A 2019 IRS report on tax compliance has finally found its way to sunlight. The report details the tax gap between taxable income and actual taxes paid; the gap is staggering and unsettling to those who believe that taxation should be fair, just, and effective. The annual amount of uncollected taxes due to non-compliance by business owners is more than $1,400,000,000 annually; that is more than half of the current federal deficit.
The executive summary, word for word, follows with a link to the full report below it. We encourage you to read it and to form your own assessment and opinion.
This report presents estimates of the tax gap for the tax year (TY) 2011–2013 timeframe. The tax gap and associated concepts are a particular way of defining and analyzing compliance and noncompliance and are based on tax year liability. The tax gap provides a rough gauge of the level of overall noncompliance and voluntary compliance given all the events that occurred during the relevant tax periods and the Internal Revenue Code (IRC) provisions in effect at the time. Tax gap estimates provide the Internal Revenue Service (IRS) with periodic appraisals about the nature and extent of noncompliance for use in formulating tax administration strategies. The word “tax” in the phrase “tax gap” is used broadly to encompass both tax and refundable and non-refundable tax credits. The IRS last issued tax gap estimates that covered the TY 2008–2010 timeframe.
Like the TY 2008–2010 tax gap estimates, these new estimates reflect an estimated average compliance rate and associated average annual tax gap covering a timeframe of three tax years. This approach is motivated primarily by the decision to pool multiple years of compliance data from the annual individual income tax reporting compliance component of the National Research Program (NRP) to provide greater reliability of individual income tax underreporting tax gap estimates by sources of noncompliance.
The estimates were prepared by the IRS and are based on original research and analysis conducted or sponsored by the IRS. Estimating the tax gap is inherently challenging and requires assessing the merits of alternative methods, assumptions, and data sources. There is no single approach that can be used for estimating all the components of the tax gap, so multiple methods are used. Each approach is subject to non-sampling error; the component estimates that are based on samples are further subject to sampling error. The uncertainty of the estimates is not readily captured by standard errors that typically accompany estimates based on sample data. For that reason, standard errors, confidence intervals, and significance tests for statistical comparisons across years are not reported. When using these estimates and making comparisons across years, the user should be mindful of these limitations. This report provides summary information about the estimation methodology used to produce these estimates of the tax gap.
The gross tax gap is the amount of true tax liability that is not paid voluntarily and timely. The estimated gross tax gap is $441 billion. The net tax gap is the gross tax gap less tax that subsequently will be paid, either paid voluntarily or collected through IRS administrative and enforcement activities; it is the portion of the gross tax gap that will not be paid. It is estimated that $60 billion of the gross tax gap eventually will be paid resulting in a net tax gap of $381 billion. The voluntary compliance rate (VCR) is a ratio measure of relative compliance and is defined as the amount of “tax paid voluntarily and timely” divided by “total true tax”, expressed as a percentage. The VCR corresponds to the gross tax gap. The estimated VCR is 83.6 percent. The net compliance rate (NCR) is a ratio measure corresponding to the net tax gap. The NCR is defined as the sum of “tax paid voluntarily and timely” and “enforced and other late payments” divided by “total true tax”, expressed as a percentage. The estimated NCR is 85.8 percent.
Many factors contribute to differences over time in both the gross tax gap and the VCR. These include factors such as the overall level of economic activity, changes in the composition of economic activity with shifts toward those with higher or lower compliance rates, changes in tax law and administration, updated Executive Summary Federal Tax Compliance Research: Tax Gap Estimates for Tax Years 2011–2013 data and improved methodologies, and changes in underlying compliance behavior on the part of taxpayers.
The approaches used to estimate the various tax gap components for TY 2011–2013 generally follow the methods used for the previous TY 2008–2010 estimates. Newly available data, however, resulted in some modifications to the estimation approaches. The change that had the greatest impact was the way in which the analytical technique for adjusting for income undetected by audits (Detection Controlled Estimation, DCE) was applied in the development of the individual income tax underreporting tax gap estimates.
Individual income tax underreporting tax gap estimates are based primarily on results from a statistical sample of individual income tax returns which were selected for audit. While these audits make every attempt to validate the accuracy of the return, it is inevitable that some unreported income will remain undetected. To account for these undetected amounts, the IRS has used DCE. For the TY 2011–2013 estimates, the availability and timing of new data allowed contemporaneous estimation of DCE, an improvement over the method used to develop the previously published TY 2008–2010 estimates.
The TY 2011–2013 estimates are not directly comparable to the previously published TY 2008–2010 estimates because of the effect of the changes to the methodology. In order to compare the current estimates for TY 2011–2013 to the TY 2008–2010 time period, the TY 2008–2010 estimates were revised using the same methods as the current estimates. A comparison with those revised estimates shows that the TY 2011–2013 VCR estimate of 83.6 percent is virtually unchanged from the estimate for the earlier period. The TY 2011–2013 gross and net tax gap estimates are higher than their respective revised TY 2008–2010 estimates by $47 billion (gross) and by $37 billion (net) because the estimated average annual true tax for the TY 2011–2013 timeframe is higher than the estimate for the TY 2008–2010 timeframe.
Comparisons of the TY 2011–2013 estimates to the earlier TY 2001 and the TY 2006 tax gap estimates must be done with care because of differences in the estimation methods. Despite those limitations and recognizing the challenges in estimating the tax gap and the many factors that contribute to differences in the estimates over time, the TY 2011–2013 estimates in conjunction with the tax gap estimates for TY 2001 and later years suggest that compliance is holding steady in the 82 percent to 84 percent range.
Since the tax gap typically moves with the economy, some of the change in the gross tax gap estimates not attributable to the change of methods is due to the expansion of the economy coming out of the Great Recession. Gross collections as reported in the IRS Data Book increased throughout the fiscal year 2011–2013 timeframe. Gross collections were $2.4 trillion in FY 2011, $2.5 trillion in FY 2012, and $2.9 trillion in FY 2013. Net collections increased from $1.9 trillion in FY 2010 to $2.0 trillion, $2.2 trillion, and $2.5 trillion in FYs 2011, 2012, and 2013 respectively. Average net collections for the FY 2011–2013 timeframe were $2.2 trillion or $0.2 trillion higher than average net collections of $2.0 trillion for the FY 2008–2010 timeframe.
The gross tax gap is composed of three components: nonfiling, underreporting, and underpayment. The estimated gross tax gaps for these components are $39 billion, $352 billion, and $50 billion respectively.
The tax gap estimates are also segmented by type of tax. The estimated gross tax gap for individual income tax is $314 billion; for corporation income tax it is $42 billion; for employment tax it is $81 billion; and forestate and excise tax combined it is $3 billion1. The estimated net tax gap for individual income tax is $271 billion; for corporation income tax it is $32 billion; for employment tax it is $76 billion; and for estate and excise tax combined it is $1 billion.
Findings from earlier tax gap analyses that compliance is higher when amounts are subject to information reporting and even higher when also subject to withholding continue to hold. The extent of coverage by information reporting and/or withholding is called “visibility” because incomes that are reported to the IRS are more “visible” to both the IRS and taxpayers. Based on the TY 2011–2013 estimates, misreporting of income amounts subject to substantial information reporting and withholding is 1 percent; of income amounts subject to substantial information reporting but not withholding, it is 5 percent; and of income amounts subject to little or no information reporting, such as nonfarm proprietor income, it is 55 percent.