CLOSING THE TAX GAP

According to the Internal Revenue Service (IRS), taxpayers paid about $1.8 trillion in taxes on time in 2001. Research conducted by the IRS has estimated that the `tax gap', or the difference between total Federal taxes owed and the tax collections received, was $345 billion for tax year 2001. Once IRS collection and enforcement actions are taken into account, the net tax gap is estimated to be $290 billion. Others have disputed this figure and argued that the actual figure is higher. In addition to the effect of the tax gap on overall Federal resources, the very existence of the tax gap stands contrary to IRS efforts to promote compliance. The Committee agrees with the assessment of the IRS Oversight Board in its most recent annual report that `the tax gap is an injustice to compliant taxpayers who ultimately are bearing the financial burden of those who do not pay what they owe, whether intentionally or not.' As the IRS National Taxpayer Advocate noted in her annual report this year, the existence of the tax gap effectively amounts to a per-taxpayer `surtax of more than $2,200 to subsidize noncompliance by others.'

The Government Accountability Office (GAO) has listed `Enforcement of Tax Laws' among the items on its latest `High-risk Series' (report number GAO-07-310). In this report, GAO notes that `enforcement of tax laws is vital to promote compliance by giving taxpayers confidence that others are paying their fair share.' While a commitment to tax law enforcement is one important way to maximize tax compliance, the Committee strongly believes that enforcement efforts should not be disproportionately focused on low-income taxpayers. For example, it was revealed last year that the IRS had delayed thousands of tax refunds under the Earned Income Tax Credit (EITC), and the vast majority of the refund claims were not fraudulent but were in fact the legitimate EITC claims of families and individuals. Today, fully 40 percent of all IRS individual examinations are of EITC claims, even though just 17 percent of individual tax returns claim the EITC. This is clearly a disproportionate audit focus on the poor. It is all the more troubling considering a recent finding by GAO with regard to audits of individuals who use offshore tax havens. Even in offshore tax haven cases in which agents have seen signs of tax evasion, the IRS has been either prematurely ending many of these audits, or even declining to conduct audits in the first place, in order to comply with the 3-year statute of limitations on offshore cases.

With regard to its fiscal year 2008 budget request, the Administration has proposed $291 million in new enforcement initiatives in its fiscal year 2008 budget request, and the Treasury Department's fiscal year 2008 budget in brief notes that `once the new staff proposed in this request are trained and gain more experience, the enforcement revenue generated each year will be $699 million. However, this estimate excludes the likely larger revenue impact from the deterrence value of these and other IRS enforcement programs (e.g., criminal investigations).' The Committee notes that since $699 million is obviously a very small portion of the overall tax gap, the indirect effect of these enforcement initiatives would need to be quite significant in order to have any appreciable impact on the overall tax gap. In addition, the Administration has issued a package of legislative proposals aimed at improving tax compliance. But these proposals are estimated to raise just $29 billion over 10 years, a mere one percent of the net tax gap.

While a commitment to tax law enforcement is important in maximizing tax compliance, the Committee believes that a strong commitment to IRS taxpayer service is equally important. As the IRS Oversight Board annual report notes, `Both good customer service and vigorous enforcement of the tax law benefit taxpayers. It is not an either/or proposition; both are necessary for effective tax administration. Good service leads to fully informed and satisfied taxpayers who understand their tax obligations and experience few problems when interacting with the IRS.' While the Committee applauds the joint efforts of the IRS, the IRS National Taxpayer Advocate, and the IRS Oversight Board in developing the recent Congressionally-mandated Taxpayer Assistance Blueprint (TAB), the Committee believes that a sustained, long-term commitment to funding and strengthening IRS taxpayer services must be included in any strategy for closing the tax gap.

Overall, the Committee believes strongly that the following priorities must be pursued by this Committee both this year and in years to come:

Consistent growth in the budget of the Internal Revenue Service. In his September 2002 `Report to the IRS Oversight Board: Assessment of the IRS and the Tax System,' former IRS Commissioner Charles Rossotti called for a two percent annual growth in IRS staff together with a 3 percent annual productivity growth, similar to recommendations made by the National Commission on Restructuring the IRS in 1997. But current IRS staff levels are far below what Commissioner Rossotti argued would be needed to help close the tax gap. The Commissioner's report noted that due to continued growth in the IRS workload and the large accumulated backlog of cases, strong productivity growth alone could not possibly close the compliance gap. The Committee strongly believes that consistent staff growth at the IRS merits attention and resources.

Regular research efforts to determine which taxpayer service and enforcement strategies are important and effective at closing the tax gap. The Committee agrees with the assessment of the IRS National Taxpayer Advocate and the IRS Oversight Board that the IRS must conduct regular, ongoing research to determine the most effective taxpayer service and enforcement strategies for reducing the tax gap. While the Committee is supportive of the Administration's proposal to add funding for regular research efforts into the base budget of the IRS, the Committee also agrees with the recommendation of the IRS Oversight Board that the IRS should develop a long-range strategic plan for research that goes beyond the IRS Strategic Plan's 2009 end date. The Committee directs IRS to work with the IRS National Taxpayer Advocate and the IRS Oversight Board to develop a 5-year strategic plan for research. The plan should be delivered to the Committee by no later than 120 days after the date of enactment of this Act.

Funding and Oversight of IRS Business Systems Modernization (BSM). The IRS continues to experience occasional cost overruns and delays associated with its multi-year effort to modernize its computer systems. Challenges and risks remain, and BSM continues to remain on the Government Accountability Office's (GAO) `high risk list'. Nevertheless, the Committee believes that the overall BSM effort is much better focused than it has been in the past. As GAO noted in a report this year, BSM `is critical to supporting IRS's taxpayer service and enforcement goals and reducing the tax gap.' As long as the IRS depends on outdated tools to perform its critical functions, the overall system of tax administration will not be in a position to effectively address the tax gap. For example, the IRS Oversight Board report points out that currently `taxpayers cannot access their own account information electronically as they can routinely do with their bank, credit card and mutual fund accounts.' BSM is critical to allowing the IRS to perform its tax administration functions at peak efficiency and effectiveness. The Committee believes that, notwithstanding the wasted dollars of the past and the challenges and risks of the present, the BSM program is a vital part of the future of both service and enforcement efforts. BSM should be provided sustained funding and close oversight both this year and in future years in order to fully modernize the IRS as soon as possible.