The Tax Gap is the difference between taxes owed and taxes paid and is a good way to raise revenue, but it doesn’t come without trade-offs. The Biden administration proposal to raise revenue for physical and social infrastructure is by reducing the tax gap.
How Big Is the Tax Gap?
The most recent official IRS estimate of the gross tax gap is an average of $441 billion over the two years of 2011-2013. After adding back late payments and other collections, the net tax gap averaged $381 billion. More recent studies show the tax gap at $630 Billion after adjusting for inflation and income growth. IRS Commissioner Charles Rettig made headlines this April when he estimated in a congressional hearing that the true tax gap is around $1 trillion. This is after adding in undermeasured cryptocurrency and offshore tax evasion income but those estimates need more research.
What Are the Biden Administration Proposals?
President Biden’s agenda for improving tax administration has four main pillars:
1- Increasing the IRS’s budget, particularly in enforcement.
2- Expanding reporting requirements for financial institutions.
3- Investing in improved IRS information technology
4- Regulating tax preparers.
There are a wide range of estimates for how much revenue better tax enforcement could generate. The Biden administration promises $700 billion in revenue over a decade, in return for $80 billion in new spending. For example, the Congressional Budget Office (CBO) estimates $40 billion of new enforcement spending would generate just over $100 billion in revenue, Charles Rossotti, the former IRS Commissioner disagrees, saying $64 billion in new IRS spending could generate as much as $1.6 trillion.
Compliance Costs Are the Main Possible Downside and Should be Measured
The potential downside of increased tax enforcement is higher compliance costs for small financial institutions, businesses and taxpayers. One example of the trade-off between more revenue from stronger enforcement is an increase in audits. More audits would catch tax evaders, raising revenue. At the same time, more audits will subject more law-abiding taxpayers to the burdensome audit process. Additionally, offshore banks can be reluctant to comply with US reporting requirements. Before investing in any additional enforcement measures, lawmakers should weigh the expected new revenues against both the additional spending and the additional compliance costs such measures would entail.
What Tax Enforcement Reforms Make the Most Sense?
The best reforms to IRS administration are ones that can raise revenue by shrinking the tax gap while reducing compliance burdens on the average taxpayer. Improvements to IRS information technology can help achieve that goal. As an example, programs to identity returns for audited to find tax evaders or cheaters will subject fewer already-compliant taxpayers to audits. Beefing up these programs would be worthwhile. Other reforms, like higher audit rates in areas of manipulation, may also be worth pursuing, but policymakers should get a clearer understanding of how those policies would impact compliance costs before their enactment. Increasing the response and punishment for those practicing in fraudulent tax services would also reduce tax evading.
Simplification Can Reduce Noncompliance and Compliance Costs
Changes to IRS administration isn’t the only approach to reduce the tax gap. Ending the complex refundable tax credits which are a common source of filing error and ripe for fraud. Meanwhile, a code with lower tax rates and fewer line items will save both businesses and individual taxpayers time, while avoiding complex tax avoidance schemes.