Tax Compliance
Better Compliance Data and Long-term Goals Would Support a More Strategic IRS Approach to Reducing the Tax Gap Gao ID: GAO-05-753 July 18, 2005According to the Internal Revenue Service (IRS), a gap arises each year between what taxpayers pay accurately and on time in taxes and what they should pay under the law. The tax gap is composed of underreporting of tax liabilities on tax returns, underpaying of taxes due from filed returns, and nonfiling of required tax returns altogether or on time. GAO was asked to provide information on (1) the estimated amount that each major type of noncompliance contributed to the 2001 tax gap and IRS's views on the certainty of its tax gap estimates, (2) reasons why noncompliance occurs, and (3) IRS's approach to reducing the tax gap and whether the approach incorporates established results-oriented planning principles.
IRS estimates that underreporting of taxes accounted for about $250 billion to $292 billion of the $312 billion to $353 billion tax gap for 2001, while underpayment and nonfiling accounted for about $32 billion and $30 billion, respectively. Although IRS has collected recent compliance data, it still has concerns with some outdated methodologies and data used to estimate the tax gap. IRS is taking laudable steps intended to improve the estimate, which it plans to revise by the end of 2005. IRS has also developed a proposed schedule of compliance studies, but it has no approved plans to periodically measure compliance for the tax gap components. While it may not be feasible or necessary to measure compliance for all components at the same frequency or level of investment, periodic compliance studies would support a more data-driven and risk-based approach to reducing the tax gap. IRS recently began to capture data on the reasons why taxpayers are noncompliant. However, IRS has concerns about the data, such as examiners assigning the same reason for noncompliance regardless of situation. Also, it is often difficult for examiners to determine a taxpayer's intent--whether the noncompliance is unintentional or intentional. Collecting better data on reasons can help IRS focus its activities on taxpayer service or enforcement. Although IRS is developing a system intended to capture better examination data, IRS does not have firm or specific plans to develop better reason data. IRS approaches tax gap reduction through improving taxpayer service and enforcing tax laws and has two broad strategic goals and related key efforts that are intended to support this approach. However, IRS has not established long-term, quantitative compliance goals and regularly collected data to track its progress, which would complement its current, important compliance efforts. Establishing clear goals and measuring progress towards them would be consistent with results-oriented management principles. IRS has begun to consider additional goals, but it is not yet clear if they will be compliance related. Long-term, quantitative compliance goals, coupled with updated compliance data, would provide a solid base upon which to develop a more strategic, results-oriented approach to reducing the tax gap.
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Director: Team: Phone:GAO-05-753, Tax Compliance: Better Compliance Data and Long-term Goals Would Support a More Strategic IRS Approach to Reducing the Tax Gap
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Report to the Committee on Finance, U.S. Senate:
United States Government Accountability Office:
GAO:
July 2005:
Tax Compliance:
Better Compliance Data and Long-term Goals Would Support a More
Strategic IRS Approach to Reducing the Tax Gap:
GAO-05-753:
GAO Highlights:
Highlights of GAO-05-753, a report to the Committee on Finance, U.S.
Senate:
Why GAO Did This Study:
According to the Internal Revenue Service (IRS), a gap arises each year
between what taxpayers pay accurately and on time in taxes and what
they should pay under the law. The tax gap is composed of
underreporting of tax liabilities on tax returns, underpaying of taxes
due from filed returns, and nonfiling of required tax returns
altogether or on time.
GAO was asked to provide information on (1) the estimated amount that
each major type of noncompliance contributed to the 2001 tax gap and
IRS‘s views on the certainty of its tax gap estimates, (2) reasons why
noncompliance occurs, and (3) IRS‘s approach to reducing the tax gap
and whether the approach incorporates established results-oriented
planning principles.
What GAO Found:
IRS estimates that underreporting of taxes accounted for about $250
billion to $292 billion of the $312 billion to $353 billion tax gap for
2001, while underpayment and nonfiling accounted for about $32 billion
and $30 billion, respectively. Although IRS has collected recent
compliance data, it still has concerns with some outdated methodologies
and data used to estimate the tax gap. IRS is taking laudable steps
intended to improve the estimate, which it plans to revise by the end
of 2005. IRS has also developed a proposed schedule of compliance
studies, but it has no approved plans to periodically measure
compliance for the tax gap components. While it may not be feasible or
necessary to measure compliance for all components at the same
frequency or level of investment, periodic compliance studies would
support a more data-driven and risk-based approach to reducing the tax
gap.
IRS recently began to capture data on the reasons why taxpayers are
noncompliant. However, IRS has concerns about the data, such as
examiners assigning the same reason for noncompliance regardless of
situation. Also, it is often difficult for examiners to determine a
taxpayer‘s intent”whether the noncompliance is unintentional or
intentional. Collecting better data on reasons can help IRS focus its
activities on taxpayer service or enforcement. Although IRS is
developing a system intended to capture better examination data, IRS
does not have firm or specific plans to develop better reason data.
IRS approaches tax gap reduction through improving taxpayer service and
enforcing tax laws and has two broad strategic goals and related key
efforts that are intended to support this approach. However, IRS has
not established long-term, quantitative compliance goals and regularly
collected data to track its progress, which would complement its
current, important compliance efforts. Establishing clear goals and
measuring progress towards them would be consistent with results-
oriented management principles. IRS has begun to consider additional
goals, but it is not yet clear if they will be compliance related. Long-
term, quantitative compliance goals, coupled with updated compliance
data, would provide a solid base upon which to develop a more
strategic, results-oriented approach to reducing the tax gap.
IRS‘s Preliminary Tax Year 2001 Gross Tax Gap Estimates by Type of
Noncompliance and Type of Tax:
[See Table 1]
[End of table]
What GAO Recommends:
GAO recommends that IRS develop plans to periodically measure tax
compliance with a focus on individual income tax underreporting; take
steps to improve IRS data on the reasons taxpayers are not complying;
and establish long-term, quantitative goals on the voluntary compliance
levels, starting with individual income tax underreporting and total
tax underpayment.
In commenting on a draft of this report, IRS agreed with our
recommendations.
www.gao.gov/cgi-bin/getrpt?GAO-05-753.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Mike Brostek at (202) 512-
9110 or brostekm@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Scope and Methodology:
IRS Lacks Approved Plans to Regularly Measure Compliance, Including
Underreporting Which Accounts for the Largest Portion of the Tax Gap:
IRS Has Concerns with Its Data on Reasons for Noncompliance but Does
Not Have Firm or Specific Plans to Develop Better Data:
IRS's Approach to Reducing the Tax Gap Focuses on Service and
Enforcement but Lacks Long-term, Quantitative Compliance Goals and
Measures That Are Consistent with Results-Oriented Management
Principles:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: IRS Compliance Measurement Surveys:
Appendix II: Detailed Tax Gap Estimates, Data Sources, and Level of
Certainty:
Appendix III: IRS Key Efforts to Reduce the Tax Gap:
Appendix IV: Comments from the Internal Revenue Service:
Appendix V: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: IRS's Preliminary Tax Year 2001 Gross Tax Gap Estimates by
Type of Noncompliance and Type of Tax:
Table 2: Data Sources for IRS's Preliminary Tax Year 2001 Tax Gap
Estimates by Type of Noncompliance and Type of Tax, and IRS's Level of
Certainty in the Estimates:
Table 3: Types of Surveys by Return Type and Year:
Table 4: IRS's Preliminary Tax Year 2001 Gross Tax Gap Estimates, Data
Sources, and Level of Certainty by Tax Gap Component and Type of Tax:
Abbreviations:
DCE: detection controlled estimation:
EITC: Earned Income Tax Credit:
GAO: Government Accountability Office:
GPRA: Government Performance and Results Act of 1993:
IRS: Internal Revenue Service:
NRP: National Research Program:
SOI: Statistics of Income:
TCMP: Taxpayer Compliance Measurement Program:
TY: Tax Year:
United States Government Accountability Office:
Washington, DC 20548:
July 18, 2005:
The Honorable Charles Grassley:
Chairman:
The Honorable Max Baucus:
Ranking Minority Member:
Committee on Finance:
United States Senate:
The federal tax system relies on taxpayers to voluntarily comply with
the tax laws. However, a gap arises each year between what taxpayers
pay accurately and on time in taxes and what they should pay under the
law. Recognizing the need for current compliance data to update the tax
gap estimate, the Internal Revenue Service (IRS) implemented a new
compliance study in 2002 called the National Research Program (NRP) to
produce such data for tax year 2001 while reducing taxpayer
burden.[Footnote 1] NRP is a significant achievement and its data
should be valuable in improving IRS operations and for other uses.
Incorporating preliminary results from NRP, IRS recently estimated a
"gross" tax gap from $312 billion to $353 billion for tax year
2001.[Footnote 2] 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 3] The tax gap estimate is an aggregate of
estimates for the three primary types of noncompliance:[Footnote 4] (1)
underreporting of tax liabilities on tax returns; (2) underpaying of
taxes due from filed returns; and (3) nonfiling, which refers to the
failure to file a required tax return altogether or on time.
The tax gap arises when taxpayers fail to comply with the tax laws,
either intentionally or unintentionally. As a result of their
noncompliance, the burden of funding the nation's commitments,
including funding growing budget deficits, falls more heavily on
taxpayers who voluntarily pay their taxes. In addition, IRS expends
substantial resources enforcing and explaining tax laws, with the goals
of increasing compliance and reducing the tax gap.
Given your concern over the burden that the tax gap places on both the
taxpayers who voluntarily pay their taxes and the federal budget, we
testified before the Senate Committee on Finance on April 14, 2005, on
a number of tax-gap-related issues.[Footnote 5] As you requested, this
report elaborates on the testimony by providing additional information
on (1) the estimated amount that each major type of noncompliance
contributed to the 2001 tax gap and IRS's views on the certainty of its
tax gap estimates, (2) reasons why the noncompliance occurs, and (3)
IRS's approach to reducing the tax gap and whether the approach
incorporates established results-oriented planning principles.
To provide information on the estimated amount that each type of
noncompliance contributed to the 2001 tax gap, we reviewed IRS's tax
gap estimates for 2001. To determine IRS's views on the certainty of
its tax gap estimates, we reviewed IRS studies and interviewed IRS
research officials about tax gap estimation. We reviewed IRS, academic,
and our prior work and interviewed IRS officials in an attempt to
identify the various reasons for taxpayer noncompliance. To determine
IRS's approach to reducing the tax gap and whether the approach
incorporates established results-oriented planning principles, we
examined IRS's strategic and performance plans and interviewed IRS
officials. We asked IRS to identify its key efforts to reduce the tax
gap as well as the related rationales, goals, and results. Using what
we learned about IRS's approach, we determined the extent to which the
approach incorporated selected planning principles consistent with the
Government Performance and Results Act of 1993 (GPRA).[Footnote 6] We
conducted our review from June 2004 through May 2005 in accordance with
generally accepted government auditing standards.
Results in Brief:
For the 2001 gross tax gap estimate of about $312 billion to $353
billion, IRS estimated in March 2005 that underreporting accounted for
about $250 billion to $292 billion while underpayment and nonfiling
accounted for about $32 billion and $30 billion, respectively. The
actual tax gap could be higher or lower due to various factors that
affect IRS's certainty of the estimate. For example, due to a lack of
reliable data, IRS's estimate does not include some types of
noncompliance, such as corporate income tax nonfiling. Also, IRS is
concerned with some of the outdated data and methodologies used to
estimate the tax gap. Finally, it is difficult for IRS to identify and
measure noncompliance, such as underreported income, when IRS has
little or no information from third parties about payments made or
taxes withheld. IRS is taking some steps, such as updating the data and
methodology for estimating individual income tax underreporting, that
IRS intends to use to revise the preliminary tax gap estimate during
2005. While IRS has proposed a schedule for NRP studies over the next
several years, it has no approved plans to regularly measure tax
compliance, the results of which it could use to update the tax gap
estimate, identify new or growing areas of noncompliance, and make
informed decisions about resource allocations to address noncompliance.
IRS has concerns about its data on the reasons why taxpayers do not
comply with tax laws. Taxpayer noncompliance can be unintentional or
intentional in various ways. For example, taxpayers might
unintentionally err on their tax returns because they misunderstand the
laws or guidance explaining compliance requirements, or improperly omit
income from their returns based on poor advice from tax practitioners.
Alternatively, taxpayers may intentionally omit income from their tax
returns to evade taxes. IRS captures data on the various unintentional
and intentional reasons for noncompliance during examinations of tax
returns. IRS is concerned with the reliability of the data since, for
example, some examiners have assigned the same reason for all
noncompliance, regardless of the situation. Also, determining taxpayer
intent--whether the noncompliance is unintentional or intentional--can
be difficult. Although IRS is developing a system intended to capture
better examination data, IRS has no firm or specific plans to develop
better data on the reasons why taxpayers do not comply, through steps
such as improved data entry controls and examiner training. Without
such data, it is more difficult for IRS to decide whether its efforts
to address specific areas of noncompliance should focus on
nonenforcement activities, such as improved forms or publications, or
enforcement activities.
IRS's approach to reducing the tax gap includes improving taxpayer
service to increase voluntary compliance and enhancing enforcement of
tax laws by detecting and addressing noncompliance, but does not
incorporate some steps consistent with results-oriented management. To
support this approach, IRS has established two broad strategic goals
and identified over 40 related key efforts, which include using direct
enforcement actions to address high-income nonfilers and using
analytical models to pursue higher priority collection cases. However,
IRS has not established long-term, quantitative compliance goals and
regularly collected data to track progress in reducing the tax gap,
which would complement its current, important compliance efforts.
Establishing long-term, quantitative compliance goals and measuring
progress towards them offer several benefits to both IRS and external
stakeholders and would be consistent with the performance management
principles set forth in GPRA. Although IRS faces challenges in
implementing a results-oriented management approach to reducing the tax
gap, IRS's recently collected compliance data provide an improved
foundation for setting compliance goals and reexamining programs
intended to reduce the tax gap.
We are making 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 a 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 Interval
Revenue agreed with our recommendations, highlighted challenges
associated with them, and commented on various steps IRS would take to
implement each recommendation.
Background:
IRS develops its tax gap estimate by measuring the rate of taxpayer
compliance--the degree to which taxpayers fully complied with their tax
obligations. IRS uses such compliance data, along with other data and
assumptions, to estimate the dollar amount of taxes not paid accurately
and on time. For tax year 2001, IRS estimated that from 83.4 percent to
85 percent of owed taxes were paid voluntarily and on time, and that
from $312 billion to $353 billion in taxes were not paid that should
have been. IRS also estimates the amount of the gross tax gap that it
will recover through enforcement and other actions and subtracts that
to estimate the net annual tax gap. For tax year 2001, IRS estimated
that it would eventually recover about $55 billion for a net tax gap
from $257 billion to $298 billion. As we have reported in the
past,[Footnote 7] closing the entire gap may not be feasible since it
could entail more intrusive recordkeeping or reporting than the public
is willing to accept or more resources than IRS is able to commit.
However, given the size of the tax gap, even modest reductions would
yield very significant financial benefits.
IRS has estimated the tax gap on multiple occasions, beginning in 1979.
IRS's earlier tax gap estimates relied on the Taxpayer Compliance
Measurement Program (TCMP), through which IRS periodically performed
line-by-line examinations of randomly selected tax returns. TCMP
started with tax year 1963 and examined individual returns most
frequently--generally every 3 years--through tax year 1988. IRS
contacted all taxpayers selected for TCMP studies. IRS did not
implement any TCMP studies after 1988 because of concerns about costs
and burdens on taxpayers.[Footnote 8]
Under NRP, a program that we have encouraged, IRS recently completed
its initial review of about 46,000 randomly selected individual tax
returns from tax year 2001 (see app. I for a list of conducted TCMP and
NRP surveys). Unlike with TCMP studies, IRS did not need to contact
taxpayers for every tax return selected under NRP, handled some
taxpayer contacts through correspondence rather than face-to-face
examinations, and generally only asked taxpayers to explain information
that it was otherwise unable to verify through IRS and third-party
databases. In addition, unlike operational examinations, NRP
examinations were randomly selected and used to measure compliance
rather than target suspected noncompliance.
IRS has a strategic planning process through which it supports
decisions about strategic goals, program development, and resource
allocation. Under GPRA,[Footnote 9] agencies are to develop strategic
plans as the foundation for results-oriented management. GPRA requires
that agency strategic plans identify long-term goals, outline
strategies to achieve the goals, and describe how program evaluations
were used to establish or revise the goals. GPRA requires federal
agencies to establish measures to determine the results of their
activities.
Scope and Methodology:
To provide information on the estimated amount that each major type of
noncompliance contributed to the 2001 tax gap, we reviewed IRS's tax
gap estimate for 2001. To determine IRS's views on the certainty of its
estimate, we reviewed IRS studies about tax gap estimation and
interviewed IRS research officials to understand the data and
methodologies used. We also spoke with IRS officials regarding planned
changes to the data sources and estimation methodologies for the tax
gap estimate. We determined that the tax gap estimates presented in
this report are sufficiently reliable for the specific purposes of our
engagement, particularly since IRS already has publicly released its
tax gap estimates and disclosed their weaknesses. These purposes
include discussing the major tax gap components and the orders of
magnitude for various components, IRS's concerns about the certainty of
its estimates, and our recommendations on IRS's compliance data and
efforts.
We reviewed IRS, academic, and our own reports and interviewed IRS
officials to identify the various reasons for noncompliance. We talked
with IRS officials to determine the extent and reliability of data and
coding on the reasons for noncompliance, and reviewed IRS's Examination
Operational Automation Database, which is a database of tax return
examination results that includes examiners' determinations of the
reasons for any noncompliance. We also talked with IRS officials to
determine any plans to develop better data on reasons for
noncompliance.
To determine IRS's approach to reducing the tax gap and whether the
approach incorporates established results-oriented planning principles,
we reviewed IRS strategic and performance plans and interviewed IRS
strategic planning officials at the agency and operating division
levels. We asked IRS to identify its key efforts to reduce the tax gap
as well as the related rationales, goals, and results. As part of our
work on whether the approach incorporates established results-oriented
planning principles, we used what we learned about IRS's approach to
determine the extent to which it incorporated selected planning
principles consistent with GPRA's requirements. For purposes of this
review, we focused on elements of results-oriented planning that,
previously, we found common to leading organizations successfully
pursuing results-oriented management- defining desired results,
measuring performance, and using performance information to support
agency missions.[Footnote 10]
IRS Lacks Approved Plans to Regularly Measure Compliance, Including
Underreporting Which Accounts for the Largest Portion of the Tax Gap:
IRS estimates that underreporting of taxes accounted for about $250
billion to $292 billion of the $312 billion to $353 billion tax gap for
2001, while underpayment and nonfiling accounted for about $32 billion
and $30 billion, respectively. The actual tax gap could be higher or
lower due to various factors that affect the certainty of the estimate,
such as old compliance data. IRS is taking some steps designed to
improve portions of its compliance measurement efforts and its
preliminary tax gap estimate and plans to release a revised tax gap
estimate by the end of 2005. While IRS has proposed a schedule for NRP
studies over the next several years, IRS has no approved plans to
regularly measure tax compliance, which it could use to update the tax
gap estimate and guide its compliance efforts.
Underreporting Accounted for Most of the Tax Gap Estimate:
As table 1 indicates, 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).
Table 1: IRS's Preliminary Tax Year 2001 Gross Tax Gap Estimates by
Type of Noncompliance and Type of Tax:
Dollars in billions.
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;
Total: $250-$292.
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;
Total: $32.
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;
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;
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 11] informal
supplier,[Footnote 12] 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). (For a more detailed
table of IRS's estimates for the various components of the 2001 tax
gap, see app. II).
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 13] 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's 2001 Tax Gap Estimate Is Inexact Due to Incomplete and Old Data,
Outdated Methodologies, and Inherent Measurement Difficulties:
Although a significant portion of IRS's new tax gap estimate is based
on recent compliance data, IRS has concerns with the certainty of the
overall tax gap estimate in part because of incomplete and old data,
outdated methodologies, and measurement difficulties. Table 2 shows
IRS's certainty level in the estimates, as well as the underlying data
sources.[Footnote 14]
Table 2: Data Sources for IRS's Preliminary Tax Year 2001 Tax Gap
Estimates by Type of Noncompliance and Type of Tax, and IRS's Level of
Certainty in the Estimates:
Type of noncompliance: Underreporting;
IRS certainty level: --[C].
Type of tax: Individual income tax;
Estimate data source(s):
* Tax Year (TY) 2001 NRP Survey;
* TY 1988 and earlier TCMP studies;
* 1981, 1985-6 University of Michigan surveys on informal suppliers;
* 1984 University of Illinois study on tip income;
IRS certainty level: --[C].
Type of tax: Corporate income tax;
Estimate data source(s):
* TY 1977 and 1980 TCMP surveys (only for small corporations);
* Operational examinations (only for mid-sized and large
corporations) - averaged over 3 years in the mid-1980s;
* TY 1982 TCMP study of unrelated business income tax of tax-exempt
organizations;
* TY 1975 TCMP study on fiduciaries;
IRS certainty level: Weaker.
Type of tax: Employment tax;
Estimate data source(s):
* TY 2001 NRP Survey;
* TY 1984 withholding noncompliance study;
* 1981 and 1985-6 University of Michigan surveys on informal suppliers;
* 1984 University of Illinois study on tip income;
IRS certainty level: --[C].
Type of tax: Estate tax;
Estimate data source(s):
* IRS's Statistics of Income (SOI) program data for filed estate tax
returns for TY 1992;
IRS certainty level: Reasonable.
Type of tax: Excise tax;
Estimate data source(s):
* No estimate;
IRS certainty level: Not applicable.
Type of noncompliance: Underpayment (all types of tax)[A];
Estimate data source(s):
* IRS Master File;
IRS certainty level: Actual figures.
Type of noncompliance: Nonfiling[B];
IRS certainty level: Reasonable.
Type of tax: Individual income tax;
Estimate data source(s):
* TY 1988 Nonfiler (TCMP);
IRS certainty level: Reasonable.
Type of tax: Corporate income tax;
Estimate data source(s):
* No estimate;
IRS certainty level: Not applicable.
Type of tax: Employment tax;
Estimate data source(s):
* No estimate;
IRS certainty level: Not applicable.
Type of tax: Estate tax;
Estimate data source(s):
* 2 University of Michigan longitudinal surveys (begun in 1992 and 1993
and interviews participants every 2 years);
* TY 1992 IRS's SOI;
IRS certainty level: Reasonable.
Type of tax: Excise tax;
Estimate data source(s):
* No estimate;
IRS certainty level: Not applicable.
Source: IRS.
[A] Unlike the other components of the 2001 tax gap, the underpayment
component is not an estimate, but rather represents the tax amounts
that taxpayers reported on time, but did not pay on time.
[B] IRS's nonfiler estimate for individual income tax is net of amounts
of true tax liability that are paid on time (e.g., through
withholding). Refunds that are due to nonfilers do not reduce the
nonfiling gap, since they are not associated with a tax liability.
[C] These estimates are based on more recent NRP data, but IRS has not
finalized the certainty level for these estimates because it has not
yet completed its assessment of the quality of the NRP data.
[End of table]
Tax Gap Estimate Is Incomplete:
As table 2 shows, IRS's estimate for the 2001 tax gap does not include
estimates of excise tax underreporting and nonfiling. According to IRS,
the reason for this omission is that numerous federal excise taxes,
many of which have specific exclusions or varying applications,
complicate excise tax computations. Further, data on excise tax
transactions are typically maintained at the state level and are often
incomplete. Also, according to an IRS research official, the estimate
does not include corporate income tax and employment tax nonfiling
because IRS lacks good, representative data for corporate and
employment tax nonfilers. Further, data from IRS's operational programs
to identify nonfilers exclude those whom IRS does not know about and do
not include the full tax liability of nonfilers whom IRS has
identified.
The 2001 tax gap estimate also does not include any estimates for taxes
due from illegal source income, as the magnitude of such income is
difficult to estimate.[Footnote 15] Moreover, the federal government
seeks to eliminate most illegal activities altogether, rather than
derive revenue from these activities.[Footnote 16]
Estimates for Some Components of the Tax Gap Are Based on Old Data:
Old data also contribute to IRS's "weaker" level of certainty for
certain segments of the underreporting portion of its 2001 tax gap
estimate. For example, IRS used data from the 1970s and 1980s to
estimate underreporting of corporate income taxes and employer-withheld
employment taxes. For large corporate income tax underreporting, IRS
based its estimate on the amount of tax recommended from operational
examinations rather than the tax ultimately assessed as part of the
total tax liability. According to IRS officials, IRS relies on the
amount of tax recommended because it is difficult to determine the true
tax liability of large corporations due to complex and ambiguous tax
laws that create opportunities for differing interpretations and that
complicate the determination. These officials further stated that
because these examinations are not randomly selected and are not
focused on identifying all tax noncompliance, the estimate produced
from the examination data is not representative of the tax gap for all
large corporations. They also explained that due to these complexities
and the costs and burdens of collecting complete and accurate data, IRS
has not systematically measured large corporation tax compliance
through statistically valid studies, even though the officials
acknowledged that such studies would be useful in estimating the
related tax gap.[Footnote 17]
Tax Gap Estimates Are Affected by Outdated Methodologies:
Further, some methodologies IRS used to estimate the tax gap are based
on older data and contribute to the uncertainty surrounding the tax gap
estimate. For example, because IRS knew that it would not detect all
underreporting noncompliance, IRS multiplied the detected amounts of
underreporting to help calculate a total estimate for underreported
individual income tax. IRS officials explained that they used a number
of "multipliers," including one derived from the 1976 TCMP study of
individual tax returns, which was before IRS expanded and improved its
computer matching programs to better detect various types of
underreported income.[Footnote 18] In addition, IRS estimated
individual income tax nonfiling based on the assumption that the
relationship between individual income nonfiling and underreporting has
been constant since the 1988 TCMP survey was conducted.
Tax Gap Is Inherently Difficult to Estimate:
Finally, it is inherently difficult for IRS to observe and measure some
types of underreporting or nonfiling. For example, underreporting of
income or nonfiling of tax returns by informal suppliers can be hard
for IRS to detect because the tax laws generally do not require third
parties to withhold income tax or file information returns on payments
made to informal suppliers, as are required with other types of
individuals such as wage earners. Similarly, academic studies have
discussed the difficulty in tracking cash payments that businesses make
to their employees, as businesses may not report these payments to IRS
in order to avoid paying employment taxes and employees may not report
these payments on their income tax return to avoid paying income taxes.
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 preliminary tax gap
estimate for tax year 2001. IRS intends to publish a revised tax gap
estimate by the end of 2005 based on the results of these steps.
For example, IRS officials stated that IRS plans to further analyze the
preliminary NRP results in an attempt to improve the certainty of the
estimate. NRP is a significant achievement and its data should be
valuable in improving IRS operations and for other uses. However, those
officials added that because IRS is still assessing the quality of the
NRP data, it has not yet finalized the certainty levels for the
preliminary estimates for individual income tax and self-employment tax
underreporting. Likewise, we cannot yet be certain about the quality of
the NRP data collected because IRS is still assessing the data.
IRS plans to implement three changes to its estimation methodology for
its revised tax gap estimate. Although it is too soon to know whether
these changes will improve the estimate, IRS expects that the changes
will help address known methodological weaknesses. According to IRS,
these changes include the following:
* IRS plans to replace the multiplier it derived in the 1970s and used
to estimate individual income tax underreporting. IRS is developing a
new methodology, known as detection controlled estimation (DCE). DCE is
a regression-based model that will use 2001 NRP data and control for
variables that could affect the amount of underreporting
detected.[Footnote 19]
* IRS plans to develop a new technique as well as replace the data from
the 1981 and 1985-1986 University of Michigan surveys to estimate the
individual income tax underreporting portion of the tax gap
attributable to informal suppliers.
* IRS intends to update its estimate of individual income tax
nonfiling, which is currently based on 1988 nonfiler TCMP data, by
using "Exact Match" data provided by the U.S. Census Bureau.[Footnote
20] Census will match data from its Current Population Survey against
the IRS Master Files to identify the extent of nonfiling by individual
taxpayers. The Census data to be provided to IRS will be aggregated and
not contain information on specific individuals.
In addition, IRS research officials are planning a compliance
measurement study that will allow IRS to update underreporting
estimates involving flow-through entities. This study, which IRS
intends to begin in October 2005, would take 2 to 3 years to complete.
Because individual taxpayers or corporations may be recipients of
income (or losses) from flow-through entities, this study could affect
IRS's underreporting estimates for individual and corporate income tax.
While these data and methodology updates could improve the tax gap
estimates, IRS has no approved plans to periodically collect more and
better compliance data over the long term beyond the study of flow-
through entities. IRS Research officials said that they recently
proposed a schedule for additional NRP studies over the next several
years. However, these officials also said this proposal is under
consideration but has not been finalized. IRS has indicated that given
its current research priorities, it could not begin another NRP study
of individual income tax returns before 2008, at the earliest, and
would not complete such a study until at least 2010.
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 costs,
including direct costs and opportunity costs (or revenue that IRS
potentially forgoes by examining randomly selected returns, which are
more likely to include returns from compliant taxpayers than returns
selected because they are likely to contain noncompliance that would
produce additional tax assessments).
Regularly Measuring Compliance Can Be Beneficial, but Determining the
Frequency of Measurement Involves Considering Several Factors:
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 21] 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 useful outside of IRS as well. Other federal
agencies and offices use compliance data for tax policy analysis,
revenue estimating, and research. For example, the Department of
Commerce's Bureau of Economic Analysis had used TCMP data to adjust its
national income and product accounts.[Footnote 22] Additionally, state
tax authorities have used IRS compliance data to develop state
compliance programs and estimate state tax gaps. Also, policy makers in
the executive branch and Congress can use the results from compliance
measurement studies to help decide on appropriate funding levels for
IRS.
As we have reported in the past, the longer the time between compliance
measurement surveys, the less useful they become given changes in the
economy and tax law.[Footnote 23] According to IRS, without current
compliance data, it has limited capability to determine key areas of
noncompliance to address and actions to take to maximize the use of its
limited resources. For example, the formulas that IRS creates from
compliance data to select returns for examination have enabled IRS to
focus examination resources on noncompliant returns rather than
burdening compliant taxpayers. When IRS updated the formulas in the
early 1990s with compliance data from the 1988 TCMP, IRS selected a
lower percentage of compliant tax returns for examination. However,
after 3 years of using formulas based on the 1988 data, the percentage
of compliant tax returns examined increased each year through 1998,
placing additional burdens on compliant taxpayers and leaving less time
for IRS to examine noncompliant returns that resulted in an additional
tax assessment.
Historically, IRS has varied how frequently it measured compliance for
particular types of taxpayers and taxes. As appendix I shows, the
period between measurements of individual income tax reporting
compliance, which consistently has accounted for the largest portion of
the tax gap, never exceeded 4 years between 1963 and 1988. In planning
the 2001 NRP to measure individual income tax compliance, IRS
envisioned doing the NRP on a 3-year cycle. Appendix I also shows that
IRS measured compliance less frequently for other types of taxpayers
and taxes, such as for small corporation income taxes, and that IRS
never measured compliance for large corporations or for excise taxes.
Although regularly measuring tax compliance can be beneficial, how
often measurements should be made is a judgment that depends on many
potential criteria including (1) the amount that a particular type of
noncompliance is thought to contribute to the tax gap, (2) whether IRS
has reason to believe that compliance may have changed (e.g., due to
tax law changes), and (3) costs, particularly when IRS officials said
that resources to conduct operational examinations are already limited.
Using these criteria, IRS would likely vary the frequency of compliance
measurement studies. Based on these criteria as well as our previous
reports,[Footnote 24] decisions about compliance measurement would also
be affected by the following factors.
* Precision. The costs and benefits of measuring compliance can vary
with how precisely IRS wishes to measure compliance to achieve an
intended use (e.g., tax gap estimation or examination return
selection). Obtaining more precise and more detailed compliance data
for more detailed populations of taxpayers or tax issues (e.g., types
of income or deductions) would likely be more costly but potentially
more useful.
* Capacity. Each compliance measurement study requires having enough
resources such as staffing, training, tools, and systems to capture the
data. Regular compliance measurement through smaller efforts targeted
at particular types of taxpayers or taxes and sampling designs that
collect data across consecutive tax years rather than for one year
could help reduce costs and sustain long-term compliance measurement.
IRS Has Concerns with Its Data on Reasons for Noncompliance but Does
Not Have Firm or Specific Plans to Develop Better Data:
Several factors concern IRS about its data on the reasons for
noncompliance, which can be unintentional or intentional. Although IRS
is developing a system intended to capture better examination data, IRS
does not have firm or specific plans to develop better data on the
reasons for noncompliance, even though the lack of such data makes it
harder to decide whether it should address specific areas of
noncompliance through nonenforcement efforts, such as designing clearer
forms or publications, or enforcement efforts.
IRS Has Concerns with Its Data on Reasons for Noncompliance:
IRS has concerns with its data on the unintentional and intentional
reasons for noncompliance. Various types of unintentional or
intentional reasons could explain why taxpayers fail to comply with the
tax laws.[Footnote 25] Unintentional reasons can include being unaware
of recordkeeping requirements, accidentally entering an item on the
wrong line of a tax return, or following inaccurate advice from a tax
practitioner. Intentional reasons for noncompliance can include
intentionally omitting income from a tax return or interpreting vague
tax laws to evade tax liability.
IRS collects data on the reasons for noncompliance for specific tax
issues during its operational examinations of tax returns.[Footnote 26]
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.[Footnote 27]
* 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.[Footnote 28]
* 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.
IRS Does Not Have Firm or Specific Plans to Develop Better Data on
Reasons for Noncompliance, which Could Help IRS's Efforts to Address
Tax Noncompliance:
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 (EDSS). 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 reason data and that they plan to consider such
enhancements.
As the National Taxpayer Advocate recently testified,[Footnote 29] 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 dependent 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.
If IRS is to develop better data on the reasons for noncompliance, it
will be important for IRS to consider factors in data collection such
as the following.
* Data reliability. To minimize examiner subjectivity and ensure that
the data are complete and accurate, IRS would need to refine the reason
categories, provide adequate training, establish system and data entry
controls, and provide supervisory oversight.
* Scope. IRS would need to decide whether the reason categories are to
be captured for selected types of noncompliance or all types of
noncompliance.
* Examination selection. IRS currently collects reason data annually
through hundreds of thousands of operational examinations. IRS also
collected reason data through NRP. In the future, IRS would need to
decide whether to collect reason data (1) during all operational
examinations, (2) for a statistical sample of operational examinations,
or (3) for examinations performed through periodic compliance studies
such as NRP. Collecting data for a sample of examinations or through
periodic compliance studies might be done with a smaller cadre of
examiners specially trained and overseen to maximize consistency of
decisions about the reasons why taxpayers are noncompliant. Also, data
from samples of examinations could be used to generalize reasons for
noncompliance for all examinations, and data from compliance studies of
all taxpayers could be used to generalize these reasons for the
population of taxpayers.
Our past reports[Footnote 30] have supported the concept of rigorously
researching the causes of noncompliance. Recognizing the benefits of
better compliance data, the National Taxpayer Advocate has also urged
IRS to consider performing additional research into causes of
noncompliance.[Footnote 31]
IRS's Approach to Reducing the Tax Gap Focuses on Service and
Enforcement but Lacks Long-term, Quantitative Compliance Goals and
Measures That Are Consistent with Results-Oriented Management
Principles:
IRS approaches tax gap reduction through improving service to taxpayers
and enforcing tax laws and has established two broad strategic goals
and related key efforts that are intended to support this approach.
However, IRS has not established long-term, quantitative compliance
goals and regularly collected data to track progress in reducing the
tax gap, which would complement its current important compliance
efforts. Establishing clear compliance goals and measuring progress
towards them benefits both IRS and external stakeholders and are
consistent with the results-oriented performance management principles
set forth in GPRA. Although IRS has lacked such data in the past and
faces other challenges, NRP and EITC data provide an improved base for
setting compliance goals and reexamining existing programs intended to
reduce the tax gap.
IRS Approaches Tax Gap Reduction through Broad Goals and Numerous
Efforts to Improve Taxpayer Service and Enforce Tax Laws:
IRS's overall approach to reducing the tax gap consists of improving
service to taxpayers and enhancing enforcement of the tax laws. Through
efforts such as education and outreach programs, IRS seeks to improve
voluntary compliance with the tax system by helping people understand
their tax obligations. In addition, IRS attempts to simplify the tax
process, such as by revising forms and publications to make them more
easily understood by diverse taxpayer communities and electronically
accessible. In conjunction with taxpayer service, IRS uses its
enforcement authority to ensure that taxpayers are reporting and paying
the proper amount of taxes. Through efforts such as examining tax
returns and collaborating with state governments to share leads on
abusive tax avoidance transactions, IRS seeks to detect and deter
noncompliance.
Two of IRS's three strategic goals, along with their associated
objectives and strategies, are intended to directly support this
approach.[Footnote 32]
* Goal 1--Improve Taxpayer Service--is intended to promote voluntary
compliance. This goal has three objectives (1) improve service options
for the tax paying public (2) facilitate participation in the tax
system by all sectors of the public and (3) simplify the tax process.
* Goal 2--Enhance Enforcement of the Tax Law--is intended to ensure,
through IRS's enforcement authority, that taxpayers are meeting their
tax obligations. The four objectives for this goal are (1) discourage
and deter noncompliance with emphasis on corrosive activity by
corporations, high-income individual taxpayers, and other contributors
to the tax gap; (2) ensure that attorneys, accountants, and other tax
practitioners adhere to professional standards and follow the law; (3)
detect and deter domestic and off-shore-based tax and financial
criminal activity; and (4) deter abuse within tax-exempt and
governmental entities and misuse of such entities by third parties for
tax avoidance or other unintended purposes. To achieve these
objectives, IRS has 15 strategies, such as "re-examine and adjust audit
processes to target likely areas of noncompliance."
In addition to these goals, IRS's service and enforcement efforts
outlined in its strategic plan are also intended to support tax gap
reduction. IRS's strategic plan mentions over 60 service and
enforcement efforts targeted at improving taxpayer compliance. Because
the plan did not prioritize these efforts, we asked IRS officials to
identify the key efforts in reducing the tax gap. In response, IRS
provided over 40 key efforts. Enforcement efforts included pursuing
high income nonfilers (taxpayers with income over $100,000 who have not
filed a tax return) through direct enforcement actions and identifying
higher priority collection cases through analytical models. Service, or
nonenforcement, efforts included a taxpayer education program on tip
reporting. (See app. III for a summary of the key efforts provided.)
IRS's Tax Gap Reduction Approach Does Not Establish Long-term,
Quantitative Compliance Goals or Regular Data Collection to Measure
Progress:
IRS has developed a strategic planning and budgeting process[Footnote
33] to help the agency comply with GPRA requirements. However, IRS's
strategies for improving compliance generally lack a clear focus on
long-term, quantitative goals and results measurement. IRS has
established broad qualitative goals and strategies for improving
taxpayer service and enhancing enforcement of the tax laws. IRS has
also identified measures, such as compliance rates for tax reporting,
filing, and payment as well as the percentage of Americans who think it
is acceptable to cheat on their taxes,[Footnote 34] which are intended
to gauge the progress of its strategies toward its broad goals.
However, IRS does not collect recent data to update all of these
compliance measures and has not established quantitative goals against
which to compare the measures and judge any progress made through its
compliance strategies.
Although IRS has not focused on quantitative, results-oriented goals
for improving voluntary compliance, IRS has established many output-
related goals and measures that track activity level, such as the
number of taxpayers contacted, collection cases closed, or returns
examined. In contrast, IRS has fewer outcome-related goals and measures
that track results, such as refund timeliness or examination quality.
In the past, IRS had set a long-term goal of improving overall
compliance to 90 percent by 2001. This goal was to be achieved through
a research approach rooted in IRS's Compliance 2000
philosophy.[Footnote 35] The Compliance 2000 philosophy envisioned
using nonenforcement efforts to correct unintentional noncompliance and
reserving enforcement efforts for intentional noncompliance. To carry
out this philosophy, in the early 1990s, IRS initiated many research
projects across IRS's 63 district offices to identify noncompliant
market segments, root causes for the noncompliance, and innovative ways
to improve compliance. However, the lack of objective compliance data,
among other factors, limited the success of this approach. Recently,
external stakeholders, such as the IRS Oversight Board, have supported
the concept of setting a numeric, long-term goal for increasing the
voluntary compliance rate.
In response to a President's Management Agenda[Footnote 36] initiative
to better integrate budget and performance information, IRS officials
said that they are considering various long-term goals for the agency.
IRS has not yet set a time frame for publicly releasing the
goals.[Footnote 37] Nor have IRS officials indicated whether any goals
will be related to improving taxpayer compliance or whether they will
be quantitative and results-oriented.
Long-term, Quantitative Compliance Goals and Measures Are Beneficial
and Consistent with Results-Oriented Management Principles:
Focusing on outcome-oriented goals and establishing measures to assess
the actual results, effects, or impact of a program or activity
compared to its intended purpose can help agencies improve performance
and stakeholders determine whether programs have produced desired
results. As such, long-term, quantitative compliance goals offer
several benefits for IRS, as discussed below.
Perhaps most important, compliance goals coupled with periodic
measurements of compliance levels would provide IRS with a better basis
for determining to what extent its various service and enforcement
efforts contribute to compliance. Additionally, long-term, quantitative
goals may help IRS consider new strategies to improve compliance,
especially since these strategies could take several years to
implement. For example, IRS's progress toward the goal of having 80
percent of all individual tax returns electronically filed by
2007[Footnote 38] 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. Focusing on intended results can also
promote strategic and disciplined management decisions that are more
likely to be effective because managers who use fact-based performance
analysis are better able to target areas most in need of improvement
and select appropriate interventions. Likewise, agency accountability
can be enhanced when both agency management and external stakeholders
such as Congress can assess an agency's progress toward meeting its
goals. Finally, 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.
Updated Compliance Data Provide Opportunities for IRS to Establish a
More Results-Oriented Tax Gap Reduction Approach:
Not unlike other agencies we have reported on in the past,[Footnote 39]
IRS faces challenges in implementing a results-oriented management
approach, such as identifying and collecting the necessary data to make
informed judgments about what goals to set and to subsequently measure
its progress in reaching its goals. However, having completed the NRP
review of income underreporting by individuals, IRS now has an improved
foundation for setting goals for improving taxpayers'
compliance.[Footnote 40]
IRS's effort to address noncompliance with the EITC provides an example
of how a more data-driven planning approach can help IRS become more
results-oriented over time.[Footnote 41] IRS's most recent EITC
compliance study estimated that between $8.5 billion and $9.9 billion,
or between 27 percent and 32 percent, respectively, of the EITC claims
filed for tax year 1999 should not have been paid. Following the
release of this study, a task force of IRS and Treasury officials
determined the three leading types of errors that accounted for about
$7 billion annually in overclaims. On the basis of compliance data and
other research, IRS started an initiative to improve service, fairness,
and compliance and designed specific corrective actions targeting the
three types of errors. IRS is evaluating these actions to determine
their effectiveness at reducing the overclaim rate in each of the three
errors. Because IRS targeted its EITC effort based on data on the
sources and extent of taxpayer errors, it was better able to determine
what actions to take and how well, using systematic data collection and
program evaluation, the effort is meeting its intended purpose.
Measuring progress toward any goals that may be set could be
challenging. For example, IRS researchers have found it difficult to
determine the extent to which its enforcement actions deter
noncompliance or its services improve compliance among taxpayers who
want to comply. Although widespread agreement exists that IRS
enforcement programs generally increase voluntary tax compliance,
challenges such as 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. Even if IRS is unable to
empirically estimate the extent to which 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.
Recently, several research studies have offered insights to better
understand the direct tax revenue effects of IRS's activities as well
as the indirect effects on voluntary tax compliance.[Footnote 42] IRS
researchers have hypothesized that the indirect effect of an
examination varies among taxpayer segments. Further, a recent study
concluded that criminal investigations have positive direct and
indirect tax effects. 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, as mentioned earlier. According to
IRS, these studies serve as a valuable baseline for further research,
but it has not yet determined how it will use these studies to make
operational decisions.
Conclusions:
As discussed in our recent testimony on the tax gap before the Senate
Committee on Finance, and underscored by IRS, periodic tax compliance
measurement is critically important to IRS's ability to estimate the
tax gap and design compliance programs intended to reduce the tax gap.
Without current, reliable compliance data, it can be difficult for IRS
to monitor trends or identify new types of noncompliance, determine its
compliance resource needs and how to allocate such resources, and
justify budget and staffing requests to policy makers in Congress and
the executive branch. Consequently, completion of NRP, which covered
the largest portion of the tax gap and was designed and implemented
with an eye to reducing the costs and burdens of data collection, is a
substantial achievement. However, although IRS has recently proposed a
schedule for future NRP studies, it has no approved plans to repeat
this study or periodically measure compliance across the various
components of the tax gap. Doing periodic compliance studies in areas
that have previously been measured, such as individual income tax
underreporting, would provide valuable information to support a more
data-driven and risk-based approach towards improving compliance and
reducing the tax gap. Although it may not be feasible or necessary to
measure compliance for all components of the tax gap at the same
frequency or with the same level of investment, where practical
methodologies exist, periodic measurements should be taken. Where
practical methodologies do not yet exist, such as for excise tax or for
large corporations, looking for ways to overcome challenging compliance
measurement difficulties would be worthwhile.
The tax gap is both a measure of the burden and frustration of
taxpayers who want to comply but are tripped by tax code complexity and
of willful tax cheating by a minority who do not wish to pay their fair
share to support government programs. As such, collecting data on the
reasons why noncompliance occurs can help IRS more effectively tailor
its efforts to improve compliance. It can be difficult for IRS
examiners to consistently determine the reasons why taxpayers have
failed to comply with the tax laws. However, IRS has no specific plans
to address this issue and, as a result, is missing opportunities to
gather better data than it already collects. Certain immediate steps,
like improving reason codes, better training examiners in applying the
codes, and possibly reducing the number of examiners who would be
responsible for making judgments on the reasons taxpayers are
noncompliant may improve the data IRS currently collects. Nevertheless,
given the difficulty of consistently determining why taxpayers are
noncompliant, sustained research on these reasons also would be needed
to develop a better understanding.
Reducing the tax gap will be a challenging task given persistent levels
of noncompliance and will not likely be achieved through a single
solution. Rather, the tax gap must be attacked on multiple fronts and
with multiple strategies over a sustained period of time. Without long-
term, quantitative voluntary compliance goals and related performance
measures, it will be more difficult for IRS to determine the success of
its strategies, adjust its approach when necessary, and remain focused
on results, especially since factors that affect compliance change over
time. Having compliance goals, coupled with recently collected NRP
data, would provide a solid base upon which IRS can develop a more
strategic, results-oriented approach to reducing the tax gap.
Taken together, these steps--periodically measuring compliance,
determining the reason taxpayers are noncompliant, and setting results-
oriented long-term goals--can help IRS build a foundation to understand
how its taxpayer service and enforcement efforts affect compliance,
improve its efforts, and make progress on reducing the tax gap.
Recommendations for Executive Action:
To establish a stronger foundation for improving IRS's efforts to
reduce the tax gap, the Commissioner of Internal Revenue should do the
following.
* Develop plans to periodically measure tax compliance for areas that
have been previously measured, such as for individual income tax
underreporting, and study ways to cost effectively measure compliance
for other components of the tax gap that have not been measured, such
as for excise tax and large corporations. Those plans and that study
should take into account risk management factors such as the amount the
component contributes to the gap, changes that may have affected
compliance levels since a measurement was last taken, and the cost of
measuring compliance.
* Take steps to ensure that IRS regularly collects complete, accurate,
and consistent data, to the extent possible, on the reasons taxpayers
are noncompliant and that sufficient broader research is undertaken to
continue learning about the reasons why noncompliance occurs.
* Establish a long-term, quantitative voluntary compliance goal for
individual income tax underreporting and for tax underpayment, as well
as for other areas of noncompliance as data become available.
Agency Comments and Our Evaluation:
The Commissioner of Internal Revenue provided written comments on a
draft of this report in a letter dated July 6, 2005, which is reprinted
in appendix IV. In the letter, the Commissioner agreed with our
recommendations. In response to the recommendation that IRS develop
plans to periodically measure tax compliance, the Commissioner
recognized the need for and value of developing and regularly updating
compliance measures for various taxpayer populations and said that IRS
will continue to consult with stakeholders to develop and refine its
compliance measurement plans. In response to our recommendation that
IRS take steps to regularly collect complete, accurate, and consistent
data on the reasons for noncompliance, the Commissioner agreed that a
better understanding of taxpayer noncompliant behavior would be useful
in shaping strategic priorities and defining efforts to improve
compliance. He further said that the operating divisions will continue
to partner with the IRS research community to identify and better
understand specific reasons for noncompliance and that IRS will ensure
that auditors are trained to properly apply reason codes in the new
report-writing system IRS is developing. In response to the
recommendation that IRS develop long-term quantitative compliance
goals, the Commissioner agreed with the concept of developing such
goals and discussed factors that make goal-setting challenging. We
appreciate IRS's current actions related to our recommendations and
recognize the challenges involved in balancing a number of complex
issues related to obtaining and using tax compliance data.
As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
from its issue date. At that time, we will send copies to the Chairman
and Ranking Minority Member, House Committee on Ways and Means; the
Secretary of the Treasury; the Commissioner of Internal Revenue; the
Director, Office of Management and Budget; and other interested
parties. We will make copies available to others on request. In
addition, the report will be available at no charge on the GAO Web site
at http://www.gao.gov/.
If you or your staff have any questions, please contact me at (202) 512-
9110 or brostekm@gao.gov. Contact points for our Offices of
Congressional Relations and Public Affairs may be found on the last
page of this report. Key contributors to this report are listed in
appendix V.
Signed by:
Michael Brostek:
Director, Tax Issues:
Strategic Issues:
[End of section]
Appendix I: IRS Compliance Measurement Surveys:
The following table summarizes the Internal Revenue Service's (IRS)
efforts to measure voluntary compliance using TCMP surveys and the
National Research Program (NRP) survey of individual income tax returns
for tax year 2001. Years provided for individual income tax surveys
refer to tax years. Years provided for surveys for all other types of
tax refer to return processing years.
Table 3: Types of Surveys by Return Type and Year:
Return type: Individual income tax;
Year: 1963;
Sample size: 92,000.
Year: 1965;
Sample size: 50,000.
Year: 1969;
Sample size: 53,000.
Year: 1971;
Sample size: 26,000.
Year: 1973;
Sample size: 55,000.
Year: 1976;
Sample size: 50,000.
Year: 1979;
Sample size: 55,000.
Year: 1982;
Sample size: 50,000.
Year: 1985;
Sample size: 50,000.
Year: 1988;
Sample size: 54,000.
Year: 2001;
Sample size: 46,000.
Return type: Small corporations;
Year: 1969;
Sample size: 16,000.
Year: 1973;
Sample size: 20,000.
Year: 1978;
Sample size: 33,000.
Year: 1981;
Sample size: 33,000.
Year: 1988;
Sample size: 19,000.
Return type: Estate returns;
Year: 1971;
Sample size: 4,600.
Return type: Exempt organization returns;
Year: 1974;
Sample size: 11,400.
Year: 1979;
Sample size: 20,000.
Year: 1988;
Sample size: 3,000.
Return type: Fiduciary returns;
Year: 1975;
Sample size: 8,900.
Return type: Employee plan returns;
Year: 1982;
Sample size: 18,000.
Return type: Partnership returns;
Year: 1982;
Sample size: 27,000.
Return type: S corporation returns;
Year: 1985;
Sample size: 10,000.
Return type: Delinquent returns--non farm business;
Year: 1963;
Sample size: 27,000.
Year: 1966;
Sample size: 114,000.
Year: 1969;
Sample size: 70,000.
Return type: Delinquent returns--individual;
Year: 1979;
Sample size: 25,000.
Year: 1988;
Sample size: 25,000.
Return type: Surveys of delinquent accounts;
Year: 1963;
Sample size: 178,000.
Year: 1964;
Sample size: 166,000.
Year: 1969;
Sample size: 1,800,000.
Year: 1970;
Sample size: 1,800,000.
Year: 1971;
Sample size: 1,800,000.
Year: 1981;
Sample size: 1,800,000.
Year: 1984;
Sample size: 1,800,000.
Source: GAO, Tax Administration: IRS' Plans to Measure Tax Compliance
Can Be Improved, GAO/GGD-93-52 (Washington, D.C.: Apr. 5, 1993); IRS,
Understanding the Tax Gap, FS-2005-14, (March 2005).
[End of table]
[End of section]
Appendix II: Detailed Tax Gap Estimates, Data Sources, and Level of
Certainty:
The following table shows estimates for the various portions of the
preliminary 2001 tax gap, the sources, including the age, of the data
the Internal Revenue Service (IRS) used for these estimates, IRS's
level of certainty for each estimate, and areas for which IRS could not
develop an estimate because of insufficient data.
Table 4: IRS's Preliminary Tax Year 2001 Gross Tax Gap Estimates, Data
Sources, and Level of Certainty by Tax Gap Component and Type of Tax:
Tax gap component: Underreporting;
Estimate dollars (in billions): $250-$292;
IRS certainty level: --[C].
Type of tax: Individual income tax;
Estimate dollars (in billions): $150-$187;
Estimate data source(s):
* Tax Year (TY) 2001 National Research Program (NRP);
* TY 1988 and earlier TCMP studies;
* 1981 and 1985-6 University of Michigan surveys of consumers (informal
suppliers);
* 1984 University of Illinois study of restaurants and other eating
places (tip income);
IRS certainty level: --[C].
Type of tax: Business income;
Estimate dollars (in billions): $83-$99;
IRS certainty level: --[C].
Type of tax: Non-business income;
Estimate dollars (in billions): $42-$57;
IRS certainty level: --[C].
Type of tax: Adjustments, deductions, exemptions;
Estimate dollars (in billions): $14-$16;
IRS certainty level: --[C].
Type of tax: Credits;
Estimate dollars (in billions): $11-$14;
IRS certainty level: --[C].
Type of tax: Corporation income tax;
Estimate dollars (in billions): $30;
IRS certainty level: Weaker.
Type of tax: Large corporations;
Estimate dollars (in billions): $25;
Estimate data source(s):
* Operational audits averaged over 1984, 1985, & 1986;
* TY 1982 TCMP study of unrelated business income tax of tax-exempt
organizations;
* TY 1975 TCMP study on fiduciaries;
IRS certainty level: Weaker.
Type of tax: Small corporations;
Estimate dollars (in billions): $5;
Estimate data source(s):
* TY 1977 and 1980 TCMP surveys;
IRS certainty level: Weaker.
Type of tax: Employment tax;
Estimate dollars (in billions): $66-$71;
IRS certainty level: --[C].
Type of tax: Self-Employment tax;
Estimate dollars (in billions): $51-$56;
Estimate data source(s):
* TY 2001 NRP;
* TY 1984 withholding noncompliance study;
* 1981 and 1985-6 University of Michigan surveys on informal suppliers;
IRS certainty level: --[C].
Type of tax: Employer-withheld employment tax (FICA);
Estimate dollars (in billions): $14;
Estimate data source(s):
* 1984 University of Illinois study on tip income;
* TY 1984 withholding noncompliance study;
IRS certainty level: Weaker.
Type of tax: Unemployment tax;
Estimate dollars (in billions): $1;
Estimate data source(s):
* 1984 University of Illinois study on tip income;
* TY 1984 withholding noncompliance study;
IRS certainty level: Weaker.
Type of tax: Estate tax;
Estimate dollars (in billions): $4;
Estimate data source(s):
* IRS's Statistics of Income (SOI) associated with filed estate tax
returns for TY 1992;
IRS certainty level: Reasonable.
Type of tax: Excise tax;
Estimate dollars (in billions): no estimate;
Estimate data source(s): N/A;
IRS certainty level: N/A.
Tax gap component: Underpayment[A];
Estimate dollars (in billions): $31.7;
Estimate data source(s): IRS Master File;
IRS certainty level: Actual.
Type of tax: Individual income tax;
Estimate dollars (in billions): $19.4;
Estimate data source(s): IRS Master File;
IRS certainty level: Actual.
Type of tax: Corporation income tax;
Estimate dollars (in billions): $2.3;
Estimate data source(s): IRS Master File;
IRS certainty level: Actual.
Type of tax: Employment tax;
Estimate dollars (in billions): $7.2;
Estimate data source(s): IRS Master File;
IRS certainty level: Actual.
Type of tax: Estate tax;
Estimate dollars (in billions): $2.3;
Estimate data source(s): IRS Master File;
IRS certainty level: Actual.
Type of tax: Excise tax;
Estimate dollars (in billions): $0.5;
Estimate data source(s): IRS Master File;
IRS certainty level: Actual.
Tax gap component: Nonfiling[B];
Estimate dollars (in billions): $30;
IRS certainty level: Reasonable.
Type of tax: Individual income tax;
Estimate dollars (in billions): $28;
Estimate data source(s):
* TY 1988 Nonfiler TCMP;
IRS certainty level: Reasonable.
Type of tax: Corporation income tax;
Estimate dollars (in billions): no estimate;
Estimate data source(s): N/A;
IRS certainty level: N/A.
Type of tax: Employment tax;
Estimate dollars (in billions): no estimate;
Estimate data source(s): N/A;
IRS certainty level: N/A.
Type of tax: Estate tax;
Estimate dollars (in billions): $2;
Estimate data source(s):
* 2 University of Michigan longitudinal surveys (begun in 1992 and 1993
and interviews participants every 2 years);
* TY 1992 IRS's SOI;
IRS certainty level: Reasonable.
Type of tax: Excise tax;
Estimate dollars (in billions): no estimate;
Estimate data source(s): N/A;
IRS certainty level: N/A.
Total;
Estimate dollars (in billions): $312-$353.
Source: IRS.
Notes: Figures may not sum to totals due to rounding. N/A = not
available.
[A] Unlike the other components of the 2001 tax gap, the underpayment
component is not an estimate, but rather represents the tax amounts
that taxpayers reported on time, but did not pay on time.
[B] IRS's nonfiler estimate for individual income tax is net of amounts
of true tax liability that are paid on time (e.g., through
withholding). However, refunds that are due to nonfilers do not reduce
the nonfiling gap, since they are not associated with a tax liability.
[C] These estimates are based on more recent NRP data, but IRS has not
finalized the certainty level for these estimates because it has not
yet completed its assessment of the quality of the NRP data.
[End of table]
[End of section]
Appendix III: IRS Key Efforts to Reduce the Tax Gap:
The Internal Revenue Service's (IRS) strategic plan outlines, but does
not prioritize, service and enforcement efforts to improve compliance.
Therefore, we asked IRS officials to identify IRS's key efforts to
reduce the tax gap. IRS's divisions provided lists that totaled 47
efforts, which are described in the following examples.
The Small Business/Self-Employed Division identified 15 efforts such as
models to identify higher priority collection cases to pursue, a
computer matching program to identify underreported income, initiatives
on high income nonfilers, attempts to improve tip income reporting, and
efforts to identify abusive tax avoidance transactions.
The Wage and Investment Division identified 7 efforts including various
initiatives on tax collection, Earned Income Tax Credit, and using
private contractors to collect certain types of tax debts.
The Large and Mid-Sized Business Division identified 5 efforts such as
identifying compliance risks, starting examinations sooner and doing
them faster, and improving the treatment of abusive tax avoidance
transactions.
The Tax Exempt and Government Entities Division identified 8 efforts
including abusive tax avoidance transactions in employee plans, abuses
in tax-exempt bond financing, pension plan noncompliance, and abuses by
credit counseling organizations.
The Criminal Investigation Division identified 12 efforts including
those involving questionable refunds, nonfilers, employment tax
evasion, corporation fraud, and offshore abusive tax schemes.
[End of section]
Appendix IV: Comments from the Internal Revenue Service:
DEPARTMENT OF THE TREASURY:
INTERNAL REVENUE SERVICE:
WASHINGTON, D.C. 20224:
COMMISSIONER:
July 6, 2005:
Mr. Michael Brostek:
Director, Tax Issues:
U.S. Government Accountability Office:
441 G Street, N.W.
Washington, D.C. 20548:
Dear Mr. Brostek:
I have reviewed the draft Government Accountability Office (GAO) report
titled "Tax Compliance: Better Compliance Data and Long Term Goals
Would Support a More Strategic IRS Approach to Reducing the Tax Gap"
(GAO-05-753). We agree with the recommendations contained in the report
and have enclosed detailed comments.
The Internal Revenue Service realizes the importance of the Tax Gap -
the difference between actual tax liability and what American taxpayers
voluntarily remit on a timely basis. In March, the Service released
preliminary estimates of the Tax Gap, indicating that the gross tax gap
for Tax Year 2001 was in excess of $300 billion. While the Service
receives about $55 billion of this gap in late payments and due to
enforcement efforts, more can be done to ensure that everyone pays
their fair share.
Congress asked the GAO to review the way the IRS estimates the size of
the Tax Gap and the steps the Service is taking to address the tax gap.
This report confirms that IRS has a strong set of tax administration
activities (both service and enforcement) underway. In the short term,
funding the President's budget request is the most important step that
Congress can take to support our efforts to reduce the size of the Tax
Gap.
I appreciate your continued support and the valuable assistance and
guidance from your staff. If you have any questions, or if you would
like to discuss this response in more detail, please contact Mark
Mazur, Director, Research, Analysis, and Statistics, at (202)-874-0100.
Sincerely,
Mark W. Everson:
Enclosure:
Enclosure:
Recommendation One:
"To establish a stronger foundation for improving IRS's efforts to
reduce the tax gap, the Commissioner of Internal Revenue should develop
plans to periodically measure tax compliance for areas that have been
previously measured, such as for individual income tax underreporting,
and study ways to cost effectively measure compliance for other
components of the tax gap that have not been measured, such as for
excise tax and large corporations. Those plans and that study should
take into account risk management factors such as the amount the
component contributes to the gap, changes that may have affected
compliance levels since a measurement was last taken, and the cost of
measuring compliance."
Response:
The IRS agrees with this recommendation and recognizes the need to
develop and regularly update measures of compliance for various
taxpayer populations. To meet that need, the IRS started the National
Research Program (NRP) in Fiscal Year (FY) 2000 to measure compliance
with filing, reporting, and payment requirements for different types of
taxes and various sets of taxpayers. The NRP is now providing payment
compliance measures for all types of taxes and taxpayers and is working
with the IRS Office of Research to produce measures of filing
compliance for individual income taxpayers. NRP recently completed the
first reporting compliance study of individual income taxpayers since
Tax Year 1988, and is poised to examine the reporting compliance of
Form 1120-S filers starting in FY 2006, the first study of this set of
taxpayers in more than 20 years. NRP has also developed a preliminary
plan for future reporting compliance studies through FY 2011, subject
to approval from IRS senior leadership.
It is important, however, to note that there are significant costs,
both to taxpayers and the IRS in conducting these studies. While the
IRS agrees that there is substantial value in better measuring taxpayer
compliance, the costs must be weighted against other IRS priorities.
Therefore, in looking toward future measurement studies, the IRS will
consider a variety of factors, including the impact a compliance study
might have on improving measurement of the overall tax gap, the value a
study may provide beyond obtaining better tax gap measurements (such as
improved audit selection criteria), and the costs associated with such
studies. The IRS will continue to consult with both internal and
external stakeholders in the development and refinement of its plans to
measure tax compliance.
Recommendation Two:
"To establish a stronger foundation for improving IRS's efforts to
reduce the tax gap, the Commissioner of Internal Revenue should take
steps to ensure that IRS regularly collects complete, accurate, and
consistent data, to the extent possible, on the reasons taxpayers are
noncompliant and that sufficient broader research is undertaken to
continue learning about the reasons why noncompliance occurs."
Response:
The IRS agrees with GAO that a better understanding of taxpayer
noncompliant behavior would be useful. Therefore, the Operating
Divisions will continue to partner with the IRS Research Community to
identify and better understand specific reasons for noncompliance. This
information has been and will continue to be used in shaping strategic
priorities and in defining efforts to improve compliance.
The IRS recognizes the value of a systematic approach to understanding
noncompliant taxpayer behavior for use in addressing and preventing
expansion of the tax gap. As we develop a new report writing system for
IRS auditors, we will include appropriate reason codes for
noncompliance for auditors to use. We will ensure the proper use of
these reason codes by incorporating this material in training for the
new system, and will make their use part of managerial
responsibilities. We agree with GAO that examiners are limited to the
explanations given by taxpayers as to intent and reasons. Thus, use of
any reason codes may or may not accurately reflect the true intent of
the taxpayer, and caution will be needed in interpreting the data.
In the interim, we will expand the reason codes available to examiners
for the upcoming NRP study of Subchapter S corporations. We will rely
upon managerial review of cases and reports for error correction and
data perfection. This will provide the IRS with valuable experience in
collecting and interpreting data on reasons for non-compliance.
Recommendation Three:
"To establish a stronger foundation for improving IRS's efforts to
reduce the tax gap, the Commissioner of Internal Revenue should
establish a long-term, quantitative voluntary compliance goal for
individual income tax underreporting and for tax underpayment, as well
as for other areas of noncompliance as data become available."
Response:
The IRS agrees with the concept behind GAO's recommendation to develop
long-term, quantitative goals for various areas of non-compliance. The
IRS has begun to study ways of achieving this objective, in the context
of developing a set of long-term outcome-oriented goals or indicators
for the agency as a whole. However, we need to proceed cautiously to
ensure that any goals we may set are: (1) based on data that can be
collected at reasonable cost to the agency and to taxpayers; (2)
updated regularly (perhaps annually); and (3) not be translated into
inappropriate production quotas or goals for IRS employees, a violation
of Section 1204 of the IRS Restructuring and Reform Act of 1998.
Moreover, any such compliance goals would need to be placed in the
context of taxpayer service or quality goals to avoid the perception
that only one dimension matters for agency performance. Given this,
success in developing compliance goals is still uncertain.
As the GAO report points out, the IRS today devotes a much smaller
portion of resources to compliance measurement efforts than in the
past. For example, the number of reporting compliance audits of small
corporations and partnerships completed as part of the TCMP program in
the 1980s exceed the total number of such audits today. Therefore, the
IRS must be more selective and more efficient with future reporting
compliance studies than in the past. A major challenge will be
obtaining the resources to undertake the types of efforts needed to
collect high-quality compliance data and to obtain support from the
various oversight bodies for these efforts. Without this level of
support from the Congress and elsewhere, it will not be possible to
credibly establish long-term compliance goals and to know with any
degree of certainty whether they are being met.
One final factor that affects the IRS' ability to establish long-term
compliance goals is the nature of the tax law itself. The constant
changes to the Internal Revenue Code affect compliance among taxpayers.
The instability of the law makes extrapolation from prior compliance
studies less reliable, and hence the ability to establish and meet long-
term goals is compromised.
[End of section]
Appendix V: GAO Contact and Staff Acknowledgments:
GAO Contact:
Michael Brostek, (202) 512-9110:
Acknowledgments:
In addition to the contact named above, Jeff Arkin, Ralph Block,
Elizabeth Curda, Elizabeth Fan, Evan Gilman, Shannon Groff, George
Guttman, Michael Rose, Sam Scrutchins, and Tom Short made key
contributions to this report.
[End of section]
FOOTNOTES
[1] GAO, Tax Administration: New Compliance Research Effort Is on
Track, but Important Work Remains, GAO-02-769 (Washington, D.C.: June
27, 2002).
[2] IRS's most recent estimates of the tax gap are preliminary, and as
such, IRS presents them as ranges.
[3] Throughout this report, references to the tax gap refer to the
gross tax gap unless otherwise noted.
[4] Estimates for each type of noncompliance include estimates for some
or all of the five types of taxes that IRS administers--individual
income, corporate income, employment, estate, and excise taxes.
Throughout this report, references to the tax gap estimate refer to the
aggregate estimate, unless otherwise noted.
[5] 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).
[6] Pub. L. No. 103-62 (1993).
[7] GAO, Taxpayer Compliance: Analyzing the Nature of the Income Tax
Gap, GAO/T-GGD-97-35 (Washington, D.C.: Jan. 9, 1997).
[8] GAO, Tax Administration: Status of IRS' Efforts to Develop Measures
of Voluntary Compliance, GAO-01-535 (Washington, D.C.: June 18, 2001).
[9] Pub. L. No. 103-62 (1993).
[10] GAO, Executive Guide: Effectively Implementing the Government
Performance and Results Act, GAO/GGD-96-118 (Washington, D.C.: June
1996).
[11] 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.
[12] 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.
[13] 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.
[14] For a discussion of the data sources IRS used to estimate the tax
gap, see Internal Revenue Service, Understanding the Tax Gap, FS-2005-
14 (March 2004),
http://www.irs.gov/newsroom/article/0,,id=137246,00.html (downloaded
Mar. 30, 2005); Internal Revenue Service, Federal Tax Compliance
Research: Individual Income Tax Gap Estimates for 1985, 1988, and 1992,
Publication 1415 (Rev. 4-96) (Washington, D.C.: Apr. 1996); and Robert
E. Brown and Mark J. Mazur, IRS's Comprehensive Approach to Compliance
Measurement (Washington, D.C.: June 2003),
http://www.irs.gov/pub/irs-soi/mazur.pdf (downloaded June 6, 2005).
[15] Illegal source income may include drugs, illegal gambling,
prostitution, etc.
[16] IRS's Criminal Investigation division pursues illegal activities
that have tax consequences, but does not measure the revenue generated
by the cases it pursues.
[17] GAO, Tax Administration: Compliance Measures and Audits of Large
Corporations Need Improvement, GAO/GGD-94-70 (Washington, D.C.: Sept.
1, 1994); Tax Administration: Factors Affecting Results from Audits of
Large Corporations, GAO/GGD-97-62 (Washington, D.C.: Apr. 17, 1997);
Tax Administration: IRS Measures Could Provide a More Balanced Picture
of Audit Results and Costs, GAO/GGD-98-128 (Washington, D.C.: June 23,
1998).
[18] IRS's computer matching programs use third-party information
documents to verify information reported on tax returns. IRS
established the multiplier by comparing the amount of income detected
through TCMP examinations conducted without information documents and
matching the income detected with the aid of these tools.
[19] By fall 2005, IRS plans to have determined which variables to
include in the DCE model.
[20] IRS has used "Exact Match" data for past tax gap estimates.
[21] GAO, Tax Administration: IRS' Plans to Measure Tax Compliance Can
Be Improved, GAO/GGD-93-52 (Washington, D.C.: Apr. 5, 1993).
[22] These accounts include measures of personal income that are used
to allocate funds for a number of federal programs.
[23] GAO/GGD-93-52.
[24] GAO/GGD-93-52; GAO, Tax Compliance: Status of the Tax Year 1994
Compliance Measurement Program, GAO/GGD-95-39 (Washington, D.C.: Dec.
30, 1994); and GAO, Tax Administration: Alternative Strategies to
Obtain Compliance Data, GAO/GGD-96-89 (Washington, D.C.: Apr. 26,
1996).
[25] Academic research on the reasons for taxpayer noncompliance is
fairly limited. That research includes a "typology of noncompliance,"
developed by Robert Kidder and Craig McEwen, to describe the various
categories of noncompliance. These categories include procedural
(failure to follow rules on which forms to file); taxpayer laziness;
classic tax cheating; brokered (involves use of a tax preparer);
symbolic (due to perceived unfairness in the tax laws); and social
(based on the extent that taxpayers believe others are complying with
the law). See Robert Kidder and Craig McEwen, "Taxpaying Behavior in
Social Context: A Tentative Typology of Tax Compliance and
Noncompliance," in Jeffrey A. Roth and John T. Scholz, Eds. Taxpayer
Compliance, Volume 2: Social Science Perspectives (Philadelphia, Pa.:
University of Pennsylvania Press, 1989).
[26] IRS also collected reason data in NRP, but we did not determine to
what extent IRS's concerns about the reason data from operational
examinations also applied to NRP data.
[27] In October 2004, IRS started implementing a system to improve case
processing and data capture, particularly for adjusted tax amounts.
[28] An IRS official said that managers are to review the accuracy of
the data entry of examination results but that they do not know the
extent to which managers actually review the entry of reason data.
[29] Testimony of Nina E. Olson, National Taxpayer Advocate, before the
Senate Committee on Finance, April 14, 2005.
[30] GAO, Tax Research: IRS Has Made Progress but Major Challenges
Remain, GAO/GGD-96-109 (Washington, D.C.: June 5, 1996).
[31] 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).
[32] Modernization objectives and strategies under Strategic Goal 3 are
intended to support tax gap reduction by helping IRS manage its
employee and technology resources effectively and efficiently. Because
this goal helps IRS meet its service and enforcement goals, this report
does not discuss the goal separately.
[33] IRS implemented a new strategic planning, budgeting, and
performance management process during fiscal year 2000. The process
begins with the operating divisions preparing strategic assessments.
After receipt and review of the strategic assessments, the commissioner
provides detailed guidance to the operating divisions for developing
their strategy and program plans. These plans are then incorporated
into an IRS-wide performance plan (which sets out measurable objectives
such as the number of audits to be done). These plans are, in turn,
incorporated into IRS's budget justification (which sets out its
resource requests to Congress). The remaining steps involve allocating
resources across IRS divisions and programs and monitoring division
adherence to the planning and budgeting decisions.
[34] Other measures for enhancing enforcement are (1) the percentage of
priority guidance list items published (percentage of tax issues IRS
will address through regulations, notices, and other forms of guidance)
and (2) average cycle time between receipt and completion of an audit
case.
[35] GAO/GGD-96-109; GAO, Tax Administration: Compliance 2000--A Worthy
Idea that Needs Effective Implementation, GAO/T-GGD-92-48 (Washington,
D.C.: June 3, 1992).
[36] 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.
[37] 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.
[38] Congress established this electronic filing goal in the IRS
Restructuring and Reform Act of 1998, Pub. L. No. 105-206 (1998).
[39] GAO, Results-Oriented Government: GPRA Has Established a Solid
Foundation for Achieving Greater Results, GAO-04-38 (Washington, D.C.:
Mar. 10, 2004).
[40] The Internal Revenue Service Restructuring and Reform Act of 1998,
Pub. L. No. 105-206 (1998), specifically prohibits IRS from using its
records of tax enforcement results to evaluate employees or to impose
or suggest production quotas or goals with respect to such employees.
That restriction does not, however, prevent IRS from using its records
of tax enforcement results to examine whether its current enforcement
efforts are effective in deterring noncompliance and to in turn
establish long-term strategies and priorities for improvement.
[41] GAO, Earned Income Tax Credit: Implementation of Three New Tests
Proceeded Smoothly, but Tests and Implementation Plans Were Not Fully
Documented, GAO-05-92 (Washington, D.C.: Dec. 30, 2004).
[42] Two types of indirect effect are (1) the increase in voluntary
compliance in the larger population resulting from examinations, or
other enforcement and nonenforcement actions, on targeted taxpayers,
and (2) the increase in voluntary compliance of the targeted taxpayer
in subsequent years. Economists have estimated the indirect effect of
an examination on voluntary compliance to range between 6 and 12 times
the amount of the proposed adjustment. See Alan H. Plumley, The
Determinants of Individual Income Tax Compliance: Estimating The
Impacts of Tax Policy, Enforcement, and IRS Responsiveness, Publication
1916 (Rev. 11-96), (Washington, D.C.: Nov. 1996), 2, 35-36; Jeffrey A.
Dubin, Michael J. Graetz and Louis L. Wilde, "The Effect of Audit Rates
on the Federal Individual Income Tax, 1977-1986," 43 National Tax
Journal, (1990), 395, 396, 405; and Jeffrey A. Dubin, "Criminal
Investigation Enforcement Activities and Taxpayer Noncompliance" (paper
written for the IRS Research Conference, June 2004),
http://www.irs.gov/pub/irs-soi/04dubin.pdf (downloaded July 1, 2005).
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