yield substantial returns, which could improve the government's
fiscal position. For example, based on IRS's most recent estimate, each
1 percent reduction in the net tax gap would likely yield more than
$2.5 billion annually. Thus, a 10 percent to 20 percent reduction of
the net tax gap would translate into from $25 billion to $50 billion or
more in additional revenue annually.[Footnote 8]
However, reducing the tax gap will be challenging given persistent
levels of noncompliance.[Footnote 9] The tax gap must be attacked on
multiple fronts and with multiple strategies on a sustained basis. For
example, efforts to simplify the tax code and otherwise alter current
tax policies may help reduce the tax gap by making it easier for
individuals and businesses to understand and voluntarily comply with
their tax obligations.[Footnote 10] For instance, the multiple tax
preferences for education assistance might increase taxpayers' burden
in understanding and complying with the rules associated with these
options. In our July 2005 report on postsecondary tax preferences, we
found that hundreds of thousands of taxpayers do not appear to make
optimal decisions when selecting education-related tax
preferences.[Footnote 11] One explanation of these taxpayers' choices
may be the complexity of postsecondary tax preferences, which experts
have commonly identified as difficult for tax filers to use. Also,
simplification may reduce opportunities for tax evasion through
vehicles such as abusive tax shelters. However, for any given set of
tax policies, IRS's efforts to reduce the tax gap and ensure
appropriate levels of compliance will need to be based on a balanced
approach of providing service to taxpayers and enforcing the tax laws.
Providing quality services to taxpayers is an important part of any
overall strategy to improve compliance and thereby reduce the tax gap.
One method of improving compliance through service is to educate
taxpayers about confusing or commonly misunderstood tax
requirements.[Footnote 12] For example, if the forms and instructions
taxpayers use to prepare their taxes are not clear, taxpayers may be
confused and make unintentional errors. One method to ensure that forms
and instructions are sufficiently clear is to test them before use.
However, we reported in 2003 that IRS had tested revisions to only five
individual forms and instructions from July 1997 through June 2002,
although hundreds of forms and instructions had been revised in 2001
alone.[Footnote 13]
In terms of enforcement, IRS will need to use multiple strategies and
techniques to find noncompliant taxpayers and bring them into
compliance. In particular, as figure 1 shows, a pair of tools have been
shown to lower levels of noncompliance: withholding tax from payments
to taxpayers and having third parties report information to IRS and the
taxpayers on income paid to taxpayers. For example, banks and other
financial institutions provide information returns (Forms 1099) to
account holders and IRS showing the taxpayers' annual income from some
types of investments. Similarly, most wages, salaries, and tip
compensation are reported by employers to employees and IRS through
Form W-2. Preliminary findings from NRP indicate that more than 98.5
percent of these types of income are accurately reported on individual
returns.
Figure 1: Taxpayer Noncompliance Categorized by Amount of Withholding
and Information Reporting, 1992:
[See PDF for image]
[End of figure]
In the past, we have identified a few specific areas where additional
withholding or information reporting requirements could serve to
improve compliance:[Footnote 14]
* Requiring tax withholding and more or better information return
reporting by organizations that make payments to independent
contractors for services provided.[Footnote 15]
* Requiring information return reporting on payments made to
corporations for services provided.
* Require that information returns dealing with capital gain income
report the purchase price, or other cost basis data, as well as the
sales price for stocks and bonds.
Although withholding and information returns are highly effective in
encouraging compliance, such additional requirements generally impose
costs and burdens on the businesses that must implement them. However,
continued examination of opportunities to expand information reporting
and tax withholding has the potential to increase the transparency of
the tax system and the level of compliance.
Finally, making progress on closing the tax gap requires that the tools
and techniques being used to promote compliance are evaluated to ensure
that they actually are effective. IRS evaluates some of its efforts to
assess how well they work--perhaps most notably, its current effort to
test new procedures designed to reduce noncompliance with the Earned
Income Tax Credit[Footnote 16]--but misses other opportunities. For
example, we reported in 2002 that the effectiveness of the Federal Tax
Deposit Alert program--a program that since 1972 has been intended to
reduce delinquencies in paying employment taxes--could not be evaluated
because IRS had no system to track contacts IRS made with delinquent
employers.[Footnote 17]
Regular Compliance Measurement Can Support Informed Decisions to Reduce
the Tax Gap, but IRS Lacks Approved Plans for Such Measurement:
Regularly measuring compliance can offer many benefits, including
helping IRS identify new or growing types of noncompliance, identify
changes in tax laws and regulations that may improve compliance, more
effectively target examinations of tax returns, understand the
effectiveness of its programs to promote and enforce compliance, and
determine its resource needs and allocations.[Footnote 18] For example,
by analyzing 1979 and 1982 TCMP data, IRS identified significant
noncompliance with the number of dependents claimed on tax returns and
justified a legislative change to address the noncompliance. As a
result, for tax year 1987, taxpayers claimed about 5 million fewer
dependents on their returns than would have been expected without the
change in law.
Tax compliance data are also useful outside of IRS. Other federal
agencies and offices use compliance data for tax policy analysis,
revenue estimating, and research. Further, the longer the time between
compliance measurement surveys, the less useful they become given
changes in the economy and tax law.[Footnote 19] Without current
compliance data, IRS has limited capability to determine key areas of
noncompliance to address and actions to take to maximize the use of its
limited resources.
Underreporting Accounted for Most of the Tax Gap Estimate:
Using its recently collected compliance data, IRS has estimated that
underreporting of individual income taxes represented about half of the
tax gap for 2001 (the estimate ranges from $150 billion to $187 billion
out of a gross tax gap estimate that ranges from $312 billion to $353
billion), as indicated in table 1.
Table 1: IRS's Preliminary Tax Year 2001 Gross Tax Gap Estimates by
Type of Noncompliance and Type of Tax:
Dollars in billions.
Type of noncompliance: Underreporting;
Type of tax: Individual income tax: $150-$187;
Type of tax: Corporate income tax: $30;
Type of tax: Employment tax: $66-$71;
Type of tax: Estate tax: $4;
Type of tax: Excise tax: No estimate;
Type of tax: Total: $250-$292.
Type of noncompliance: Underpayment;
Type of tax: Individual income tax: $19;
Type of tax: Corporate income tax: $2;
Type of tax: Employment tax: $7;
Type of tax: Estate tax: $2;
Type of tax: Excise tax: $1;
Type of tax: Total: $32.
Type of noncompliance: Nonfiling;
Type of tax: Individual income tax: $28;
Type of tax: Corporate income tax: No estimate;
Type of tax: Employment tax: No estimate;
Type of tax: Estate tax: $2;
Type of tax: Excise tax: No estimate;
Type of tax: Total: $30.
Total;
Type of tax: Individual income tax: $198-$234;
Type of tax: Corporate income tax: $32;
Type of tax: Employment tax: $73-$78;
Type of tax: Estate tax: $8;
Type of tax: Excise tax: $1;
Type of tax: Total: $312-$353.
Source: IRS.
Note: Figures may not sum to totals due to rounding.
[End of table]
Within the underreporting estimate, IRS attributed about $150 billion
to $187 billion, or about 50 percent of the total tax gap, to
individual income tax underreporting, including underreporting of
business income, such as sole proprietor,[Footnote 20] informal
supplier,[Footnote 21] and farm income (about $83 billion to $99
billion); nonbusiness income, such as wages, interest and capital gains
(about $42 billion to $57 billion); overstated income adjustments,
deductions, and exemptions (about $14 billion to $16 billion); and
overstated credits (about $11 billion to $14 billion). Underreporting
of corporate income tax contributed an estimated $30 billion, or about
10 percent, to the 2001 tax gap, which included both small corporations
(those reporting assets of $10 million or less) and large corporations
(those reporting assets of over $10 million).[Footnote 22]
Employment tax underreporting accounted for an estimated $66 billion to
$71 billion, or about 20 percent, of the 2001 tax gap and included
several taxes that must be paid by self-employed individuals and
employers. Self-employed individuals are generally required to
calculate and remit Social Security and Medicare taxes to the U.S.
Treasury each quarter. Employers are required to withhold these taxes
from their employees' wages, match these amounts, and remit
withholdings to Treasury at least quarterly. Underreported self-
employment[Footnote 23] and employer-withheld employment taxes
respectively contributed an estimated $51 billion to $56 billion and
$14 billion to IRS's tax gap estimate. The employment tax
underreporting estimate also includes underreporting of federal
unemployment taxes (about $1 billion).
IRS has concerns with the certainty of the overall tax gap estimate in
part because some areas of the estimate rely on old data and outdated
methodologies. For example, IRS used data from the 1970s and 1980s to
estimate underreporting of corporate income taxes and employer-withheld
employment taxes. IRS has no estimates for other areas of the tax gap,
such as for corporate income, employment, and excise tax nonfiling or
for excise tax underreporting. For these types of noncompliance, IRS
maintains that the data are either difficult to collect, imprecise, or
unavailable. In addition, it is inherently difficult for IRS to observe
and measure some types of underreporting or nonfiling, such as tracking
cash payments that businesses make to their employees, as businesses
and employees may not report these payments to IRS in order to avoid
paying employment and income taxes, respectively.[Footnote 24]
IRS Plans to Issue a Revised Tax Gap Estimate, but Has No Approved
Plans to Regularly Collect Compliance Data:
IRS is taking several steps that could improve the tax gap estimate for
tax year 2001. IRS plans to further analyze the preliminary results
from NRP and expects to publish a revised estimate by the end of 2005.
The revised estimate will incorporate new methodologies, including
those for estimating overall individual income tax underreporting as
well as for the portion attributable to self-employed individuals who
operate businesses informally, and for estimating individual income tax
nonfiling. In addition, IRS has begun a compliance measurement study
that will allow IRS to update underreporting estimates involving S
corporations.[Footnote 25] This study, which IRS began in July 2005, is
scheduled to take 2 to 3 years to complete. Because individual
taxpayers may be recipients of income (or losses) from S corporations,
this study could affect IRS's estimates for the underreporting gap for
individual income tax.
Beyond this study of S corporations, IRS has no approved plans to
periodically collect more or better compliance data over the long term.
Also, IRS has indicated that given its current research priorities, it
would not begin another NRP study of individual income tax returns
before 2008, and would not complete such a study until at least 2010.
When IRS initially proposed the tax year 2001 NRP study, it had planned
to study individual income tax underreporting on a 3-year cycle.
According to IRS officials, IRS has not committed to regularly
collecting compliance data because of the associated costs and burdens.
Taxpayers whose returns are examined through compliance studies such as
NRP bear costs in terms of time and money. Also, IRS incurs both direct
costs and opportunity costs--revenue that IRS potentially forgoes by
using its resources to examine randomly selected returns, which are
more likely to include returns from compliant taxpayers and less likely
to produce additional tax assessments compared to traditional
examinations. One IRS official also emphasized that IRS has fewer
resources than in the past to conduct examinations as well as
compliance studies.
Although the costs and burdens of compliance measurement are legitimate
concerns, we believe compliance studies to be good
investments.[Footnote 26] The lack of firm plans to continually obtain
fresh compliance data is troubling because the frequency of data
collection can have a large impact on the quality and utility of
compliance data. Any plans for obtaining and maintaining reasonably
current information on compliance levels for all portions of the tax
gap would need to take into account costs, burdens, and compliance
risks in determining which areas of compliance to measure and the scope
and frequency of such measurement.
Knowing the Reasons for Noncompliance Could Help Guide Compliance
Efforts, but IRS Has Concerns with Its Data on These Reasons:
Data on whether taxpayers are unintentionally or intentionally
noncompliant with specific tax provisions are critical to IRS for
deciding whether its efforts to address specific areas of noncompliance
should focus on nonenforcement activities, such as improved forms or
publications, or enforcement activities to pursue intentional
noncompliance. For example, taxpayers may unintentionally claim the
Earned Income Tax Credit (EITC) because they do not understand the
child residency requirements for this credit (i.e., a qualifying child
must live with the taxpayer for more than half of the year). This type
of unintentional noncompliance may require IRS to more clearly explain
the EITC requirements within related forms and publications. However,
other taxpayers may file false EITC claims with the intent of evading
tax liability, which may suggest a strategy that relies on IRS's
enforcement programs and tools. Similar situations could exist for
other tax code provisions. Recognizing the benefits of better
compliance data, we, as well as the National Taxpayer Advocate, have
urged IRS to consider performing additional research into causes of
noncompliance.[Footnote 27]
IRS collects data on the reasons for noncompliance for specific tax
issues during its operational examinations of tax returns. In many of
these cases, it is difficult for examiners to determine a taxpayer's
intent--whether the noncompliance is unintentional or intentional.
Unless the evidence clearly points to the reason, the examiner would
have to make subjective judgments about why the noncompliance occurred.
IRS has a number of other concerns with the data:
* The database is incomplete because not all examination results,
including data on reasons for noncompliance, were being entered into
the database.
* IRS has not tested the adequacy of the controls for data entry or the
reliability of the data being collected. IRS has found instances where
examiners close examinations without assigning a reason for
noncompliance or by assigning the same reason to all instances of
noncompliance, regardless of the situation.
* IRS has not trained all examiners to ensure consistent understanding
and use of the various codes to indicate the reason for noncompliance.
* The data do not represent the population of noncompliant taxpayers
but rather only those who had their tax returns examined.
According to IRS officials, the agency does not have firm or specific
plans to develop better data on the reasons for noncompliance. One
official explained that IRS decided not to improve the consistency of
its current reason data because it is devoting its limited resources to
other efforts, such as developing the Examination Desktop Support
System. Although this system is intended to allow examiners to capture
better examination data, specific system features have not yet been
identified to improve examiners' selection of reason codes. IRS
officials said that the system could be enhanced in the future to
improve the data on reasons for noncompliance and that they plan to
consider such enhancements. If IRS enhances the data on reasons for
noncompliance, it will be important to consider factors such as how
complete and reliable such data need to be, and whether to collect the
data for all types of noncompliance or for all examinations (as opposed
to a targeted random sample).
Long-term, Quantitative Goals for Improving Taxpayers' Compliance Would
Be Consistent with Results-Oriented Management:
Focusing on outcome-oriented goals and establishing measures to assess
the actual results of a program compared to its intended purpose can
help agencies improve performance and stakeholders determine whether
programs have produced desired results. Furthermore, setting long-term,
quantitative goals would be consistent with results-oriented management
principles that are associated with high-performing organizations and
incorporated into the statutory management framework Congress has
adopted through GPRA. As such, establishing long-term, quantitative
compliance goals coupled with periodic measurements of compliance
levels offers several benefits for IRS. These benefits include
providing a better basis for determining to what extent its various
service and enforcement efforts contribute to compliance, considering
new strategies to improve compliance over time,[Footnote 28] and
promoting strategic and disciplined management decisions that target
areas most in need of improvement.
IRS's strategies for improving compliance, which involve improving
taxpayer service and enhancing enforcement of the tax laws, generally
lack a clear focus on long-term, quantitative goals and results
measurement. In response to a President's Management Agenda[Footnote
29] initiative to better integrate budget and performance information,
IRS officials said that they are considering various long-term goals
for the agency. However, IRS has not yet set a time frame for publicly
releasing the goals or indicated how many goals will be related to
improving taxpayer compliance or whether they will be quantitative and
results-oriented. According to IRS officials, developing long-term,
results-oriented goals is a complex process that requires sustained
management commitment. These factors contribute to IRS's uncertainty
about when it will publicly release its goals.
Like other agencies,[Footnote 30] IRS faces challenges in implementing
a results-oriented management approach. For example, collecting
reliable compliance data, developing reasonable assumptions about
taxpayer behavior, and accounting for factors outside of IRS's actions
that can affect taxpayer compliance, such as changes in tax law, make
it difficult to estimate the effect of IRS's enforcement and service
activities.[Footnote 31] However, even if IRS is unable to show that
its actions directly affected compliance rates, periodic measurements
of compliance levels can indicate the extent to which compliance is
improving or declining and provide a basis for reexamining existing
programs and triggering corrective actions if necessary. Moreover,
having completed the NRP review of individual income tax
underreporting, IRS now has an improved foundation for setting a goal
or goals for improving taxpayers' compliance.
Concluding Observations:
Reducing the tax gap is one approach that would help address the
looming fiscal challenges facing the nation. While our long term-fiscal
imbalance is too large to be eliminated by one strategy, reducing the
tax gap can ease the difficult decisions that are needed. Toward that
end, in our July 2005 report on reducing the tax gap, we made
recommendations to IRS to develop plans to periodically measure tax
compliance, take steps to improve its data on the reasons why taxpayers
do not comply, and establish long-term, quantitative goals for
voluntary compliance levels with an initial focus on individual income
tax underreporting and total tax underpayment. Taken together, these
steps can help IRS build a foundation to understand how its taxpayer
service and enforcement efforts affect compliance, improve the efforts,
and make progress on reducing the tax gap. The Commissioner of Internal
Revenue agreed with our recommendations, highlighted challenges
associated with them, and commented on various steps IRS would take to
implement each recommendation.
Mr. Chairman and Members of the Subcommittee, this concludes my
testimony. I would be happy to answer any questions you may have at
this time.
Contact and Acknowledgments:
For further information on this testimony, please contact Michael
Brostek on (202) 512-9110 or brostekm@gao.gov. Individuals making key
contributions to this testimony include Jeff Arkin, Elizabeth Fan,
Shannon Groff, George Guttman, Michael Rose, and Tom Short.
FOOTNOTES
[1] IRS's most recent estimates of the tax gap are preliminary, and as
such, IRS presents them as ranges.
[2] Throughout this statement, references to the tax gap refer to the
gross tax gap unless otherwise noted.
[3] GAO, Tax Compliance: Reducing the Tax Gap Can Contribute to Fiscal
Sustainability but Will Require a Variety of Strategies, GAO-05-527T
(Washington, D.C.: Apr. 14, 2005), and Tax Compliance: Better
Compliance Data and Long-term Goals Would Support a More Strategic IRS
Approach to Reducing the Tax Gap, GAO-05-753 (Washington, D.C.: July
18, 2005).
[4] Taxpayers who receive filing extensions, pay their full tax
liability by payment due dates, and file returns prior to extension
deadlines are considered to have filed timely.
[5] GAO, Tax Administration: Status of IRS' Efforts to Develop Measures
of Voluntary Compliance, GAO-01-535 (Washington, D.C.: June 18, 2001).
[6] GAO, Tax Administration: New Compliance Research Effort Is on
Track, but Important Work Remains, GAO-02-769 (Washington, D.C.: June
27, 2002).
[7] Pub. L. No. 103-62 (1993).
[8] Any significant reduction of the tax gap would likely depend on an
improvement in the level of taxpayer compliance. In some instances, the
amount of the tax gap can change without a corresponding change in the
level of compliance. For example, a reduction in marginal tax rates
could result in a smaller tax gap simply because the amount of tax that
should be paid has been reduced, even if the level of compliance
remains unchanged.
[9] Recognizing these challenges, we have long been concerned about tax
noncompliance and IRS's efforts to address it. Since 1990, we have had
various aspects of tax noncompliance on our high-risk list, and this
year we have affirmed our broad concern by consolidating two prior high-
risk areas into one--Enforcement of Tax Laws. See GAO, High-Risk
Series: An Update, GAO-05-207 (Washington, D.C.: Jan. 2005).
[10] GAO's report, Understanding the Tax Reform Debate, discusses a
number of topics, such as the growing complexity of the current tax
system, that tax experts have identified as those that should be
considered when evaluating tax policy. See GAO, Understanding the Tax
Reform Debate: Background, Criteria, & Questions, GAO-05-1009SP
(Washington, D.C.: Sept. 2005).
[11] GAO, Student Aid and Postsecondary Tax Preferences: Limited
Research Exists on the Effectiveness of Tools to Assist Students and
Families through Title IV Student Aid and Tax Preferences, GAO-05-684
(Washington, D.C.: July 29, 2005).
[12] GAO/T-GGD-97-35.
[13] GAO, Tax Administration: IRS Should Reassess the Level of
Resources for Testing Forms and Instructions, GAO-03-486 (Washington,
D.C.: Apr. 11, 2003).
[14] GAO, Tax Gap: Many Actions Taken, but a Cohesive Compliance
Strategy Needed, GAO/GGD-94-123 (Washington, D.C.: May 11, 1994).
[15] GAO, Tax Administration: Approaches for Improving Independent
Contractor Compliance, GAO/GGD-92-108 (Washington, D.C.: July 23,
1992).
[16] GAO, Earned Income Credit: Qualifying Child Certification Test
Appears Justified, but Evaluation Plan Is Incomplete, GAO-03-794
(Washington, D.C.: Sept. 30, 2003), and Earned Income Tax Credit:
Implementation of Three New Tests Proceeded Smoothly, But Tests and
Evaluation Plans Were Not Fully Documented, GAO-05-92 (Washington,
D.C.: Dec. 30, 2004).
[17] GAO, Tax Administration: IRS's Efforts to Improve Compliance With
Employment Tax Requirements Should Be Evaluated, GAO-02-92 (Washington,
D.C.: Jan. 15, 2002).
[18] GAO, Tax Administration: IRS' Plans to Measure Tax Compliance Can
Be Improved, GAO/GGD-93-52 (Washington, D.C.: Apr. 5, 1993).
[19] GAO/GGD-93-52.
[20] Sole proprietors are self-employed individuals who should file a
Schedule C with their individual tax return to report profits and
losses from their business. Sole proprietors include those who provide
services, such as doctors or accountants; produce goods, such as
manufacturers; and sell goods at fixed locations, such as car dealers
and grocers.
[21] Informal suppliers are sole proprietors who work alone or with few
workers and, by definition, operate in an "informal" manner. Informal
suppliers include those who make home repairs, provide child care, or
sell goods at roadside stands. These taxpayers should report business
profits or losses on a Schedule C.
[22] GAO-05-753.
[23] As employment taxes and income taxes for self-employed taxpayers
are largely assessed on the same income, self-employed individuals who
underreport their income consequently underreport the employment tax
due on that income.
[24] For a more detailed discussion about data sources and
methodologies used in estimating the tax gap, see GAO-05-753.
[25] S corporations, as well as partnerships, are businesses commonly
referred to as flow-through entities as they do not generally pay taxes
on income. Instead, they distribute net income and losses to partners,
shareholders, and beneficiaries, who are subsequently required to
report net income or losses on their individual tax returns and pay any
applicable taxes. According to an IRS research official, IRS expects to
conduct a compliance measurement study of partnerships at a later
date.
[26] GAO/GGD-93-52.
[27] Testimony of Nina E. Olson, National Taxpayer Advocate, before the
Senate Committee on Finance, July 21, 2004, and Internal Revenue
Service, Taxpayer Advocate Service, National Taxpayer Advocate 2004
Annual Report to Congress (Washington, D.C.: Dec. 31, 2004); and GAO,
Tax Research: IRS Has Made Progress but Major Challenges Remain, GAO/
GGD-96-109 (Washington, D.C.: June 5, 1996).
[28] For example, IRS's progress toward the goal of having 80 percent
of all individual tax returns electronically filed by 2007 has required
enhancement of its technology, development of software to support
electronic filing, education of taxpayers and practitioners, and other
steps that could not be completed in a short time frame. Congress
established this electronic filing goal in the IRS Restructuring and
Reform Act of 1998, Pub. L. No. 105-206 (1998).
[29] The President's Management Agenda is intended to help the federal
government become more results-oriented and encourage federal managers
to ask whether their programs are working as intended and, if not, what
can be done to achieve greater results.
[30] GAO, The Government Performance and Results Act: 1997
Governmentwide Implementation Will Be Uneven, GAO/GGD-97-109
(Washington, D.C.: June 2, 1997), and Results-Oriented Government: GPRA
Has Established a Solid Foundation for Achieving Greater Results, GAO-
04-38 (Washington, D.C.: Mar. 10, 2004).
[31] As discussed in our July 2005 tax gap report, several research
studies have offered insights to better understand the direct and
indirect effects of IRS's activities on tax revenue and voluntary
compliance. Indirect effects arise when voluntary compliance increases
in the larger population or in subsequent years due to examinations, or
other enforcement and service actions, on targeted taxpayers. Although
these studies generally indicate that IRS activities have positive tax
effects, the magnitude of these effects is not yet known with a high
level of confidence given compliance measurement challenges.
