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What is the U.S. 'Tax Gap' and what can be done about it?

By Edited Oct 15, 2016 0 0

Imagine that the U.S. Government is owed billions of dollars in tax payments and all of it goes unpaid year after year after year.

Actually, you don’t have to imagine it because it is actually happening each year, according to the government’s own General Accounting Office. It’s so common that it has its own name – The Tax Gap

What Is The Tax Gap?

Not very many people have heard the term, but economists both inside and outside the government, as well as most politicians and elected officials have. It’s a secret that isn’t often talked about. Yet, everyone knows that lots of money due the U.S. government goes unpaid. Yet, what’s not known is how much goes unpaid each year and that this has been going on for years and nothing seems to be getting done about it.

The tax gap, says the General Accounting Office (1) is simple. It’s the difference between the taxes that are owed the government and the taxes that are actually paid. But, this simple definition masks the size of the problem. In 2006, for example the tax gap totaled $385 billion. Worse, the amount is fairly common year after year.

Even the Internal Revenue Service, which is charged with collecting taxes, knows all about the Tax Gap. The Internal Revenue Service collects more than $2 trillion annually in taxes so $385 billion, give or take a million or two, might not seem like a big deal. But, when the government is desperately seeking new revenue, and government services are being reduced or shut down entirely, another billion or two in tax payments might be a nice thing to add to the government coffers, right?

Individual Taxpayers Are Biggest Culprits

According to Jeffrey A. Dubin, a professor at UCLA, in his book  “The Causes and Consequences of Income Tax Noncompliance,” the tax gap comes about because taxpayers underreport the taxes the owe, underpay the amount they owe, or don’t file at all.

Perhaps even more startling is that the Internal Revenue Service knows all about the tax gap yet is only able to recover a pittance of the amount owed, maybe $50 billion of what’s owed. Somewhat surprisingly, most of the gap comes from individual taxpayers rather than large corporations or businesses. Individuals make up about 57 percent of the underreporting of taxes and the bulk of that is from people who have their own businesses and are relied upon by the government to self-report their income and expenses accurately.

Dubin says that simplifying the tax code, conducting better educational campaigns, and increasing tax withholding from workers could help diminish the tax gap, but no one thinks it well ever go away completely.

When the General Accounting Office reported to U.S. House of Representatives’ Subcommittee on Government Organization, Efficiency, and Financial Management, it told the representatives that from 2001 to 2006, the IRS had estimated that the gross tax gap had increased by $105 billion.

What Are The Solutions To The Tax Gap?

While there is general agreement on what needs to be done to solve the problem, the solutions often run up against government bureaucracies and the lack of funding for additional resources needed to close the gap, even though those resources would help bring in more revenue than it would cost.

The General Accounting Office is recommending several actions that would help reduce the gap. The first idea is getting so called “third parties” to better report income and getting taxpayers to voluntarily comply by paying what they should in taxes. The third parties could be employees, accounting professionals, tax consultants, and others who normally interact with individuals and small businesses from where the bulk of unpaid taxes emanate.

Next, the GAO is suggesting that boosting the idea that the IRS needs more resources to do a better job – not a new idea. But, the GAO goes on to suggest that technology could help by using electronic communication to speed up tax information exchanges and tax payments. A great deal of communication with the IRS is still done via snail mail and the GAO is recommending that secure electronic communication (such as email) could get better results. The GAO even goes so far as to say that the IRS could more easily get in touch with millions of taxpayers that it currently has difficulty getting in touch with because addresses change, people move, etc.

Of course all this electronic communicating would require significant upgrades to the computer systems the IRS currently uses – another expensive proposition. But, more work being done electronically could mean that the IRS could do tax checking before refunds are issues – as they are now – and avoid the problem of having to chase after taxpayers after they have an ill-gotten refund in hand.

Simplifying The Tax Code

If there is one thing everyone can agree on it’s that the tax code is too complicated. The GAO says simplifying the tax code could help taxpayers understand and voluntarily comply with their tax obligations and limit opportunities for tax evasion. That alone would lessen the tax gap. However, simplifying the code has been discussed for a long time in Washington, but doing it has been as elusive as … well, getting a big tax refund.



1. Government Accounting Office report number 12-651T

2. The Causes and Consequences of Income Tax Noncompliance by Dubin, Jeffrey A. (2012).



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