Watch Out: 7 Ways to Fix the ‘Tax Gap’

GAO, IRS want new, tougher measures.

by Rick Telberg

In a new report, U.S. Comptroller General David Walker tells the Senate Budget Committee that cracking down on tax cheats alone isn’t enough to close the nation’s widening tax-revenue shortfall.

Walker, a CPA, goes further. He says Congress must simplify the tax code if we really want to close the tax gap. And he seems to have the backing of IRS Commissioner Mark Everson. The IRS figures it gets only 81 percent to 84 percent of the taxes the government is actually owed. That’s almost $400 billion. Even in Washington, that’s a lot of money. But Walker sounds a new alarm: “Our nation’s fiscal policy is on an imprudent and unsustainable course.”

“Over the long term,” Walker says, “we face a large and growing structural deficit due primarily to known demographic trends, rising health care costs, and lower federal revenues as a percentage of the economy.”

The problem “is too big to be solved by economic growth alone or by making modest changes to existing spending and tax policies. Rather, a fundamental reexamination of major policies and priorities will be important to recapture our future fiscal flexibility.”

Using 2001 data, the GAO reports under-reporting of income by businesses and individuals accounted for most of the estimated $345 billion tax gap, with individual income tax under-reporting alone accounting for $197 billion, or over half of the total gap. Corporate income tax and employment tax under-reporting accounted for an additional $84 billion of the gap, according to the GAO.

Clearly, reducing the tax gap would help improve the nation’s fiscal sustainability. And neither the Congress nor the Administration have done enough over the years. “Given the tax gap’s persistence and size,” Walker says, “it will require considering not only options that have been previously proposed but also new administrative and legislative actions.”

Even modest progress would yield significant revenue; each 1 percent reduction would likely yield nearly $3 billion annually, according to GAO calculations.

But where to start?

Walker says: regularly obtain data on the extent of, and reasons for, noncompliance; simplify the tax code; provide quality service to taxpayers; enhance enforcement of tax laws by utilizing enforcement tools such as tax withholding, information reporting, and penalties; leverage technology; and “optimize resource allocation.”

Break it down, and you can glean seven key items on Walker’s to-do list:

1. Crack down on “complex and abusive tax shelters.”

2. Close loopholes for multinationals. “U.S.-based multinational corporations appear to engage in transactions,” the report notes, “that shift income from their affiliates in high-tax countries to subsidiaries in low-tax countries to take advantage of the differences in tax rates in foreign countries.”

3. Hire back seasoned IRS people to break the tough cases that are slipping through the cracks because they’re too complicated for the Service to handle.

4. Focus on independent contractors. Typically they report only 83 percent of their taxable income, the GAO says.

5. Require information return reporting on payments made to corporations.

6. Demand more data on information returns dealing with capital gain income.

7. Leverage technology. E-Filing alone saves $2.15 per return and so far has freed up 1,000 IRS employees for other duties. But the modernization program still has a long way to go.

Some of the items will frighten some people, and maybe they should, because doing what we’ve been doing may be even scarier.

[First published by the AICPA]

Posted at February 27, 2006
Filed Under BSG [CPA TRENDLINES] |

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