The Tax Gap

Each year the Taxpayer Advocate’s Office of the Internal Revenue Services issues a report on it’s dealings with the other offices of the Internal Revenue Service. The report is issued in January and sent to the Director as well as numerous other concerned parties.

One of the focuses of this year’s report is the “tax gap”, that is, the difference between the amount of taxes actually owed by U.S. taxpayers and the amount of taxes actually paid. The IRS is engaged in an ongoing effort to improve compliance and narrow the tax gap. But the enormity of the gap (by conservative estimates it could be as much as $300 billion dollars) seriously damages the public confidence in the Internal Revenue Service and in the tax system as a whole.

Taxpayer Advocate Nina Olson has suggested that the IRS is not using an adequate plan for its examination and collection strategy. It needs to reexamine its approach to these activities and devise a more “thoughtful and comprehensive approach.”

The IRS responded that Olson does not have “a full understanding of the examination function in tax administration.” And with that comment, the report from the Taxpayer Advocate’s office was dismissed. Olson was obviously disappointed with the IRS response to her report.

The largest part of the “tax gap” is from non-reporting and under-reporting on the part of individuals. Recent surveys have shown that a growing segment of the population believe it is OK to under-report because “Everyone else is doing it.” Most under-reported income is income that is not subject to the information reporting forms or 1099s. Included in this is income that is earned off-shore.

Olson has suggested that to increase compliance and reduce that portion of the tax-gap due to non-compliance will require a major overhaul in social norms. Taxpayers will have to change the way they think of the IRS, the federal government and its spending habits, and the entire tax structure. This is not a simple task.