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September 18, 2013
IRS Needs to Improve Tax Gap Estimates, TIGTA Finds
by William Hoffman

Full Text Published by Tax Analysts®

This article first appeared in the September 17, 2013 edition of Tax Notes Today.

The IRS should produce more timely and accurate estimates of the tax gap and consider new ways to measure businesses' contributions to the gap, according to a Treasury Inspector General for Tax Administration report released September 16.

The last IRS calculation of the tax gap was $450 billion for tax year 2006 ($385 billion net, after accounting for an estimated $65 billion in late payments and enforcement revenue), but it wasn't released until January 2012. TIGTA recommended that the IRS study ways to update the data more frequently, perhaps annually.

Policymakers in Congress and at Treasury and tax administrators in the IRS use the tax gap to determine tolerable thresholds of noncompliance.

The TIGTA report makes seven recommendations for IRS studies, reports, and processes to improve the accuracy of tax gap estimates. They are:
studying the feasibility of the IRS providing interim updates of tax gap estimates;
developing processes and procedures to ensure compliance with Office of Management and Budget standards to improve the accuracy of tax gap estimates, including ways to estimate the cost of generating those estimates;
publishing a report on the methods, assumptions, and premises used to develop tax gap estimates;
developing the ability to estimate the tax gap in the informal economy;
studying the feasibility of estimating the tax gap attributable to offshore tax evasion;
considering changing the estimation model for large corporations from using recommended tax to assessing tax from operational examinations; and
considering a National Research Program review of small corporations with less than $10 million in assets that file Form 1120, "U.S. Income Tax Return for an S Corporation."

The IRS agreed or substantially agreed with all seven of the recommendations.

Methodological Questions

Eric Toder, co-director of the Urban-Brookings Tax Policy Center, who said he was interviewed for the TIGTA report, told Tax Analysts that estimating the size of the tax gap is a difficult project.

Applying OMB standards to the cost of the tax gap estimates is an interesting recommendation, Toder said. "But I don't know that [TIGTA is] aware of the conceptual issues and how they should be estimating the costs, because it's not straightforward. It's not just a matter of how many bodies you throw at it."

The random audits performed for tax gap estimates by the National Research Program, an IRS-wide project on employment tax compliance, are different from operational audits performed elsewhere within the IRS, Toder said. Random selection yields less revenue per audit than operational audits that select returns based on their potential yield, but the information gained from the random audits improves selection criteria and therefore makes future operational audits more productive, he said. Any estimates of the cost of calculating the tax gap would have to account for those considerations, he said.

Similarly, Toder said, a random sample review of corporations with assets of less than $10 million a year that file Form 1120 may be of questionable value. "It would provide a more accurate estimate of the tax gap for small corporations, if they were to do random audits, but the question is what's the cost of that?" he said.

"Clearly [TIGTA has] done a lot of research, it's a thoughtful report," Toder said, adding that he thinks the IRS does the best it can at the difficult job of estimating the tax gap with tightly constrained resources. "I just don't know what to take away from" TIGTA's report, he said.

While better estimates of the tax gap would help tax policy experts, "if [TIGTA is] supposed to be investigating, aren't they supposed to be making suggestions for improvements?" Toder said. "Saying [the tax gap] should be studied more is really not much of a recommendation."

Tax Gap, Meet the IRS Budget Gap

"The IRS has neither the resources nor the political support to do real research on the tax gap," Citizens for Tax Justice Director Robert S. McIntyre said.

"Its so-called random audits are not really random and the sample size is much too small," McIntyre told Tax Analysts. "That's largely because Congress got too many complaints about the [early 1960s taxpayer compliance measurement program] system, and the IRS had to abandon it." Further, he said, "Many of the [tax gap] estimates are based on ancient data."

"The solution would be for Congress to give the IRS the resources and the political support to do real research," McIntyre said. "That does not seem to be forthcoming."

Colleen Kelley, president of the National Treasury Employees Union, said closing the tax gap is "a worthwhile goal that is largely dependent on the Internal Revenue Service having the resources and personnel it needs. . . . This requires adequate budgets, which have not been the case for the IRS in recent years."

The IRS budget has been cut by nearly $1 billion since 2011, Kelley noted, and the agency is down 8,000 permanent full-time employees -- 5,000 of whom she said were enforcement employees -- since the end of fiscal 2010.

"With the IRS putting the tax gap at some $450 billion annually, the numbers strongly support the contention that adequately funding the IRS is an investment, not a cost -- and it is an investment that could make a meaningful difference in that gap," Kelley said.

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