August 6 2021

Congressional Research Service Explains Federal Tax Gap

Source: IBFD Tax Research Platform News

The Congressional Research Service (CRS) of the US Library of Congress has analysed the US federal tax gap in its recent report. The CRS report is entitled "Federal Tax Gap: Size, Contributing Factors, and the Debate Over Reducing It" (IF11887-Version 2, 2 August 2021).

The federal tax gap is a measure of taxpayer non-compliance. The US Internal Revenue Service (IRS) provides two estimates of the tax gap:

  • the gross federal tax gap, i.e. the difference between:
    • the total amount of federal individual and corporate income, employment, and estate and gift taxes owed in a year; and
    • the total amount of those taxes paid voluntarily in full and on time; and
  • the net tax gap, i.e. the difference between:
    • all taxes owed; and
    • taxes paid after late taxpayer payments and taxes collected through IRS enforcement actions.

The federal tax gap has three components:

  • the understatement of tax liability through underreporting of income or overstating deductions, credits and other income adjustments;
  • the failure to pay the full amount of taxes owed when filing a tax return on time (tax underpayment); and
  • the failure to file a required return on time (non-filing).

The CRS report includes the following table showing the net federal tax gap from 2001 to 2013:

Years Current USD Constant 2020 USD Net Taxpayer Non-compliance Rate*
2001 290 billion 423 billion 13.7%
2006 385 billion 493 billion 14.5%
2008-2010 406 billion 491 billion 16.3%
2011-2013 381 billion 431 billion 14.2%
* The percentage of total taxes owed in a year that were not paid in full and on time after IRS enforcement actions.

An updated estimate from the IRS is unlikely to be released before 2022. In testimony given at a congressional hearing in April 2021, IRS Commissioner Charles Rettig stated that the current gross federal tax gap could total as much as USD 1 trillion, although not everyone agrees with that assessment.

The CRS report states that options for decreasing the federal tax gap include:

  • increasing the IRS's resources, especially for enforcement;
  • regulating paid tax preparers;
  • requiring new information reporting for certain taxpayer transactions with banks;
  • major new investments in the IRS's information technology and employee training;
  • a greater emphasis on the IRS's taxpayer services;
  • a redesign of the IRS's information systems;
  • simplifying the federal tax code to make it possible for more taxpayers to meet their tax obligations on their own with fewer errors; and
  • clarifying ambiguous areas of the tax code to make it harder for corporations and high-income individuals to prevail in disputes with the IRS over the legality of their tax minimization strategies.

Note: The CRS is an agency within the US Library of Congress and serves the US Congress throughout the legislative process by providing legislative research and analysis for an informed national legislature.