Tax reform could close the "tax gap"

  • 23 May 2019
  • NormanL

The Joint Committee on Taxation has released a report in which it estimates the difference between the amount of taxes the federal government collects each year, and the amount it estimates the government should have collected, if everyone paid what they owed.

This "tax gap" now stands at $500 billion. While we may quibble with an estimate of what government thinks it should have gotten from taxpayers, there's ample evidence to suggest not everyone is paying all the taxes they legally owe. According to a Tax Foundation analysis, this gap exists for multiple reasons:

During the 2008 to 2010 time frame...noncompliance was highest under the individual income tax, at about $319 billion in nominal dollars. This compares to just $91 billion for employment taxes (which includes Self-Employment Taxes,  FICA taxes to fund Medicare and Social Security, and Unemployment taxes witheld by employers to pay for programs like social security), and $44 billion for the corporate income tax. The tax gap for estate and excise taxes was even smaller, at about $4 billion.

One way to close the gap is for taxpayers to get more information about their income -- from employers, clients, banks, and so forth. The more information they have, the more likely they are to pay what they owe:

The IRS also breaks down the tax gap based on “visibility.” The main variable is income information reporting requirements. In some cases, third parties, such as employers and financial firms, are required to report income information to taxpayers on wages, salaries, and other income, such as dividends and real estate sales. According to JCT, this third-party reporting helps taxpayers comply with the tax code:

Evidence shows that compliance is greatest for sources of income, such as wages and salaries, which are reported to the IRS by employers and other payers and for which taxes are withheld by third parties. Noncompliance is greatest for income and tax preferences, including self-employment income, for which third-party information is not separately reported to the IRS and is very difficult to obtain.

During the period studied, the tax gap was highest in cases when income was subject to “little or no information reporting,” at about $136 billion. The tax gap declines as more income information reporting is required. The tax gap was lowest, at about $5 billion, when income was witheld and subject to substantial information reporting, or when third paries remit payments for taxpayers.

There's an even simpler way to get folks to pay what they owe: scrap the current tax code, and start over with either a flat tax or national sales tax. Regardless of the choice, a tax system that is easy to understand is also one that's easy to follow. Our current tax code fails on both counts.

If the federal government wants to close its so-called "tax gap," then is needs to start with closing the books on the tax code.