[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
IRS AND THE TAX GAP
=======================================================================
HEARING
before the
COMMITTEE ON THE BUDGET
HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
__________
HEARING HELD IN WASHINGTON, DC, FEBRUARY 16, 2007
__________
Serial No. 110-9
__________
Printed for the use of the Committee on the Budget
Available on the Internet:
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COMMITTEE ON THE BUDGET
JOHN M. SPRATT, Jr., South Carolina, Chairman
ROSA L. DeLAURO, Connecticut, PAUL RYAN, Wisconsin,
CHET EDWARDS, Texas Ranking Minority Member
JIM COOPER, Tennessee J. GRESHAM BARRETT, South Carolina
THOMAS H. ALLEN, Maine JO BONNER, Alabama
ALLYSON Y. SCHWARTZ, Pennsylvania SCOTT GARRETT, New Jersey
MARCY KAPTUR, Ohio THADDEUS G. McCOTTER, Michigan
XAVIER BECERRA, California MARIO DIAZ-BALART, Florida
LLOYD DOGGETT, Texas JEB HENSARLING, Texas
EARL BLUMENAUER, Oregon DANIEL E. LUNGREN, California
MARION BERRY, Arkansas MICHAEL K. SIMPSON, Idaho
ALLEN BOYD, Florida PATRICK T. McHENRY, North Carolina
JAMES P. McGOVERN, Massachusetts CONNIE MACK, Florida
BETTY SUTTON, Ohio K. MICHAEL CONAWAY, Texas
ROBERT E. ANDREWS, New Jersey JOHN CAMPBELL, California
ROBERT C. ``BOBBY'' SCOTT, Virginia PATRICK J. TIBERI, Ohio
BOB ETHERIDGE, North Carolina JON C. PORTER, Nevada
DARLENE HOOLEY, Oregon RODNEY ALEXANDER, Louisiana
BRIAN BAIRD, Washington ADRIAN SMITH, Nebraska
DENNIS MOORE, Kansas
TIMOTHY H. BISHOP, New York
[Vacancy]
Professional Staff
Thomas S. Kahn, Staff Director and Chief Counsel
James T. Bates, Minority Chief of Staff
C O N T E N T S
Page
Hearing held in Washington, DC, February 16, 2007................ 1
Statement of:
Hon. John M. Spratt, Jr., Chairman, House Committee on the
Budget..................................................... 1
Hon. Paul Ryan, a Representative in Congress from the State
of Wisconsin............................................... 2
Mark Everson, Commissioner, Internal Revenue Service......... 4
Prepared statement of.................................... 5
Response to question posed by Mr. Ryan................... 23
Response to question posed by Mr. Andrews................ 40
Hon. J. Russell George, Inspector General for Tax
Administration, U.S. Department of the Treasury............ 49
Prepared statement of.................................... 51
Nina E. Olson, National Taxpayer Advocate, Internal Revenue
Service.................................................... 65
Prepared statement of.................................... 66
Michael Brostek, Director, Tax Issues, Strategic Issues Team,
U.S. Government Accountability Office...................... 83
Prepared statement of.................................... 85
Chris Edwards, director of tax policy studies, Cato Institute 109
Prepared statement of.................................... 111
IRS AND THE TAX GAP
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FRIDAY, FEBRUARY 16, 2007
House of Representatives,
Committee on the Budget,
Washington, DC.
The committee met, pursuant to call, at 10:05 a.m. in room
210, Cannon House Office Building, Hon. John Spratt [chairman
of the committee] presiding.
Present: Representatives Spratt, Cooper, Schwartz, Kaptur,
Becerra, Doggett, Blumenauer, Berry, Boyd, McGovern, Sutton,
Andrews, Scott, Etheridge, Hooley, Moore, Bishop, Ryan,
Barrett, Garrett, Hensarling, Conaway, Campbell, Tiberi,
Porter, Alexander, and Smith.
Chairman Spratt. Good morning. I will call this hearing to
order. I am pleased to open today's hearing on the IRS and tax
gap.
I welcome our panel of witnesses: Mark Everson,
Commissioner of the Internal Revenue Service; Treasury
Inspector General for the Tax Administration, Russell George;
GAO's Director for Tax Issues, Michael Brostek; the National
Taxpayer Advocate, Nina Olson; and the Director of Tax Policy
Studies at the Cato Institute, Chris Edwards.
We will first hear from the Commissioner of the Internal
Revenue Service Mr. Everson, and then we will turn to the other
witnesses for a second panel after questions of Mr. Everson.
Given our committee's jurisdiction and our commitment to
getting the country's fiscal house back in order, our focus
today will be on the so-called ``tax gap.'' the tax gap is the
difference between taxes legally owed and taxes actually
collected. The Internal Revenue Service has developed a recent
estimate of the size of our tax gap, the most recent being
2001, which was $345 billion, a sizable sum, and that was 6
years ago. The gap has, in all likelihood, grown even larger by
now, but even that tax gap from 6 years ago is $1 billion more
than last year's unified budget deficit, which was $248
billion.
This suggests that, if we can only do a better job of
collecting taxes that are already current policy, already in
the current Tax Code, our fiscal situation could be
substantially better. The persistence of the tax gap means that
we have larger deficits than we would otherwise rack up and a
growing legacy of debt for our children and grandchildren.
Saddling future generations with this huge mountain of debt is
not just a budgetary problem, but it raises fundamental issues
of moral fairness.
There is another issue of fairness at work here as well.
The tax gap is unfair to the scrupulous taxpayers, the vast
majority who end up having to pay more in taxes because of
those who do not pay what they obviously owe in taxes. So, as
we try to get the budget back on the right track, for the sake
of both fairness and practicality, a good place to look and
look carefully is the tax gap and what we can do to collect
better what is already owed the United States Government. That
is why we have assembled this group of witnesses today to help
us understand more about how we can narrow this tax gap and
reap the benefits.
I look forward to the witnesses' testimony. As I said, we
will first hear from IRS Commissioner Everson and then
entertain questions for him, and once those questions are
completed, we will call up our second panel. But before turning
to the Commissioner, let me turn to our Ranking Member Mr. Ryan
for his opening statement.
Mr. Ryan. I thank the Chairman, and I am excited that we
are having this hearing today because this is an issue that we
are going to be talking about quite a bit in the days to come
as we assemble our budget. We are talking about this over on
the Ways and Means Committee as well, and as you can see,
Commissioner, there is a lot of Member interest here.
First, I think it is important to note that the pro-growth
tax policy and the tax relief that we have passed have helped
to significantly increase the revenues that are now coming into
the Federal Government. In fact, we have seen double-digit
revenue growth for 2 consecutive years, the first time that
this has happened since the 1980s, and again, through the first
4 months of fiscal year 2007, revenues are coming in at a rate
of 9.8 percent over last year. So right along with our economy,
revenues are continuing to grow at a robust rate.
Clearly our budget challenges are on the spending side
rather than on the revenue side, but I understand that we are
here to talk today about how we might close the so-called ``tax
gap'' or the difference between the amount of taxes owed and
the amount actually collected to get even more revenue. This
tax gap has proven extremely difficult to define. I have spent
the last 6 years on the Ways and Means Committee looking at
this issue, and it is tougher than it first seems. We are never
really sure how big it is, and we really do not know whether
closing it would actually bring in much additional revenue, but
beyond that, we have got to ask ourselves whether or not it is
worth it to significantly increase enforcement and to try and
get after what we are calling the ``tax gap'' because this
could come with considerable costs.
Back in the mid-1990s, you remember the hearings that were
occurring here at the time. Congress saw a parade of taxpayers
complaining about how IRS enforcement tactics were violating
their rights. To relieve this, Congress passed the IRS
Restructuring and Reform Act. The IRS has come a long way since
that time, and IRS Commissioner Everson is really to be
commended for that progress. They have done a great job of
developing a very respectful relationship with the American
people, and clearly that is something I would imagine Members
on both sides of the aisle would want to preserve and see
continue. So I think we need to be extremely careful that we do
not reverse that progress and force the IRS back into the time
when the American taxpayers consider compliant enforcement
methods an actual threat.
Furthermore, I think there is great danger that if we
significantly increase enforcement and paperwork requirements
to try and close this gap, we could be placing a larger burden
on those who can afford it least, on the individuals in our
small businesses who are struggling to compete in the global
marketplace.
Finally, I think it is also important to note that, while
we have very limited data on the so-called ``tax gap,'' we do
know that more than 80 percent of the tax gap is thought to be
a result of simple individual taxpayer error. So what we are
really talking about is well-meaning Americans who
misunderstand one or more portions of the Federal Government's
17,000-page Tax Code and 66,000 pages of accompanying
regulations.
As the Treasury Department concluded in its 2006
Comprehensive Strategy for Reducing the Tax Gap report, the
fact is that most Americans simply do not understand how to
calculate their taxes because our Tax Code is too complex.
Trying to comply with the current Tax Code is also tremendously
difficult and costly for small-business owners. According to
the Tax Foundation, the cost of Tax Code compliance has more
than doubled in the past 10 years and was at $265 billion in
2005, placing a large drain on our economy.
So, clearly, the key to get after all of these taxpayer
errors is to first reform the IRS Tax Code. This would provide
significant improvement in taxpayer compliance rates and get us
as close as we will ever be to closing the tax gap, while
avoiding adding immense new taxpayer burdens and returning to a
free reform-style IRS. I think if we really want to get at
this, which we clearly do--we want people to pay the taxes that
they owe, end of story--that is what the fair thing to do is,
but the question is do we do it with an army of IRS agents and
more complexity to the Tax Code and make it more burdensome for
those who can least afford it, like individuals and small
businesses, especially when we have a challenge of global
competition, or do we clean the whole code up, reform the IRS
Code and make it much easier for people to willingly and easily
comply with the Tax Code?
That seems to be, to me, the crux of this debate, and I
hope we can flesh that out as this hearing and others like it
continue on.
Thank you, Mr. Chairman. I yield back the balance of my
time.
Chairman Spratt. Just to follow up on one thing that Mr.
Ryan mentioned, you say that we do not have a revenue problem,
that we have a spending problem. We do have a revenue problem,
I think you will agree, with the alternative minimum tax. If we
cannot stop it from applying to middle-income taxpayers, who
are well in this target range right now, we are going to see
millions of middle-income taxpayers paying the alternative
minimum tax, and it was never meant to be imposed upon them.
But to repeal it, to change it, to revise it, we have to come
up with a substantial portion of revenues to make up for the
revenues that will be lost due to the repeal or to the revision
of the alternative minimum tax, and this is one source I think
we should look to first. Let us see what we can squeeze without
bearing down overmuch on the taxpayers out of the tax gap.
So, for that reason, among others, we welcome you today,
Mr. Commissioner. We are glad to have you.
Before turning to you, let me ask for unanimous consent
that all Members who wish may be able to submit an opening
statement for the record at this point.
Chairman Spratt. And I would like to say, if you have a
statement, you can submit it for the record, and we will make
it part of the record so that you can summarize it as you see
fit. The floor is yours, Mr. Commissioner, and thank you again
for coming.
STATEMENT OF MARK EVERSON, COMMISSIONER, INTERNAL REVENUE
SERVICE
Mr. Everson. Thank you, Mr. Chairman, Ranking Member Ryan
and members of the House Budget Committee.
I am pleased to be with you this morning to discuss the
President's fiscal year 2008 budget proposals that cover this
subject of tax compliance. I am glad that the committee has an
interest in this subject of tax administration. This is my
first appearance before the committee.
Before I start, I would like to introduce my daughter Emma.
If you could stand up, Emma. She is here today because Fairfax
County has decided to close the schools for the third day, and
we did not let her sleep late. She came down for a civics
lesson, and if I get any particularly tough questions, she is
quite good, and I am going to ask her to answer them, so--but
thank you.
I have been in this job almost 4 years now, and during this
period, we have worked hard to rebuild IRS enforcement
capabilities. We have made real progress. Over the last several
years, I would suggest we have restored respect for tax
enforcement and the need to comply with the law, but I would
add that we have not done so at the expense of service to
taxpayers. At the IRS our working equation remains service plus
enforcement equals compliance. That is not service or
enforcement. You have to do both. I think we have a pretty good
balance right now and are making strides in both areas.
Turning to the President's 2008 budget request for the IRS,
I want you to know that I am pleased with the submission which
provides almost a 5 percent increase from the 2007 funding
level. Most significantly, the request not only augments our
enforcement activities, but also devotes monies to rebuild our
system's infrastructure and increase our research capabilities.
I feel that the request reflects Secretary Paulson's and
Director Portman's confidence that the IRS will use these
monies wisely and generate a real return for the Government.
I know that a subject of keen interest to the members of
the committee and to many others in Congress is the tax gap. By
the ``tax gap,'' I mean the difference between taxes owed the
government and those actually paid on a timely basis. Before
taking your questions, I would like to make several
observations about the tax gap.
First, while the most recent National Research Program
study did a good job of updating our numbers and sizing the
gap, we need more research to better identify the sources of
noncompliance. We need to conduct this research on a timely and
continuing basis.
Second, we cannot audit our way out of the tax gap, and
while simplification of our tax laws will surely help the vast
majority of Americans who already voluntarily comply with those
laws, I would note that we will actually have to complicate the
tax laws to change the behavior of noncompliant taxpayers, as
an example, by requiring more information reporting.
Third, in recent years we have made considerable progress
in improving compliance, as indicated by the steady growth in
enforcement revenues. Those are the direct monies that we
receive from our audit-collection and document-matching
programs.
Fourth, to quickly and dramatically reduce the tax gap
would take Draconian steps that would fundamentally alter the
relationship between taxpayers and their government, require an
unacceptably high commitment of enforcement resources and risk
imposing unacceptable burdens on compliant taxpayers.
That having been said, there are reasonable steps that can
be taken to improve compliance. We have made 16 such proposals.
In order to further improve tax administration, I ask the
Congress to both fully support the President's 2008 budget
request for the IRS and to enact the 16 accompanying
legislative proposals into law.
Before closing, since this is my first appearance before
this committee, I would like to explain the nature of my duties
and how they impact my ability to answer some of the questions
you may wish to pose. As Commissioner of Internal Revenue, I
oversee our Nation's tax administration system. I do not,
however, develop tax policy proposals or take a position on
them as a part of the legislative process. Questions on tax
policy issues are better addressed to Treasury Secretary
Paulson or Assistant Secretary Solomon.
Beyond the fact that policy questions are outside of my
lane, there are very practical reasons for the IRS not to be
drawn into policy conversations. If, for example, a
Commissioner were to take a position against a piece of pending
legislation on policy grounds, and then the Congress were to
actually pass it into law, the public might be skeptical
concerning IRS implementation of the statute because of the
Commissioner's previously stated opposition to the legislative
proposal. In the tax policy area, the IRS' role is limited to
advising on the potential compliance impact of legislative
proposals.
Having offered that clarification, Mr. Chairman, I am happy
to take your questions. Thank you.
Chairman Spratt. Thank you very much.
[The prepared statement of Mark Everson follows:]
Prepared Statement of Mark Everson, Commissioner of Internal Revenue
Good morning Chairman Spratt, Ranking Member Ryan and Members of
the Committee on the Budget. I am pleased to be here this morning to
discuss the President's FY 2008 Budget request, and the IRS' efforts to
improve compliance with our nation's tax laws.
a commitment to service and enforcement
In FY 2006, we continued making improvements in both our service
and enforcement programs. This is not just our assessment, but also
that of the IRS Oversight Board in its most recent annual report.
According to the Board, the IRS has made steady progress towards
``transforming itself into a modern institution that provides efficient
and effective tax administration services to America's taxpayers.''
improving taxpayer service
According to a survey commissioned by the Board in 2006, taxpayers
increasingly recognize that the IRS provides good quality service
through a variety of channels, such as its Web site, toll-free
telephone lines and Taxpayer Assistance Centers. This is supported by
the metrics that we use to measure the effectiveness of our taxpayer
service efforts. In category after category we continue to see
improvement in the numbers in our telephone services, electronic
filing, and our IRS.gov access. This is demonstrated by the following:
Electronic filing by individuals continued to increase, up
6 percent from TY 2005 (3 percentage points) to 54 percent of all
individual returns.
The level of service for toll-free assistance was 82
percent, about the same level of 2005 and up substantially from 2001.
The level of customer satisfaction with the toll-free line remains 94
percent, the same as last year.
The tax law accuracy of toll-free response improved to 91
percent from 89 percent in the prior year.
Taxpayers continued to find IRS.gov a useful source of
information about the tax system and how to comply with their tax
obligations. Visits to the IRS Web site jumped nearly 10 percent in
2006 to more than 193 million visits.
More taxpayers used the online refund status tool
``Where's My Refund.'' In 2006, there were 24.7 million status checks,
up nearly 12 percent from 2005.
Clearly, more work needs to be done by the IRS to improve services.
But we are making progress, and these numbers underscore that point.
Another development in our taxpayer service program is the Taxpayer
Assistance Blueprint (TAB). This collaborative effort of the IRS, the
IRS Oversight Board, and the National Taxpayer Advocate began in July,
2005 through a Congressional mandate. We sent Phase 1 of the Blueprint
to Congress in April, 2006. Phase 1 identified and reported the
following five strategic service improvement themes for increasing
taxpayer, partner, and government value:
Improve and expand education and awareness activities:
This theme addresses the critical need for making taxpayers and
practitioners aware of the most effective and efficient IRS service
options and delivery channels for meeting their tax obligations and
receiving benefits they are due.
Optimize the use of partner services: This theme
emphasizes the critical role of third parties in the delivery of
taxpayer services, and calls for improving the level of support and
direction provided to partners to ensure consistent and accurate
administration of the tax law.
Enhance self-service options to meet taxpayer
expectations: This theme focuses on providing clear, standard, and
easily customized automated content to deliver accurate, consistent,
and understandable self-assistance service options--particularly for
transactional tasks.
Improve and expand training and support tools to enhance
assisted services: This theme highlights the need for ensuring accurate
information across all channels by improving and expanding training,
technology infrastructure, and support for employees, partners, and
taxpayers.
Develop short-term performance and long-term outcome goals
and metrics: This theme provides for the development of a comprehensive
set of performance goals and metrics to evaluate how effectively the
IRS is meeting taxpayer expectations, and how efficiently it is
delivering services.
Phase 2 of the Blueprint will be sent to Congress soon. Throughout
this project, extensive research allowed us to refine our understanding
of taxpayer and partner needs, preferences, and behaviors and to
identify current planning documents, decision processes, and existing
commitments affecting IRS service delivery. Certain recurring findings
emerged from the wealth of data analyzed. These findings, combined with
agency-wide considerations and priorities, led to the development of
the five-year Strategic Plan for taxpayer service.
The Strategic Plan includes a suite of service improvement
initiatives across all delivery channels, a portfolio of performance
metrics, and an implementation strategy, which recommends numerous
future research studies. The Strategic Plan outlines a decision-making
process for prioritizing service improvement initiatives based on
taxpayer, partner, and government value and ensuring continued
stakeholder, partner, and employee engagement. This process is designed
to help the IRS to balance quality service with effective enforcement
to maximize compliance. More details on TAB Phase 2 will be available
when the report is delivered to Congress.
While TAB remains a work in progress, the FY 2008 budget request
includes the funding necessary to implement some of the telephone
service and Web site enhancements recommended by the Blueprint.
Enhancing telephone service will contribute to the goal of increasing
taxpayer, partner, and government value. Improving IRS.gov will help us
to make the Web site the first choice of individual taxpayers and their
preparers when they need to contact the IRS for help.
The Blueprint also recommends a suite of multi-year research
studies to continue to refine and improve our understanding of optimal
service delivery. In addition to funding for research regarding non-
compliance, the FY 2008 budget includes funding for research to
understand better the effect of service on compliance.
expanding enforcement efforts
Another reason for the Oversight Board's positive assessment of our
work in FY 2006 is that IRS enforcement efforts have increased in
virtually every area. According to the Board, ``As demonstrated by a
variety of measures, the IRS' performance on enforcement has improved
considerably, and real progress has been achieved over the past six
years.''
One of the most obvious measures is the increase in enforcement
revenue, which has risen from $34 billion in FY 2002 to almost $49
billion in FY 2006, an increase of 44 percent. Since 2003, Federal
government receipts have also increased by $600 billion. In FY 2006,
the Federal government collected over $2.4 trillion in total receipts.
This is an historic level, with annual receipts up 12 percent over FY
2005 alone. In the past two years the U.S. has seen the highest year-
to-year revenue growth in 25 years. Revenue growth has been the
greatest for corporate taxes and high income individual taxes--both
areas where we have substantially increased our enforcement presence in
recent years.
In FY 2006, both the levels of individual returns examined and
coverage rates have risen substantially. We conducted nearly 1.3
million examinations of individual tax returns. This is almost 77
percent more than were conducted in FY 2001, and reflects a steady and
sustained increase since that time. Similarly, the audit coverage rate
has risen from 0.58 percent in FY 2001 to 0.98 percent in FY 2006.
While the growth in examinations of individual returns is visible
in all income categories, it is most visible in examinations of
individuals with incomes over $1 million. The number of examinations in
the category rose by almost 80,000 as compared to FY 2004, the first
year the IRS began tracking audits of individuals with income over $1
million. The coverage rate has risen from 5.03 percent in FY 2004 to
6.30 percent in FY 2006.
Growth in audit totals and coverage rates extend to other taxpayer
categories. Preliminary estimates show that the IRS examined over
52,000 business returns in FY 2006, an increase of nearly 12,000 over
FY 2001. The coverage rate over the same period rose from 0.55 percent
to 0.60 percent. For corporations with assets over $10 million,
examinations rose from 8,718 in FY 2001 to 10,591 in FY 2006, an
increase in the coverage rate from 15.1 percent to 18.6 percent. For
the largest corporations, those with assets over $250 million,
examinations have increased by nearly 30 percent growing from 3,305 in
FY 2001 to 4,289 in FY 2006.
Finally, examinations of tax exempt organizations have also risen.
In FY 2001 5,342 tax exempt examinations were closed. This has risen to
7,079 in preliminary FY 2006 numbers.
the president's fy 2008 irs budget request
The first step in continuing the progress we have made to improve
service and voluntary compliance is approval of the President's FY 2008
budget request for the IRS. That request is for $11.1 billion in
appropriated resources and represents a 4.7 percent increase over the
FY 2007 House-passed Joint Resolution (JR) level of $10.6 billion.
The request includes $3.6 billion in appropriated resources for
taxpayer service and $7.2 billion for enforcement, an increase of 0.9
and 5.8 percent, respectively, over the FY 2007 JR level. This increase
includes $56 million in initiatives supporting taxpayer service and
$291 million is initiatives supporting enforcement. As in FY 2006 and
FY 2007, the Administration proposes to include IRS enforcement
increases as a Budget Enforcement Act program integrity cap adjustment.
The Budget also requests $282 million for Business Systems
Modernization. This is a $69 million and 33 percent increase over the
level in the House passed Joint Resolution.
If approved, we project that these investments will increase annual
enforcement revenue by $699 million dollars a year, once the new hires
reach full potential in FY 2010. This does not include the indirect
benefits of these investments, which as I will discuss later in my
testimony, could be several times the direct return on investment. In
addition, we estimate that the legislative proposals for improving
compliance that are in the Budget, which I discuss later, will generate
$29.5 billion over the next ten years.
In addition to the broad goals of continuing the improvement of
service and enforcement, the President's Budget request for the IRS
will support a number of initiatives.
enhancing taxpayer service
Taxpayer service is especially important to help taxpayers avoid
making unintentional errors. The IRS provides year-round assistance to
millions of taxpayers through many sources, including outreach and
education programs, tax forms and publications, rulings and
regulations, toll-free call centers, the Internet, Taxpayer Assistance
Centers (TACs), and Volunteer Income Tax Assistance (VITA) and Tax
Counseling for the Elderly (TCE) sites.
Assisting taxpayers with their tax questions before they file their
returns reduces burdensome post-filing notices and other correspondence
from the IRS and reduces overall inadvertent noncompliance.
The FY 2008 Budget contains two significant taxpayer service
initiatives. First, we are requesting $5 million to expand volunteer
income tax assistance. This taxpayer service initiative will help
expand the IRS' volunteer return preparation, outreach and education,
and asset building services to low-income, elderly, Limited English
Proficient (LEP), and disabled taxpayers.
Second, the budget contains a $10 million request to begin
implementation of the TAB. As part of the TAB effort, we conducted a
comprehensive review of our current portfolio of services to individual
taxpayers to determine which services should be provided and improved.
Based on the findings of the Blueprint, the funding for this initiative
will implement the following telephone service and Web site interaction
enhancements:
Contact Analytics provide a tool for evaluating contact
center recordings for the purpose of improving understanding of service
levels for potential enhancements.
Estimated Wait Time provides a real-time message that
informs taxpayers about their expected wait time in queue, allowing
them to make more informed decisions based on the status of their call
and thus reducing taxpayer burden and increasing customer satisfaction.
Expanded Portfolio of Tax Law Decision Support Tools
enables taxpayers to conduct key word and natural language queries to
get answers to tax law questions through the Frequently Asked Questions
database accessed on IRS.gov, thereby steadily increasing customer
satisfaction and operational savings.
Spanish ``Where's My Refund?'' adds the ability to check
refund status to the Spanish Web page on IRS.gov, enabling the Spanish-
speaking community to receive the same level of customer service on the
web as available to the English Web page.
Continued technological advancements offer significant
opportunities for the IRS to improve the efficiency and effectiveness
of call center services. Website enhancements are designed to maximize
the value of IRS.gov, making the site taxpayers' first choice for
obtaining the information and services required to comply with their
tax obligations.
improving compliance activities
The IRS is continuing to improve efficiency and productivity
through process changes, investments in technology, and streamlined
business practices. We will continue to reengineer our examination and
collection procedures to reduce cycle time, increase yield, and expand
coverage. As part of its regular examination program, the IRS is
expanding the use of cost-efficient audit techniques first pioneered in
the National Research Program (NRP).
The IRS is also expanding its efforts to shift to agency-wide
strategies, which maximize efficiency by better aligning problems (such
as nonfilers and other areas of noncompliance) and their solutions
within the organization. The IRS is committed to improving the
efficiency of its audit process, measured by audit change rates and
other appropriate benchmarks.
There are six specific initiatives proposed in the FY 2008 Budget
aimed at improving compliance. These include:
Providing $73.2 million to improve compliance among small
business and self-employed taxpayers in the elements of reporting,
filing, and payment compliance. This funding will be allocated for
increasing audits of high-risk tax returns, collecting unpaid taxes
from filed and unfiled tax returns, and investigating for possible
criminal referral, persons who have evaded taxes. It is estimated that
this request will produce $144 million in additional annual enforcement
revenue per year, once new hires reach full potential in FY 2010.
Providing $26.2 million for increasing compliance for
large, multinational businesses. This enforcement initiative will
increase examination coverage for large, complex business returns;
foreign residents; and smaller corporations with significant
international activity. It addresses risks arising from the rapid
increase in globalization, and the related increase in foreign business
activity and multi-national transactions where the potential for
noncompliance is significant in the reporting of transactions that
occur across differing tax jurisdictions. With this funding, we
estimate that coverage for large corporate and flow-through returns
will increase from 7.9 to 8.2 percent in FY 2008, and produce over $74
million in additional annual enforcement revenue, once the new hires
reach full potential in FY 2010.
Providing $28 million for expanded document matching in
existing sites. This enforcement initiative will increase coverage
within the Automated Underreporter (AUR) program by minimizing revenue
loss through increased document matching of individual taxpayer account
information. We believe the additional resources will result in an
increase in AUR closures from 2.05 million in FY 2007 to 2.64 million
in FY 2010. We expect $208 million of additional enforcement revenue
per year, once the new hires reach full potential in FY 2010. In
addition, the budget requests $23.5 million to establish a new document
matching program at our Kansas City campus. This enforcement initiative
will fund a new AUR site within the existing IRS space in Kansas City
to address the misreporting of income by individual taxpayers.
Establishing this new AUR site should result in over $183 million in
additional enforcement revenue per year once the new hires reach full
potential in FY 2010.
Providing $6.5 million to increase individual filing
compliance. This enforcement initiative will help address voluntary
compliance. The Automated Substitute for Return Refund Hold Program
minimizes revenue loss by holding the current-year refunds of taxpayers
who are delinquent in filing individual income tax returns and are
expected to owe additional taxes. We estimate that this initiative will
result in securing more than 90,000 delinquent returns in FY 2008 and
produce $82 million of additional enforcement revenue per year, once
the new hires reach full potential in FY 2010.
Approving $15 million to increase tax-exempt entity
compliance. This enforcement initiative will deter abuse within tax-
exempt and governmental entities (TEGE) and misuse of such entities by
third parties for tax avoidance or other unintended purposes. The
funding will aid in increasing the number of TEGE compliance contacts
by 1,700 (6 percent) and employee plan/exempt organization
determinations closures by over 9,000 (8 percent) by FY 2010.
Appropriating $10 million for increased criminal tax
investigations. This will help us to aggressively attack abusive tax
schemes, corporate fraud, nonfilers, and employment tax fraud. It will
also address other tax and financial crimes identified through Bank
Secrecy Act related examinations and case development efforts, which
includes an emphasis on the fraud referral program. Our robust pursuit
of tax violators and the resulting publicity, foster deterrence and
enhance voluntary compliance.
In addition to these initiatives, I should stress to you the
importance of allowing us to continue with the private debt collection
program. The use of private collection agents (PCAs) was authorized by
the American Jobs Creation Act of 2004. As we continue to debate the
efficacy of this program, I want to take this opportunity to make a
couple of points for purposes of our ongoing discussions.
One issue that has been debated is the relative efficiency of using
PCAs versus using IRS employees to collect the taxes owed. The most
important question is not whether IRS employees or PCAs can do the job
more efficiently, but rather whether PCAs collect money that would
otherwise go uncollected. The IRS lacks the resources to pursue the
relatively simple, geographically dispersed cases that are now being
assigned to PCAs. It is not realistic to expect that the Congress is
going to give the IRS an unlimited budget for enforcement, and if
Congress provided the IRS additional enforcement resources, I believe
those resources would be applied best by allocating them to more
complex, higher priority cases that are not appropriate for PCAs.
The IRS continues to work with PCAs to ensure that the program is
fair to taxpayers and respects taxpayer rights. We currently estimate
that between now and FY 2017, our partnership with PCAs will result in
approximately 2.9 million delinquent cases receiving treatment that
would otherwise have gone unworked. This partnership will help reduce
the backlog in outstanding tax liabilities, which has grown by 118
percent over the last 12 years. From September 7, 2006, when cases were
first assigned to PCAs, through December 31, 2006, PCAs collected more
than $11 million in net revenue. We estimate that cases worked by PCAs
will generate estimated gross revenue of between $1.4. billion through
FY 2017.
Another reason to continue to use this tool is to evaluate whether
we in the public sector can learn anything from these PCAs that will
enable us to do our jobs better. Particularly over the last 20 years,
government agencies at all levels have adopted many practices and ways
of doing business that have been pioneered in the private sector. One
need look no further than the vastly expanded use by the government of
the Internet in providing services to the public as an example of a
practice that was pioneered in the private sector but adopted quickly
and effectively by the government. We should not remove PCAs as a tool
for addressing the problem before we have an opportunity to evaluate
PCAs' potential to help improve compliance and perhaps even to show the
government how to be more effective in its own efforts.
reducing opportunities for evasion
The IRS is already aggressively pursuing enforcement initiatives
designed to improve compliance and reduce opportunities for evasion. As
pointed out earlier, these efforts have produced a steady climb in
enforcement revenues since 2001, as well as an increase in both the
number of examinations and the coverage rate in virtually every major
category.
In the budget request, the Administration proposes to expand
information reporting, improve compliance by businesses, strengthen tax
administration, and expand penalties in the following ways:
Expand information reporting--Specific information
reporting proposals would:
1. Require information reporting on payments to corporations;
2. Require basis reporting on sales of securities;
3. Expand broker information reporting;
4. Require information reporting on merchant payment card
reimbursements;
5. Require a certified taxpayer identification number (TIN) from
non-employee service providers;
6. Require increased information reporting for certain government
payments for property and services; and
7. Increase information return penalties.
Improve compliance by businesses--Improving compliance by
businesses of all sizes is important. Specific proposals to improve
compliance by businesses would:
1. Require electronic filing by certain large businesses;
2. Implement standards clarifying when employee leasing companies
can be held liable for their clients' Federal employment taxes; and
3. Amend collection due process procedures applicable to employment
tax liabilities.
Strengthen tax administration--The IRS has taken a number
of steps under existing law to improve compliance. These efforts would
be enhanced by specific tax administration proposals that would:
1. Expand IRS access to information in the National Directory of
New Hires database;
2. Permit the IRS to disclose to prison officials return
information about tax violations; and
3. Make repeated failure to file a tax return a felony.
Expand penalties--Penalties play an important role in
discouraging intentional non-compliance. Specific proposals to expand
penalties would:
1. Expand preparer penalties;
2. Impose a penalty on failure to comply with electronic filing
requirements; and
3. Create an erroneous refund claim penalty.
The Administration also has four proposals relating to IRS
administrative reforms.
The first proposal modifies employee infractions subject to
mandatory termination and permits a broader range of available
penalties. It strengthens taxpayer privacy while reducing employee
anxiety resulting from unduly harsh discipline or unfounded
allegations.
The second proposal allows the IRS to terminate installment
agreements when taxpayers fail to make timely tax deposits and file tax
returns on current liabilities.
The third proposal eliminates the requirement that the IRS Chief
Counsel provide an opinion for any accepted offer-in-compromise of
unpaid tax (including interest and penalties) equal to or exceeding
$50,000. This proposal requires that the Secretary of the Treasury
establish standards to determine when an opinion is appropriate.
The fourth proposal modifies the way that Financial Management
Services (FMS) recovers its transaction fees for processing IRS levies
by permitting FMS to add the fee to the liability being recovered,
thereby shifting the cost of collection to the delinquent taxpayer. The
offset amount would be included as part of the 15-percent limit on
continuous levies against income.
The proposed budget provides $23 million to implement these
initiatives. This will fund the purchase of software and the
modifications to IRS information technology systems necessary to
implement these legislative proposals.
enhancing research
Research enables the IRS to develop strategies to combat specific
areas of noncompliance, improve voluntary compliance, and allocate
resources more effectively.
Historically, our estimates of reporting compliance were based on
the Taxpayer Compliance Measurement Program (TCMP), which consisted of
line-by-line audits of random samples of returns. This provided us with
information on compliance trends and allowed us to update audit
selection formulas.
However, this method of data gathering was extremely burdensome on
the taxpayers who were forced to participate. One former IRS
Commissioner noted that the TCMP audits were akin to having an autopsy
without benefit of death. As a result of concerns raised by taxpayers,
Congress, and other stakeholders, the last TCMP audits were done in
1988.
We conducted several much narrower studies since then, but nothing
that would give us a comprehensive perspective on the overall tax gap.
As a result, until the recent NRP data, all of our subsequent estimates
of the tax gap were rough projections that basically assumed no change
in compliance rates among the major tax gap components; the magnitude
of these projections reflected growth in tax receipts in these major
categories.
The National Research Program, which we have used to estimate our
most recent tax gap updates, provides us a better focus on critical tax
compliance issues in a manner that is far less intrusive than previous
means of measuring tax compliance. We used a focused, statistical
selection process that resulted in the selection of approximately
46,000 individual returns for Tax Year (TY) 2001. This was less than
previous compliance studies, even though the population of individual
tax returns had grown over time.
Like the compliance studies of the past, the NRP was designed to
allow us to meet certain objectives: to estimate the overall extent of
reporting compliance among individual income tax filers and to update
our audit selection formulas. It also introduced several innovations
designed to reduce the burden imposed on taxpayers whose returns were
selected for the study.
Almost as important as understanding what the NRP research provides
is to understand its limitations. The focus of the first NRP reporting
compliance study was on individual income tax returns. It did not
provide estimates for noncompliance with other taxes, such as the
corporate income tax or the estate tax. Our estimates of compliance
with taxes other than the individual income tax are still based on
projections that assume constant compliance behavior among the major
tax gap components since the most recent compliance data were compiled
(i.e., 1988 or earlier).
The NRP provided accurate data for determining the sources of
noncompliance and for measuring changes in compliance rates over time.
The IRS also uses the NRP findings to better target examinations and
other compliance activities, thus increasing the dollar-per-case yield
and reducing ``no change'' audits of compliant taxpayers. Innovations
in audit techniques to reduce taxpayer burden, pioneered during the
2001 NRP, have been adopted in regular operational audits.
Recurring and timely compliance research is needed to ensure that
the IRS can efficiently target its resources and effectively provide
the best service possible and respond to new sources of noncompliance
as they emerge. Compliant taxpayers benefit when the IRS uses the most
up-to-date research to improve workload selection formulas, as this
reduces the burden of unnecessary taxpayer contacts. Research is also
critical in helping the IRS to establish benchmarks against which to
measure progress in improving compliance.
The FY 2008 Budget would fund two significant research initiatives.
First, the budget requests $41 million to improve compliance estimates,
measures, and detection of noncompliance. This will fund research
studies of compliance data for new segments of taxpayers needed to
update existing estimates of reporting compliance.
Unlike the past, the IRS will conduct an annual study of compliance
among 1040 filers based on a smaller sample size than the 2001 NRP
study. This will provide fresh compliance data each year, and by
combining samples over several years will provide a regular update to
the larger sample size needed to keep the IRS' targeting systems and
compliance estimates up to date.
The second research program funded by the request is to research
the effect of service on taxpayer compliance. The budget requests $5
million for this project, which will undertake new research on the
needs, preferences, and behaviors of taxpayers. The research will focus
on four areas:
Meeting taxpayer needs by providing the right channel of
communication;
Better understanding taxpayer burden;
Understanding taxpayer needs through the errors they make;
and
Researching the impact of service on overall levels of
voluntary compliance.
continuing improvements in information technology
Tax administration in the twenty-first century requires improved
IRS information technology (IT). We are committed to continuing to make
improvements in technology and the FY 2008 Budget reflects that
commitment. The FY 2008 Budget requests $81 million to improve the IRS'
information technology infrastructure. Sixty million dollars of this
amount is requested to upgrade critical IT infrastructure. This
infrastructure initiative will provide funding to upgrade the backlog
of IRS equipment that has exceeded its life cycle. Failure to replace
the IT infrastructure will lead to increased maintenance costs and will
increase the risk of disrupting business operations. Planned
expenditures in FY 2008 include procuring and replacing desktop
computers; automated call distributor hardware; mission critical
servers; and Wide Area Network/Local Area Network routers and switches.
The other $21 million will be used to enhance the Computer Security
Incident Response Center (CSIRC) and the network infrastructure
security. This infrastructure initiative will provide $13.1 million to
fund enhancements to the CSIRC necessary to keep pace with the ever-
changing security threat environment through enhanced detection and
analysis capability, improved forensics, and the capacity to identify
and respond to potential intrusions before they occur. The remaining
$7.9 million will fund enhancements to the IRS' network infrastructure
security. It will provide the capability to perform continuous
monitoring of the security of operational systems using security tools,
tactics, techniques, and procedures to perform network security
compliance monitoring of all IT assets on the network.
Finally, the FY 2008 Budget requests a total of $282.1 million to
continue the development and deployment of the IRS' Business Systems
Modernization program in line with the recommendations identified in
the IRS' Modernization, Vision, and Strategy. This funding will allow
the IRS to continue progress on modernization projects, such as the
Customer Account Data Engine (CADE), Account Management Services (AMS),
Modernized e-File (MeF), and Common Services Projects (CSP).
The development of the CADE (Customer Account Data Engine) and AMS
(Account Management Services) systems is the heart of the IT
modernization of the IRS. The combination of these two systems working
together will enable the IRS to process tax returns and deal with
taxpayer issues in a near real-time manner. In fact, our objective is
that IRS operate similarly to what one expects from one's bank; account
transactions occurring during the business day will be posted and
available by the next business day. In addition, AMS will enable the
IRS representatives who work with taxpayers to have access to all the
information regarding that taxpayer, including electronic access to tax
return data, and electronic copies of correspondence. Armed with such
comprehensive and up-to-date information, our representatives will be
in a much better position to help taxpayers resolve their issues.
MeF is the future of electronic filing. It provides a standard data
format for all electronic tax returns, which will reduce the cost and
time to add and maintain additional tax form types. MeF is a flexible
real-time system that streamlines the processing of e-filed tax returns
resulting in a quicker acknowledgement of the filing to the taxpayer or
their representative. In FY 2007, the IRS will start development and
implementation of the 1040 on the MeF platform, which is expected to
take two years.
CSP will provide funding for new portals, which are technology
platforms that meet many IRS business needs through Web-based front-
ends and provide secure access to data, applications, and services. The
portals are mission-critical components of the enterprise
infrastructure required to support key business processes and
compliance initiatives.
The benefits accruing from the delivery and implementation of BSM
projects not only provide value to taxpayers, the business community,
and government, but also contribute to operational improvements and
efficiencies within the IRS.
implications for the tax gap
On September 27, 2006, the Office of Tax Policy in the Department
of Treasury forwarded to Congress the outline of a comprehensive
strategy to reduce the tax gap. It detailed a seven-prong approach
needed to implement a multi-year strategy to reduce the tax gap. Many
of the specific elements in our FY 2008 Budget request support this
approach.
Put simply, the tax gap is the difference between the amount of tax
imposed on taxpayers for a given year and the amount that is paid
voluntarily and timely. The tax gap represents, in dollar terms, the
annual amount of noncompliance with our tax laws. While no tax system
can ever achieve 100 percent compliance, the IRS is committed to
finding ways to increase compliance and reduce the tax gap, while
minimizing the burden on the vast majority of taxpayers who pay their
taxes accurately and on time.
It is important to understand, however, that the complexity of our
current tax system is a significant reason for the tax gap and that
fundamental reform and simplification of the tax law is necessary in
order to achieve significant reductions.
distinguishing the tax gap from related concepts
The tax gap is not the same as the so-called ``underground
economy,'' although there is some overlap (particularly in the legal-
sector cash economy). The tax gap numbers do not reflect taxes owed on
income generated from illegal activities. This makes up a significant
portion of the underground economy. However, what we think of as the
underground economy does not include various forms of tax
noncompliance, such as overstated deductions or claiming an improper
filing status or the wrong number of exemptions. These are all included
in our calculations of the tax gap.
Equally important, the tax gap does not arise solely from tax
evasion or cheating. It includes a significant amount of noncompliance
due to the complexity of the tax laws that results in errors of
ignorance, confusion, and carelessness. This distinction is important,
even though we do not have the ability to distinguish clearly the
amount of non-compliance that arises from willfulness from the amount
that arises from unintentional mistakes. We expect future research to
improve our understanding in this area.
If all reporting errors were unintentional, we would expect to see
a relatively even balance between over reporting and under reporting.
However, since taxpayer overstatements of tax appear to be much smaller
than understatements of tax, one can reasonably infer that much of the
gap is the result of intentional behavior.
the most recent estimates
The results of the NRP individual income tax reporting compliance
study were combined with earlier estimates concerning other taxpayer
segments such as corporate taxpayers resulting in an estimate of the
overall gross tax gap for Tax Year 2001 of approximately $345 billion.
The net tax gap, or what will remain after enforcement and other late
payments, is estimated to be about $290 billion, corresponding to 13.7
percent of estimated total liabilities.
Noncompliance takes three forms: not filing required returns on
time (nonfiling); not reporting one's full tax liability when the
return is filed on time (underreporting); and not paying by the due
date the full amount of tax reported on a timely return (underpayment).
We have separate estimates for each of these three types of
noncompliance.
Underreporting constitutes over 82 percent of the gross tax gap, up
slightly from our earlier estimates. Nonfiling constitutes almost 8
percent and underpayment nearly 10 percent of the gross tax gap.
The individual income tax accounted for about half of all tax
receipts in 2001. However, as shown on the chart below, individual
income tax underreporting was approximately $197 billion or about 57
percent of the overall tax gap. The NRP data suggest that well over
half ($109 billion) of the individual underreporting gap came from
understated net business income (unreported receipts and overstated
expenses). Approximately 28 percent ($56 billion) of the underreporting
gap came from underreported non-business income, such as wages, tips,
interest, dividends, and capital gains. The remaining $32 billion came
from overstated subtractions from income (i.e., statutory adjustments,
non-business deductions, and exemptions) and from overstated tax
credits.
FEDERAL GROSS TAX GAP ESTIMATES, TAX YEAR 2001
------------------------------------------------------------------------
Gross Tax
Tax Gap Component Gap ($ Share of
billions) Total Gap
------------------------------------------------------------------------
Individual income tax underreporting gap.... 197 57%
Understated non-business income......... 56 16%
Understated net business income......... 109 31%
Overstated adjustments, deductions, 32 9%
exemptions and credits.................
Self-Employment tax underreporting gap...... 39 11%
Corporate and Other Underreporting.......... 49 15%
Non-Filers.................................. 27 8%
Underpayment................................ 33 10%
Total Gross Tax Gap......................... 345 100%
------------------------------------------------------------------------
Note: Detail does not add due to rounding
The corresponding estimate of the self-employment tax
underreporting gap is $39 billion, which accounts for about 11 percent
of the overall tax gap. Self-employment tax is underreported primarily
because self-employment income is underreported for income tax
purposes. Taking individual income tax and self-employment tax
together, we see that individual underreporting constitutes
approximately two-thirds of the overall tax gap.
The amounts least likely to be misreported on tax returns are
subject to both third party information reporting and withholding, and
are, therefore, the most ``visible'' (e.g., wages and salaries). The
net misreporting percentage for wages and salaries is only 1.2 percent.
Amounts subject to third-party information reporting, but not to
withholding (such as interest and dividend income), exhibit a somewhat
higher misreporting percentage than wages. For example, there is about
a 4.5 percent misreporting rate for interest and dividends.
Amounts subject to partial reporting by third parties (e.g.,
capital gains) have a still higher misreporting percentage of 8.6
percent. As expected, amounts generally not subject to withholding or
third party information reporting (e.g., sole proprietor income and the
``other income'' line on form 1040) are the least ``visible'' and,
therefore, are most likely to be misreported. The net misreporting
percentage for this group of line items is 53.9 percent.
observations on the tax gap
In the context of the President's Budget request, I would like to
make several observations about the tax gap.
First, while the most recent NRP study did a good job of updating
our numbers, we need more research to better identify the sources of
non-compliance on a timely and continuing basis.
Second, I think it is well understood that we will never be able to
audit our way out of the tax gap. And, while simplification of our tax
laws will surely help the vast majority of Americans who already
voluntarily comply with those laws, we will actually have to complicate
the tax laws to go after the non-compliant taxpayers (e.g., by
requiring more information reporting).
Third, we have already made considerable progress in improving
compliance as indicated by the steady growth in enforcement revenues in
recent years.
Fourth, to reduce the tax gap dramatically will take some draconian
steps, ones that will fundamentally change the relationship between
taxpayers and the IRS, require an unacceptably high commitment of
enforcement resources, and risk imposing unacceptable burdens on
compliant taxpayers. Nevertheless, there are reasonable steps, which I
have outlined in this statement that can be taken to improve
compliance.
summary
The FY 2008 Budget request includes significant increases for IRS
enforcement efforts. Fully funding that request will help us make
progress in greatly improving compliance.
Based on our analysis covering the most recent 11 years of
collection experience, we estimate that every dollar we have spent on
enforcement has generated a direct return of an average of four dollars
in increased revenue to the Federal Treasury. This return can be
expected to occur when the full productive benefit of the investment is
realized.
This 4:1 return on investment does not consider the indirect effect
of increased enforcement activities in deterring taxpayers who are
considering engaging in non-compliant behavior. Econometric estimates
of the indirect effects indicate a significant impact from increased
enforcement activities. Stated another way, taxpayers who see us
enforcing the law against their friends, neighbors or competitors are
more likely to comply voluntarily and not risk the chance that we might
audit them. We have no means to measure this indirect impact, but
research suggests it is at least three times as large as the direct
impact on revenue.
Our role is not unlike that of a highway patrolman. He will never
be able to ticket every speeder, but he attempts to position himself in
areas where he knows that his time is more likely to be spent
productively. He also knows that every time he pulls a speeder over,
other motorists see that and slow down as well.
We also believe that dollars spent on taxpayer service have a
positive impact on voluntary compliance. The complexity of complying
with the nation's current tax system is a significant contributor to
the tax gap, and even sophisticated taxpayers make honest mistakes on
their tax returns. Accordingly, helping taxpayers understand their
obligations under the tax law is a critical part of improving voluntary
compliance. To this end, the IRS remains committed to a balanced
program assisting taxpayers in both understanding the tax law and
remitting the proper amount of tax.
In addition, the President's FY 2008 Budget contains a number of
legislative proposals that provide additional tools for the IRS to
enforce the existing tax law. Perhaps the most critical of these tools
is greater third party reporting.
An analysis of the data from the National Research Program of TY
2001individual income tax returns leads to one very obvious conclusion.
Compliance is much higher in those areas where there is third party
reporting. For example, only 1.2 percent of wages reported on Forms W-2
are underreported. This compares to a 53.9 percent underreporting rate
for income subject to little or no third party reporting.
The FY 2008 Budget request asks Congress to expand information
reporting to include additional sources of income and make other
statutory changes to improve compliance. These legislative proposals
are intended to improve tax compliance with minimum taxpayer burden.
When implemented, it is estimated that these proposals will generate
$29.5 billion over ten years.
I anticipate that some of this year's Budget proposals will be
criticized, perhaps because of concerns about their potential impact on
small businesses. Our proposals are part of an effort to help small
businesses and all other taxpayers pay less by collecting more of the
taxes that are owed. In addition, while the information reporting
proposals will inevitably impose some burden on compliant taxpayers,
they are designed to minimize that burden and to help the IRS better
target its audit resources, thereby reducing the number of burdensome
audits that result in little or no change to compliant taxpayers'
reported liability. The challenges that a small business faces are
difficult enough without having to compete directly with noncompliant
competitors. We have an obligation to support those compliant small
businesses by ensuring that their competitors are also paying their
fair share. This is not only a matter of fairness, but also a way of
supporting compliant small businesses in their efforts to remain
compliant.
Finally, full funding of the budget request will enable the IRS to
improve its research with respect to the tax gap. Despite all of our
progress, there is still much we do not know about the tax gap.
Although the updated estimates provided by the NRP study are more
accurate than our previous estimates, and more accurate than the
estimates made at various times by others using more indirect methods,
they have many limitations.
Tax gap estimates are useful for understanding the general areas
and levels of noncompliance and the scope of the problem, but they are
far from exact measurements. With the exception of the individual
income tax gap, the estimates do not adjust for noncompliance that goes
undetected during examination, and estimates are not even available for
certain (minor) components of the tax gap.
It is also important to understand that the NRP study looked only
at TY 2001 individual income tax returns. The study provided no new
information on anything other than the reporting behavior of individual
income taxpayers. The data used to estimate corporate compliance and
other tax gap components are much older. The estimates are based on
data such as the Taxpayer Compliance Measurement Program (TCMP), which
we ceased doing in 1988.
To collect more data, we are currently doing an NRP study of
reporting compliance of businesses filing Form 1120S (Subchapter S)
returns. This involves approximately 5,000 Form 1120S returns from Tax
Years 2003 and 2004, taken from a nationwide random sample. This is the
first time the IRS has conducted a reporting compliance study across
tax years, and it will require that we knit the data together to
provide a comprehensive picture. We expect the study to continue
through 2007.
Beginning in October 2007, the IRS will begin ongoing annual
research activities that will ensure we have the most up to date
compliance data possible to measure portions of the tax gap, focus our
resources, and improve our audit selection criteria.
While I am confident we have made a significant dent in the tax
gap, the lack of current data makes it difficult to quantify exactly
how big of a dent has actually been made.
I appreciate the opportunity to testify this morning, and I will be
happy to respond to any questions that Members of the Committee may
have.
Chairman Spratt. Would you take a stab at what the size of
the so-called ``tax gap'' is today?
Mr. Everson. Well, let us put up the tax gap map.
As you indicated, our research on this was conducted in
2001. What happened was the last time we had really updated
this previous to that was in 1988, and then we stood down in
our research programs for a period of years, largely at the
behest of the Congress, this feeling that the audits that you
did to get the numbers were intrusive, and it was a pretty
tough climb, as was indicated back in the 1990s.
What we did in 2001--you can see the areas on this map that
are sort of the underreporting. The gap has three components.
There is an underreporting component, and that is the biggest
piece of it, over 80 percent; then there is a nonfiling
component, which is about 8 percent of it; and then there is an
underpayment component. That is where somebody files a return,
but then they just do not full pay, or they do not pay at all.
So those are the three pieces of it.
What we did in 2001 was we conducted 46,000 audits of
individuals. We did not look at corporations. We looked at
individuals. And so these blue lines or blue cones there--
boxes--under the underreporting, talk about the numbers that we
estimated for individuals, and of the total gross tax gap in
2001, which we estimated at $345 billion, the underreporting
piece was $285 billion, and the individual income tax piece of
that was almost $200 billion, and if you look over here, we
draw these two together. That is a self-employment tax. This
gap is really derivative of this piece, the underreported
business income from individuals. So, if you link all of those
together, some two-thirds of the tax gap, we would estimate, is
tied to the individual income tax reporting.
I readily concede that this $30 billion on corporation
income tax was probably understated. What we did here was we
simply took our old research, and then we updated it for
changes and sizes of the economy.
The point I always make, though, Mr. Chairman, is that,
when you look at that, I would not have reallocated or I do not
think any Commissioner would have reallocated our resources,
because we were already doing quite a bit on the corporations
with much higher audit rates.
To get to the question about where is it today, there are a
couple different things. Obviously, if the noncompliance rate,
which here was estimated at 16 percent, remains steady, and the
economy grows, the tax gap grows, but there are other things
that happen. There are mixed changes in the revenue streams.
There are rate reductions in capital gains and other areas, so
that all impacts the gap as well.
The other thing I would say is, if we go down to the
enforcement revenue chart, the other thing that has happened
is, in the 1990s, we drew down our enforcement resources by
over 25 percent. We stepped back from really doing all that we
could in enforcement. We, very clearly, had to improve
services, but we did so at the expense of our enforcement
activities. We have now brought the enforcement back, as I
indicated.
What this chart does is--the blue lines are the monies that
we get in on our collection activities. The yellow strip is the
money that we get in from our document-matching activities, and
the green lines up top are the monies that come in from our
audit, our exam activities, and you can see that between 2001
when those monies totaled about $34 billion--and now this past
fiscal year they came up to $49 billion--that is an increase of
some $15 billion because of our enforcement activities. But the
other point about this is that, when we audit you, Mr.
Chairman, even if you are as clean as a whistle, if one of your
colleagues is a little more aggressive and might be inclined to
overstate the deductions, they hear about that audit--people
talk--and there is an indirect impact, and those individuals--
because of the experience that you have had, they are less
likely to overstate or to cheat, whatever you want to call it.
It is not unlike the State trooper under the bridge who does
not just pull over the guy doing 80. Everybody who sees that
State trooper slows down and does a better job of obeying the
law.
What this chart does is it takes a look at and makes an
assumption, which we think is pretty conservative, about the
indirect effects that I am talking about. Very simply it says,
if there is a 3-to-1 indirect effect, then what you would get
is--on that $15 billion of extra enforcement effort since 2001,
maybe you have clawed back something like $60 billion. So that
is the other thing that is happening in here that I would draw
your attention to in terms of if you are trying to say, ``What
will we do? Where are we now?'' you would look at a variety of
different factors, and I think you would also look at some
improvement.
The last thing I would say, and I am sorry I have gone on
so long here, is that one of the problems, as I indicated, is
getting research. The President's budget requests $41 million
of incremental funding for the IRS, which we will put into the
base so that now, instead of just having a 2001 update and then
waiting a whole bunch of years, we will start to work on this
on a regular basis, and that is--the real key is to get regular
recurring research on all of the different facets of this and
to be able to have a more timely conversation.
Chairman Spratt. Using the factor you used, that 16
percent, can you give us an updated current dollar estimate of
what the tax gap is in 2006-2007?
Mr. Everson. I would decline to do that, sir, just because
there are so many moving parts.
What we are going to do now is we are going to start to--we
are working on updating the research right now on 1120S
corporations, which we have not done any research on that in a
long time, and we are going to restart doing the individuals
shortly, but I think it would really be very difficult because
of all of the factors I have outlined.
Chairman Spratt. Well, you indicated, I believe, that the
factor in deriving the $345 billion figure represented 16
percent of the GDP.
Mr. Everson. No. No, sir. What I said is it is about a 16.3
percent noncompliance rate as what we estimated, yes, sir.
Chairman Spratt. Do you have any back-of-the-envelope
calculation for how much additional agents or additional
audits, how much marginal income and incremental effort brings
in?
Mr. Everson. Yes. What we have said, sir, is with the
monies we have requested in the President's budget, which, as I
again indicated, would be about--do you want to bring up the
budget chart--5 percent, you can see, as I indicated, the first
thing we are doing is we are asking for money for
infrastructure. Improving the infrastructure to us is critical
because it supports not just the enforcement, but also the
service side, the processing of the returns, the ability to
communicate with the taxpayers, which is very important. But we
have a big enforcement increment there, as you can see, almost
$250 million.
What we have done is--we can show a direct impact, we
believe, or a correlation on things like adding auditors. There
are some areas where we do not show a number. It would be like
adding criminal investigators. We do not draw a direct point,
but what happens here with this basket of proposals is we
anticipate that after you hire the workforce and then you train
them, which takes, of course, a couple of years, that you would
get to a point where on this basket you would get something
like $700 million of direct incremental revenues.
The President's budget, as I mentioned, has 16 legislative
proposals that run from the reporting of gross receipts for
small businesses--from credit card issuers--that does get after
this issue on small businesses that cuts both ways, as Mr. Ryan
was talking about it. If you look at all of those 16 proposals,
they have been scored by the Treasury economists as adding
after, by 2010, about $3.5 billion, and there is no direct
impact necessarily on that, and the way they have calculated
it, I think their calculations are pretty conservative.
If you think also about the normal growth in productivity
that the IRS would have and just say that that is 2 percent a
year, over a 3- or 4-year period that would get you another $4
billion, let us say, of these enforcement revenues that I am
talking about.
I do not know if everybody can follow that, but, in a
business, you would expect us to get more productive; and I am
saying, if you steady state our funding, I would expect the
organization to do something along that line. If you take that
productivity increase and you take the incremental enforcement
increase of $700 million, you would probably get a total of
about $5 billion of direct impact. Then you could add an
indirect impact on that.
So, all things considered, when I testified Wednesday
before the Senate, your counterpart committee in the Senate, it
was that if you compare 2006 and 2010 and if you do all of
these things--if you fund us at the increment and you adopt the
legislative proposals--I believe it is fair to say that you
would probably get another $20 billion pop or more from where
we are now. But that does not score. I mean, one of the issues
here, as you know, is that does not score.
The only things that you folks score are the legislative
proposals, none of the impact. We are just a drag. We had $500
million. That is a $2.5 billion drag on the budget even though
we make money, which is kind of hard to understand.
Chairman Spratt. A couple more questions, and then others
will have similar questions, I am sure.
You have not mentioned havens and shelters; and there are
certain havens that, to most of us, look like blatant devices
for evasion, the Cayman Islands with one building having 12,000
firms domiciled there. Can you tell me what the IRS is doing in
that regard and what you need to have done legislatively to go
after some of these cases of blatant evasion?
Mr. Everson. Yes, sir. You are addressing what is a very
important issue and what is a real compliance challenge for the
IRS, and I would suggest to you that our estimates do not
include either illegal activity here in the country or--I do
not think that they have a particularly good--we do not have as
good an idea as we ought to have about what is going on in some
of these countries that you are talking about because the whole
idea is that they are trying to obscure information from us.
Now what we have done is we have significantly stepped up
what we are doing in the corporate arena and in the high-income
individual arena, and when we do see indications that there may
be some abuse we will follow that as best we can, including
criminal. There are criminal matters that we have brought.
This is a bigger issue in the international community. The
OECD established a group of tax administrators some 4 years ago
in about three dozen countries, and it is sort of unusual to
have an American-run OECD group, but I actually chair that
group of tax administrators now. We met in Seoul in September,
and the statement that we issued talks about tax avoidance as a
growing international problem. We are looking at it across
borders.
We have commissioned a study of the role of intermediaries,
because a lot of this is put together by investment banks,
accounting firms and law firms; and the other thing we have
done here is the IRS led an effort. We formed a Joint
International Tax Shelter Information Center here in Washington
where we have counterparts from the U.K., Canada and Australia,
and we meet. They work side by side and share information, all
of them treaty obligations or standards, to try to get some of
this.
But as to what you have just raised, the tax havens are
amongst the most challenging areas for us to get after.
Chairman Spratt. One final question, some years ago, there
was a move on the part of the IRS to improve and to make a lot
more rigorous information reporting. For example, there was a
proposal to require contractors who make payments to vendors,
suppliers and subcontractors above a certain amount to file
what amounted to a 1099 or a W-2 or something like that so that
these could be correlated to that payee's account as gross
income.
I chaired the subcommittee at that time with Chris Cox, and
we held a hearing on all of these subjects, and the small
business folks came and testified that, number one, it would be
unduly onerous, but number two, even if the IRS got that
information, it would not know what to do with it because it
did not have anywhere near the equipment--the computers and
scanners and everything else--that they needed to keep track of
these payments on a volume basis.
Do you have the wherewithal today to have that necessary
complement to that kind of enforcement effort?
Mr. Everson. This gets at the infrastructure question, and
we do have monies in the budget to address the proposal we have
made. If you will allow me for just one minute, I do want to
get to the core of this point.
Chairman Spratt. Sure.
Mr. Everson. If we go to the tax gap map again just for a
second, Lenny, if you look at that individual income tax number
that has the 197 and you drop down there, the biggest piece of
this is the underreported business income, $109 billion.
Let us go to the visibility chart now.
As we look across these 46,000 returns, there are some very
clear conclusions, and these are not going to really surprise
anybody. Out at the left here, where you have the spreading of
some of these amounts that we are talking about, that is your
wage income where you have substantial information reporting
and withholding. That is to say that, if there is a police
officer in your district, Mr. Chairman, that individual is not
cheating on their salary. The noncompliance rate on their
salary is 1 percent. That is de minimus. That is because we get
the information.
Chairman Spratt. Withholding. How is that?
Mr. Everson. The information of withholding.
If we have the information reporting, you get to a 4.5-
percent noncompliance rate. All the way out here at the right,
though, it indicates that the noncompliance rate is about 50
percent where there is no reporting.
So what we have done is we made some proposals last year to
try and get after this, and we have added some proposals this
year, but the centerpiece and the proposal I would particularly
draw to your attention is we would like to get the reporting of
the gross receipts by credit card issuers to us, and we want to
do this. We think that this would--this is not the collection
of new information that each one of us gets a bill from the
credit card company issuer. They know how much they have
reported, and the business gets a summary of what they get as
well. So you are not capturing new information. What you are
doing is you are sending the information to the IRS, and it is
not a small business that has to send that information to the
IRS. It is a pretty big business. The credit card issuers are
pretty big.
What this would do is, if you had a dry cleaning business,
for example--and let us assume that the typical breakdown of
that revenue is 50-percent credit and 50-percent cash--and if
you were reporting to us $1 million in revenues and then we got
a notice from a series of credit card issuers that there was
actually $1 million of credit card revenues from that business,
that would raise a real red flag and might prompt an audit. It
would certainly prompt the communication. The other thing it
would do is it would change behaviors.
Let me just draw one simple example about the impact of
reporting. The last time that Congress really went after the
Tax Code was in 1986, as you will recall. After 1986, on the
face of the 1040, taxpayers put down the Social Security
numbers of their dependents. The next year, even though the IRS
had not phased in any matching capability yet--it did not have
the infrastructure to do that--it had to work on this, which
gets to your question--the next year, 5 million dependents
vanished, 5 million. So what you really have here is you have
an interaction in the change in behavior. So you need to do two
things.
You need to build the infrastructure, which we will do. We
need the money to do that, and we have got some in the request
to do that, but you will change the behaviors if you do some of
the third-party reporting.
Chairman Spratt. This is clearly an area where we need to
be working in tandem.
We very much appreciate your testimony, and others now have
questions, Mr. Ryan to begin with.
Mr. Ryan. Thank you, Mr. Chairman.
I guess I will just pick up where we were leaving off. Let
me go back to the estimate you just gave us in answering the
chairman's question. Because, you know, for the Budget
Committee purposes, we have got to find out how much is this
and how much is recoverable, then to the question of how do you
score this stuff.
You are telling us that you think, with about $5 billion in
direct and then maybe another $15 billion indirect, you know,
having the trooper under the bridge, that it is about $20
billion additional revenue that can be recovered without
resorting to sort of draconian things. But that banks all of
those 16 legislative changes you would make, the additional
people at the agency? That is about $20 billion you are saying?
Mr. Everson. That is by 2010. That is the delta between
2006 and 2010. That is right. I think that is in the ballpark.
And, again, this is an area where it is very hard to be precise
because these things have a--I think they have a reinforcing
effect throughout the system. If you just do the IRS stuff, the
budget stuff, but you do not change the Code, that does not get
to the powerful force that everything is happening.
Mr. Ryan. So it will take years to phase in these reforms
to get to that $20 billion number?
Mr. Everson. Absolutely. Let me give you one very clear
example on this.
One of the proposals is basis reporting for securities. The
way that would work is that you would not put that in going
back for----
Mr. Ryan. You would go prospective.
Mr. Everson. You would go prospective.
So that would roll in over a period of years, starting with
purchases down the road; and then each year you would get more
purchases and you would be capturing more information.
Mr. Ryan. Okay. Now on to this credit card idea, because I
am trying to get a better handle on this. That seems to be sort
of one of the bigger pieces of your legislative package.
Last year, when the administration first proposed requiring
banks to provide annual information reports to the IRS on total
payment of credit card reimbursements to merchants, the
Treasury's estimate was that this would raise $225 million over
10 years. This year, it seems like the proposal is a little
narrower than last year's proposal, but Treasury is estimating
that this will raise $11 billion over that period. What is the
basis for this tremendous increase in your revenue estimate?
Mr. Everson. You will have to, honestly speaking, refer
that to them, because I do not make those estimates. Those are
estimates made within tax policy by the economists.
Mr. Ryan. Well, give me an idea of last year's proposal
versus this year's proposal.
Mr. Everson. I do not think we are making a substantially
different proposal. We want the information reporting of gross
receipts by a credit card issuer to a business, and that is the
long and the short of the proposal. I actually do think--as a
whole, I would say I think that the Treasury estimates are on
the conservative side. Now there is a reason why they do that,
and it gets back to the chairman's last question.
The experience has been that you will put in something new
and then it will not always be administered effectively by the
service, so that gets in there, but I think that is a number, I
believe, that is reasonably conservative, sir.
Mr. Ryan. Okay. So I guess that is sort of puzzling to me.
You know, we do a lot of scoring around here. How you see a
score go from $225 million to $11 million is interesting.
You are talking about not the credit card companies'
reporting their information to the IRS. You are talking about
banks' reporting the information to the IRS on behalf of their
clients, right?
Mr. Everson. Yes. There is a difference between, as I
understand it, the banks and the issuer. It is the issuer of
the credit card that has all of the information.
Mr. Ryan. It is not Visa, MasterCard, Discover. It is every
bank in America that has a merchant as a customer is reporting
their merchant data----
Mr. Everson. If they are in the credit card business, yes,
sir.
Mr. Ryan. Right. So, if a bank issues a credit card, which
I think most do, they are the ones who are supposed to report
this.
Now how is this data square with, you know, your typical
AGI measurement? How do credit card receipts square with
measuring the profit and, therefore, the taxable income of a
merchant?
Mr. Everson. Well, the merchant--and where a lot of this
problem is is in the Schedule C filers. That is the biggest
number that is a part of what I indicated where you are not
incorporated. You are doing the business, and if you are
showing your receipts, you have to report your receipts to the
IRS. You have got a number there. We are going to have a
different number or we are going to have information reporting
that is coming in that says what you got in the credit card
receipts from--it would probably be from a series of issuers
for just the reason that you indicated. It would not be just--
people do not just accept the American Express.
Mr. Ryan. You will have 1,000 customers in a given year at
a dry cleaner's. I do not know. I cannot even think of the
number. But let us say you have 10,000 people who come to your
dry cleaner's in a given year with all of their different
credit cards. So for you to audit that dry cleaner, you are
going to have to have the banks of each of those 10,000
customers report to you the credit card receipts that go from
that bank to that dry cleaner, and then you are going to look
at that data. Is that basically what you would do?
Mr. Everson. Well, that would all be electronically
communicated to us or transmitted to us; and I do not think, as
I have had conversations with systems people, that this is that
heavy a lift. If you do something--this is not like we get
suspicious activity reports----
Mr. Ryan. I am just trying to understand the proposal.
Mr. Everson. Yes, yes. No, they capture that data. They
know how much they did over the course of the year with you if
you are the merchant. They are just giving us that data. They
have that data. That is different from, say, asking, which we
do--we have suspicious activity reports you are familiar with
when you have large cash transactions. That takes the creation
of a different business process within a bank, say, to look at
that and then do a special report. Here you are talking about
the rolling up of the information which they already roll up by
customer and then give it to us.
Mr. Ryan. Okay, and then you are just going to look and see
if there is something that stands out?
Mr. Everson. Yes. And, again, I think this would
potentially have even a bigger impact than it is scored for,
because a lot of the indirect, some of that is in there, but
this would make a big change.
Mr. Ryan. One quick last one.
Your budget also proposes that all contractors who receive
payments of $600 or more in a calendar year from a particular
business would be required to furnish the business with the
contractor-certified TIN, the Taxpayer Identification Number.
The business would then be required to verify the contractor's
TIN with the IRS. If a contractor fails to furnish an accurate
TIN, the business would be required to withhold the flat
percentage of gross payments and do withholding.
How does this work in practice? I mean, there have got to
be tens of millions of contractors who would be subject to this
requirement, and do you have the capability of, on a real-time
basis, furnishing this TIN to people who call up and request
it?
If you want to give that to me in writing, that would be
great.
Mr. Everson. I will certainly do that, sir.
Mr. Ryan. My time is getting short. Thanks.
[The information follows:]
Since October 2003, payers of certain income reported on Forms 1099
B, DIV, INT, MISC, OID and PATR have had the ability to match their
payee name and taxpayer identification number with the information
contained in IRS tax records for that payee. This service is provided
to payors in an attempt to assist them with perfecting the Form 1099
prior to filing an information return with the IRS. As the law
requires, the IRS may impose a penalty to payors who fail to obtain an
accurate TIN from the payees with whom they conduct business.
Current IRS operations provide an on-line interface for registered
users to submit the name and TIN (Taxpayer Identification Number) of a
payee to the TIN Matching program and receive a response regarding the
status of the match request. This process may be accomplished via an
interactive on-line input, whereby the user receives an on-screen
instantaneous response or, via a bulk file submission which is
transmitted to the IRS by a secure mailbox assigned to the user by the
IRS. The processed file is returned to the requestor anywhere between
2-24 hours and accommodates requests of up to 100,000 TIN/name
combinations per file.
The budget proposal would increase the overall TIN perfection rate
for all payors of non-employee compensation reported on Form 1099-MISC,
not just the payors who voluntarily utilize the TIN Matching program.
If this proposal were enacted, the expansion of this voluntary program
to mandatory usage for TIN verification of contractors (1099-MISC non-
employee service providers) may result in a substantial amount of user
traffic for both the interactive and bulk features. Any staffing or
other resource issues related to increased volumes would be addressed
as part of implementation.
Chairman Spratt. Mr. Cooper.
Mr. Cooper. Thank you, Mr. Chairman; and thank you, Mr.
Everson, for appearing before us.
You noted that this is your first appearance before the
committee, and you have been on the job for 4 years. I do not
think it should go unnoticed that this is the Budget Committee.
I have been on it for 4 years, and it is a shocking dereliction
of our duty that we did not have the IRS Commissioner here
before.
If we look at the government as an enterprise, to ignore
the revenue side of the income statement is truly an amazing
oversight. So I would like to congratulate the current
management of the committee for conducting things in a
businesslike fashion. We should have regular visits.
We can discuss exactly how big the tax gap is. I think it
is important to remember the many flaws in our Code, I think,
going all the way back to Jimmy Carter. I think he called it an
abomination. So what we are discussing is a gap in complying
with an abomination. It is our job as lawmakers to try to
improve that abomination, to make it easier to comply with and
to cut out some of the loopholes. I worry sometimes that there
is barely enough law left to hold the loopholes together.
We have seen an astonishing increase in so-called ``tax
expenditures.'' with 17,000 lobbyists in Washington who lobby
the Ways and Means Committee alone, most of them are seeking
tax expenditures; and that, of course, does not create a tax
gap. That creates someone who does not have to pay taxes
because they were able to be successful in persuading Congress
that he did not need to pay taxes.
According to the GAO testimony that is coming out following
you, the number of tax expenditures is up to $847 billion a
year. That is a lot of money, and I am sure many of these are
quite legitimate, but perhaps some of them are less legitimate,
and the analytical question I want to focus on is this--and
this was presented to this committee before by Pam Olson, a
former Treasury official.
She pointed out that, as bad as entitlement programs are--
and they are burgeoning beyond our ability to pay for them--
that tax expenditures are even worse because, as she put it,
these are unmeasured and immeasurable losses in revenue,
unverified and unverifiable losses in revenue.
So while we can conduct estimates of what a tax expenditure
costs, we do not really know. There is not the methodology in
place to be accurate in giving us an estimate of foregone
revenue.
So I would suggest that our colleagues on Ways and Means
need to be particularly careful, now that we are under new and
improved management, in handing out these things because they
are so difficult to measure and to verify.
Of course, if you cannot succeed in persuading Congress to
get a tax break, well, then the next best thing is to hope that
the IRS will be slow in noticing there is a problem; and I
wonder about your efforts in coordinating--and, of course, you
do not want to invade client privacy--with the big four or big
five accounting firms to find out their experience.
Because, as a former investment banker and businessman, I
have worked with probably several hundred small businesses, and
I have noticed that when they were forced to adopt real
accounting standards it was amazing how many hunting dogs were
found on the payroll, how many minor children were hired as
janitors to take out the garbage and other worse abuses,
sometimes including an entire industry that had adopted overly
lenient accounting standards. A lot of these are practices
known to our brethren in the big four/big five accounting
firms, and I would suggest that your employees would learn a
lot if they talked more frequently with those folks.
It seems to me that we are in a situation right now where
the government needs more revenue. We need to arrive at it
legitimately, and no one wants a tax increase. So I would hope
that we could encourage more of our taxpayers to remember the
proper basis for their stocks. I thought when we filled out
those forms we were supposed to tell the truth, that if you
bought Intel or GE at XYZ price--and it is pretty easy to look
up--that that should be reported honestly on the return.
As you point out, the large majority of noncompliance is
underreporting of business income, and I hope our friends in
the business community would help encourage their members to
report honestly their true revenues and to be fair about
claiming these new tax breaks because, as the GAO again will
point out following you, there is a $32 billion noncompliance
problem. Because we give someone a tax break and that is not
good enough, then they exaggerate the tax break; and to have a
$32 billion problem grow on top of $847 billion in tax
expenditures is truly an amazing situation.
So I appreciate your good work. We look forward to seeing
more of you before this committee.
Mr. Everson. Thank you. I appreciate your comments.
If I could just respond very briefly, one of the challenges
in the system is about visibility. You will write a law, and it
could take 10 or 20 years before anybody really knows what the
impact of that is because it takes us sometimes a year or 2 to
write the regulations that interpret the law.
Then in the corporate area, where there is a lot of
complexity, we may not be auditing those companies for years;
and then you get into challenges that go into our appeals, our
administrative system or, ultimately, in the courts. So your
visibility can be 10 or 20 years down the road before this gets
resolved. That is not in anybody's interest.
Simplifying the Code is clearly something that is very
important that we have got to get after, but I have to say
there is a tension there between that and a representative
democracy because you are paid by your constituents to get the
best deal for the industries or for the people in your
districts. That means a different deal all too often. So
simplification is a very tough thing to get after, but it would
help a great deal, and we do meet regularly with the accounting
firms, and we can do more of that.
Chairman Spratt. Mr. Garrett.
Mr. Garrett. Thank you, Mr. Chairman.
Thank you, Mr. Commissioner.
Before I begin, I am a little shocked about the 5 million
dependents who have vanished in 1 year. I am hoping that the
IRS is looking into it so we can track down those people and
bring them home.
Mr. Everson. That is right.
Mr. Garrett. Yes. I appreciate your speaking with us today.
I am sure members of both sides of the aisle believe that it is
the obligation of all of us--I am sure we all do--to pay our
appropriate tax to sustain the country, but when we discuss tax
avoidance and tax schemes, you know, I thought of the words of
Judge Learned Hand. He had a comment on this.
He said that anyone who may arrange the failures so that
his taxes shall be as low as possible is not bound to choose a
pattern which best pays the Treasury. It is not even a
patriotic duty to increase one's taxes over and over again. The
courts have said that there is nothing sinister in so arranging
failures as to keep taxes as low as possible. Everyone does it,
rich and poor alike, and all do it right for everyone, and no
one owes any public duty to pay more than the law demands.
So here we are just trying to find out those who are paying
less than what the law demands.
Mr. Everson. That is entirely correct, sir.
Mr. Garrett. Right. Part of the question goes to the issue
of the complexity of the Tax Code. The ranking member pointed
out there are 17,000 pages, 60-some-odd thousand, I guess,
pages of rules. I would be curious how many members around here
actually still do their own taxes. I stopped doing my taxes a
number of years ago because of that complexity; and, as it gets
more and more complex, I assume that puts a burden on both the
taxpayer and the IRS and that is, in part, what adds to the tax
gap--isn't it--the basic complexity of the Code.
Mr. Everson. What I say, sir, is that complexity obscures
understanding.
What that means is that the taxpayer who seeks to be
compliant has difficulty doing so and can ultimately throw up
his hands and say, ``Why bother?'' Then, on the other hand, the
taxpayer who seeks to be noncompliant counts on the complexity
and uses the complexity to obscure things and to avoid
detection by the IRS. So simplification is something that I
strongly favor.
Mr. Garrett. Yes, and if I go back to my constituents back
home tomorrow or the next day and I ask them about the idea of
greater enforcement, the first question or comment that most
people would say is, ``Well, I pay my legitimate share. I am
paying what I am supposed to be paying. It is too much,'' they
will all say, ``but I pay my fair share.''
Their first gut reaction is, yes, if there somebody out
there who is not paying, then the IRS and the government should
do everything they can do to track them down. But the flip side
argument of that is, if I explain to them, ``Well, in order for
us to do that, there may be added complications or added burden
on you, the honest taxpayer, in additional requirements or in
additional intrusions by the IRS and forms in addition to what
you are talking about here as far as the administration's
recommendations,'' then their response might be a little bit
different.
Mr. Everson. I agree with both of those observations. We
say that we want--our service obligation is to help taxpayers
understand their obligation and facilitate their participation
in the system but that enforcing the law is important because
average citizens do pay their taxes, and they have every right
to expect that neighbors and competitors are doing the same.
Some have criticized our 16 proposals, legislative
proposals, as meager, but both the Secretary and I are acutely
conscious of this second issue you are talking about. We feel
what we try to do is craft things that are minimally burdensome
that do not get to be too much, and each extra step you are
going to take in this arena will get more resistance just for
the reasons you are getting at, sir. They will touch more
compliant people, and they will be more burdensome.
So what we would like to do is get what we have got here
now, and then if there is stomach for more, we will continue to
talk, but we do not want to go too far on this.
Mr. Garrett. And I hope either side of the aisle would as
well, because it does put a burden on the legitimate taxpayer
as to what the dishonest crook out there is doing. This may be
beyond your area of comment, but I am just curious.
Is there anything either in the proposals that you are
making here, considering today, as far as the administration's
proposals or other proposals that have been out there to try to
get at this tax gap that look at the overall impact that it
would have on the competitive nature of our whole new global
economy that you will place on small businesses and mid-sized
businesses as well?
Mr. Everson. Again, I think that we are sensitive to that.
As I think you know, the Secretary has particularly been clear
on looking at this whole question of the regulatory
environment. I think that we are comfortable that what we have
put in here thus far does not really get to where it is too
burdensome.
Mr. Garrett. Okay. Thank you. I appreciate it.
Chairman Spratt. Mr. Becerra of California.
Mr. Becerra. Mr. Commissioner, thank you very much for
being here, and I look forward to working with you on some of
these matters. I know that when you have been before us in Ways
and Means we have talked about this, and I know we have tried
to figure out ways to tackle this in a more efficient way.
Give me a quick sense. I know that the IRS underwent an
automation of its computer systems and so forth and it did not
work too well at first, but, overall, how much did that cost
and is it completed yet?
Mr. Everson. What happened was there were several sort of
false starts that took place on this, one in, I guess, the
early 1990s and then----
Mr. Becerra. And I am just trying to find out how much have
you spent.
Mr. Everson. I would have to get you a figure, but we have
each year now a separate appropriation that, for the last
couple of years, has been running between $200 million and $400
million a year. We actually brought it down, and now we are
bringing it back up.
Mr. Becerra. Okay. My point here is that, if we could help
you get automated in ways that are modern and comprehensive so
that your system is compatible with systems with other agencies
and so forth or with other private sector entities, then it is
probably going to be easier to move towards compliance through
the Internet system, through the new wireless systems that we
have in place today around the world.
Mr. Everson. You are entirely correct.
If you go back to that budget chart, the most important
number in there for me is this $146 million increment--or,
pardon me, it is $143 million on the infrastructure
modernization side. In fact, if you asked our operating people
right now, somebody running the unit, we can give you $5
million or we could spend $5 million on getting better systems
to support your people, they would, to a person, take the
systems money and the infrastructure money. So you are right.
Mr. Becerra. So if you have a $345 billion gap and you know
that a major portion of that is coming from those who are in
the small business arena who are not filing all of their
information and, for example, the proposal that you have in
your budget that would try to get us towards using the credit
card of a business or of an enterprise to try to--or credit
cards that are used to make purchases with that commercial
enterprise, you could do a better job of tracking what is going
on. If you could find a system, an IT system, that could help
make it easier for the banks and commercial enterprises that
have to report all of that information on credit cards, you
could then probably do a pretty decent job of collecting far
more than the cost of that IT system that you acquire to try to
do a better job of collecting.
Mr. Everson. They are collecting this information.
What we would have to do is--any time we do new document
matching, we have to adjust our system and then we have to work
with them. This last year--at the end of 2004, we mandated
electronic filing for large corporations. That had never been
done before, and that information started to come in this past
year, 2006 for 2005. That required new software and real
changes for us and for the companies. So systems is important.
Mr. Becerra. Is it fair to say that efficient investment in
IT infrastructure pays off for you?
Mr. Everson. It is essential, and it does pay off.
Mr. Becerra. Okay. Could you use more than what you have in
your current budget?
Mr. Everson. Now that is dangerous territory here.
Mr. Becerra. I did not say ``did you want'' or I am not
asking----
Mr. Everson. No. No. Well, I am going to be very clear
here, as I was in the Senate.
I am asking for every penny of this request but not a penny
more, and what I said is we have to be extremely careful in
this area because what happens----
Mr. Becerra. You need not go into it, because I am going to
run out of time, and I know what you are going to have to say.
Let me move to another question.
Given your testimony and the charts that you showed us, if
I were a wage earner, if I got a check and I had deductions--
and, by the way, I guess all of us as Members of Congress do.
We are wage earners, we get a paycheck, and out of that
paycheck every month is deducted--or every 2 weeks or however
often you get paid--is deducted the income taxes that we are
supposed to pay along with the FICA taxes and Social Security
and so forth. Whereas, if you are an independent
businessperson, you independently file the paperwork to the IRS
to document what taxes you should pay.
Given your testimony, if I am a wage earner, I think I am
the knucklehead in this process. Because if I own a business, I
get to report what I want, but if I work for that business, it
gets reported automatically, and the charts show it, that wage
earners are the ones who pay. The honest folks are the folks
who probably make the least amount of money. The folks who are
not paying are the folks who can most afford to pay their
taxes.
I hope what we can do is work with you to make sure that we
get rid of that tax gap of $345 billion when we have a budget
that exceeds $200 billion and that we do more to make sure that
the wage earner is not having to compensate for the folks who
are not paying their taxes by paying more out of their
paychecks every month or every week and that we do a little
more. I hope we can work with you because I think it is
extremely unfair, and it seems to me it is ripe for a revolt by
those who are getting taxes deducted every month.
Mr. Everson. Two points if I could respond briefly.
First of all, there is disparate treatment between wage
earners and others.
The second thing I would say is I also view it as a matter
of fairness in the small business community because--probably
most of you are homeowners, but we have all been given two
different quotes for a job at our house, one by somebody who is
playing all by the rules and another that is a better quote by
somebody who is not. The person who is not paying the taxes on
his or her business has an unfair competitive advantage. That
should be a concern to all of us, too.
Chairman Spratt. Mr. Hensarling.
Mr. Hensarling. Thank you, Mr. Chairman.
Commissioner, welcome, and thank you for your service to
your Nation. You have a thankless job. You may be the only man
in America less popular than we are. We thank you for that.
Commissioner, according to GAO, apparently since 1970 the
compliance rate for taxes has been at 86 percent. So through
roughly 15-20 Congresses--Republican and Democrat--through
roughly six or seven presidents--Republican and Democrat--
through I do not know how many different IRS Commissioners,
apparently this tax gap has remained fairly constant. So I
think all of us on this committee would certainly share the
goal of ensuring that every American pays their fair share of
taxes, not a penny less, not a penny more. I know that we are
always searching for that elusive pot of free money out there,
the easy fix, but why should I not be skeptical? If it is such
an easy fix, why hasn't it been done before now?
Mr. Everson. I think that your observations in the broadest
sense are quite fair, and there are some who say, let us just
get rid of the tax gap, and then we have taken care of our
fiscal issues here. It is not that easy, and it is not that
easy for a variety of reasons.
One is it gets into this issue of how much of a presence
you would want to have for the IRS. The other gets into the
very real issue we are talking about of burden and adding more
reporting.
So what I think we have done is we believe there is
opportunity here, sir, and what we have made is what I would
consider some pretty significant proposals, but it does not say
you are going to eliminate or hugely reduce that gap just
because of the difficulty and the many complicated things you
get into if you try to do it.
Mr. Hensarling. Also, Commissioner, is it possible that the
cure could be worse than the ill?
Let me just state the ridiculous. You could corner an IRS
agent in every small business and home in America. Do you know
what I mean?
Mr. Everson. Yes. Let me say this, and I have not said
this. We enjoy the best system in the world. Let us all be
clear on that. Our system is the envy of other countries. I
meet with a fair number of international counterparts, and we
have got a great system here, so we want to make it better, but
we could make some real mistakes here if we overreach.
Mr. Hensarling. Well, in speaking of possibly the cure
being worse than the ill, according to the Tax Foundation, the
compliance cost has doubled over the last 10 years, and now
there is a $265 billion drain on our economy. I mean, that is a
huge figure, a huge transaction cost.
Theoretically, might we raise more Fed revenue, say at 90
percent compliance instead of a hundred? In other words, if we
could somehow figure out how to take part of that $265 billion
being devoted to compliance, instead turn it more into economic
growth, capitalizing more small businesses, increasing revenue
bases, isn't it at least theoretically possible that we don't
want a hundred percent compliance because that would create
less revenue than, say, 90 percent compliance.
Mr. Everson. I think what you are saying is common sense,
that to get after every last nickel here, that causes a whole
series of costs to get in there, and burden is important. We
have an Office of Burden Restriction, and we are constantly
seeking ways to reduce burden and simplify it within our
purview.
Mr. Hensarling. Speaking of simplification, and I know at
the outset of your testimony you said you weren't here to
promote a favorable and predictable tax policy over another,
but would you be in a position to offer an opinion that if our
sole goal--if our sole goal was to close that tax gap, have you
run models on either the flat tax or the fair tax and what the
tax gap might be under one of those two policies? Would we have
a smaller tax gap if Congress adopted one or the other?
Mr. Everson. I have not run those models. People at the
Treasury may look at this.
What I say about legislative proposals of VAT or a flat tax
is that my observation is that you can't compare a perfect
theoretical system with an imperfect actual system. So you need
to make sure you look at these things fairly.
As an example, I know from discussions of my colleagues in
the U.K. There are real compliance issues with the VAT. You
need to bear that in mind when you have those conversations.
Chairman Spratt. Mr. Doggett.
Mr. Doggett. Thank you for your service, Commissioner, and
your testimony. It is a measure of the new direction in which
this Congress is moving that you are here today.
Several of my colleagues have used the term ``shock''; and
I have to say, frankly and sincerely, that I view your
responses as shocking. As I understand your testimony as the
Internal Revenue Service Commissioner, you are unable to tell
us or the American people--to give us an estimate that you
believe is reliable, that you can feel comfortable with, of
what the gap is between taxes owed and taxes collected in
America today.
Mr. Everson. I think that is correct, sir, because we don't
have the precise numbers.
Mr. Doggett. If you put your tax gap map back up, we can
get a better understanding. Because your tax gap map--as you
pointed out, the last time that you did any study of this
matter was tax year 2001, right?
Mr. Everson. And it takes several years to complete a
study.
Mr. Doggett. That is a tax year that ends on December 31st
of 2001, the end of the first year of the Bush administration.
And in tax year 2002, tax year 2003, tax year 2004, tax year
2005, you didn't do a study, you said, because you were told to
stand down at the request----
Mr. Everson. No, no, no, sir. What I said was that we had
done--the last time before 2001 was in 1988 and then nothing
was done in the intervening years because, during the 1990s,
the Service was told to stand down.
Mr. Doggett. To stand down, and you also had a 25 percent
reduction in your enforcement resources.
Mr. Everson. At the end of the 1990s, in 1996 through about
2002, and so----
Mr. Doggett. And the study that you did in 2001, as I
understand it, you said there is a $3 billion figure there for
corporations. You didn't really study that in 2001. You used
old data. So that has not been studied.
Mr. Everson. That has not, and I believe that is
understated.
Mr. Doggett. You indicated that one of the areas that you
have found most of the greatest challenges is on the tax
havens, and the biggest chunk you believe from your chart is
business income. I realize much of that is not related to tax
savings, but I was concerned that in your legislative
recommendations you don't really seem to have much of anything
to deal with that other than the 163(j) provision on related
party interest deductions which the Ways and Means Committee
should put a stop to and change but instead asked you to do a
study. Is the study complete?
Mr. Everson. I don't have an answer for that. That is a
Treasury issue. What you are getting to is more legislative
policy proposals, sir.
Mr. Doggett. And you have input on those, but these are
really Treasury's recommendations?
Mr. Everson. Again, what I am talking about here is more
tax compliance.
Mr. Doggett. Let me turn to an area that is within your
jurisdiction. I wrote you about this 3 weeks ago, and I know
that some other colleagues wrote you about it. That was the
report in the New York Times on January 12th saying that the
IRS, when it came to large and mid-size business audits,
basically had a catch-and-release program, that you limit the
time of your auditors. That if your auditors find other tax
avoidance schemes, they are only there to go for the tax
avoidance scheme that they were sent to.
Employees were interviewed, auditors were interviewed,
retired auditors were interviewed in a number of States
indicating that, though there had been an increase in
collections, that they said that could be explained by the fact
there are so many more tax avoidance schemes out there and that
the IRS limited the access of the auditors to information. You
set up a way that they would be rewarded on the faster they
closed the case, not based on how effective they were.
I asked you for a report about what I thought were very
disturbing practices as reported in the Times, as editorialized
in the times. Are you near----
Mr. Everson. I am happy to respond to that, sir.
Mr. Doggett. Will you have a more complete report?
Mr. Everson. If we haven't responded, I sent a letter
earlier this week on that issue to, I think, one that came in
before yours, and I will send you a complete response.
But I am glad you raised this because I spoke to this the
other day in the Senate. If you could go to--yes.
First, let me say this: Currency is important. It is
shameful that things take years and years to get resolved. That
serves neither the corporation's interest nor the government's
interest. The compliant taxpayers need to get issues resolved
because there is a real cost of certainty and the government
needs to move quicker. In any given examination, decisions are
going to be taken, and there will be a tension between the
employee conducting that examination and the manager.
I think we get things, by and large, correct; and if
somebody thinks that something is being left behind and they
think it is being done intentionally, they may object because
they could get more. But the manager has to make the decision
as to whether at a certain point they can be more productively
used elsewhere. That is a basic question.
I wouldn't say to you, sir, that we get it right each and
every time. But when I look at the big picture--and, yes, we
are trying to drive down a cycle time--I am reassured by the
statistics.
If I could just show you these. It is a little hard to
read, but this takes the Es/Ex class of 10 to $250 million per
corporation and this takes the Es/Ex class of over $250
million. It says that in 2003 the number of audits that we did
on the smaller class had declined over a 30-year period, until
I got here, to 3,800 audits; and I had said for the bigger
companies, they declined to 3,300 and that the amount of money
set up was less than a billion here and the amount of money was
just over $12 billion. Now that has increased in 2006 to 4,300
audits. We didn't have much coverage here. We want to increase
it. And the amount of money we set up has grown to $25 billion.
You could argue that maybe there is more, and I am sure
there is more. You got the chart. But I would point out to you
the other statistics, that the corporate receipts as a
percentage of GDP have increased during this period, corporate
profits have increased, but they have gone to their highest
level as a percentage of the GDP in 18 years. You have to go
back to 1978 or--pardon me--yeah, I guess it will be 1988. It
may be 28 years. But, anyway, it is a long time since they got
up to 2.7 percent or wherever they are now.
When I look at the big picture, sir, I think this is all
working. We are doing more. We are trying to move faster. I
don't doubt that some people don't like that.
The other things we have done is we have changed our
personnel policies here. We rotate people off the big
companies. They can get too cozy, frankly, by staying 5 or 6 or
7 or 10 years; and that is not good. So not everybody is happy.
Chairman Spratt. Mr. Campbell of California.
Mr. Campbell. Thank you, Mr. Chairman; and thank you,
Commissioner Everson. I have a series of kind of unrelated
informational questions.
First one is, my understanding is the Senate Finance
Committee has talked about perhaps having the IRS build online
tax preparation software through a Web portal as a suggestion
on the tax gap. Is that something you think will reduce the tax
gap or not?
Mr. Everson. This is a very important issue. It could be
helpful.
I would say to you, as a general matter, right now 80
percent of the returns right now are prepared with the use of
some computer software; and returns are so complex or the Code
is so complex that I am sure people couldn't comply if they
didn't go through the software.
When you get into the issue of should there be a portal
developed, I am reluctant to embrace that idea at this time,
first because, going back to the chairman and other comments
about it, the infrastructure, this is not an easy thing to do
if you really want to do it, and I don't think we are ready to
do it.
The other thing I would say----
Mr. Campbell. Have you ever estimated how much it would
cost?
Mr. Everson. Clearly, it is a hefty price tag.
The other point I would make that I think is very pertinent
here is the acceptance of the IRS, as some have indicated here
today, is better than it was. There is a big industry out
there, and they will go to war when this policy is pursued.
They already did that in California when California tried to
extend the free file alliance. They had big pictures of, you
know, dogs eating steaks. There will be a collision here, and I
don't welcome that as trying to run a system where people have
trust in the IRS.
Mr. Campbell. I am from California and was in the state
legislature during that whole issue.
But I will say there are a lot of privacy concerns having
to do with this. The California proposal is going to keep track
of entries and strokes. So if someone put in $300 of charitable
contributions and erased it and put in $400, they would have
kept that. There would be a whole lot of privacy----
Mr. Everson. There would be a lot of allegations about it.
Mr. Campbell. Another issue relating to the tax gap--and I
am curious how we get to this. Computing the correct tax is an
art, not a science. And you can put together everyone in this
room and have them do the best job they can of interpreting the
laws and regulations to come up with the correct tax, have the
IRS do the same thing, and there could be a gap between those
two with completely honest people.
If there weren't ambiguity, there wouldn't be Tax Court,
there wouldn't be revenue rulings, private letter rulings, et
cetera. It can come all the way from anyone who gives a piece
of furniture to the Salvation Army, and what is that worth, to
a major corporate reorganization or something.
Mr. Everson. Yes.
Mr. Campbell. Is that included in the tax gap or--because
there is a gap between honest interpretation of the law.
Mr. Everson. You are absolutely correct. And the resolution
of that uncertainty is a very important facet of our system,
and the fact that it happens fairly, it happens--we have a
group that is independent within the IRS appeals group that
takes a real look at this, and then people do go into the
courts. This is one of the reasons why getting the right number
on corporations is so difficult, because it takes so many years
off and to figure out where the courts will land on the
interpretation of a statute. It is a real challenge. If I had
one observation, it is the stuff takes too long to resolve,
frankly.
Mr. Campbell. Okay.
The $20 billion number you gave as a delta 2010 for your
ideas for closing, I was unclear if that was the cumulative
total to that point or if that was the annual total at that
point.
Mr. Everson. It is the second, sir. It is the lift you
would get between 2006 and 2010.
Again, you have to fund the service. We would have to get--
and that is dependent upon adequate funding in the outyears,
too, so you get continued productivity lists and all of the
legislative proposals.
Mr. Campbell. On your credit card proposal, one thing I was
unclear about. If you get from the banks the merchant credit
information, will it have detail or is it just going to be a
total single number?
Mr. Everson. It would be a total number.
Mr. Campbell. Then the last thing is just kind of getting
back to the preparation and privacy issues, that another thing
with, frankly, in my view, with either online tax preparation,
frankly, even e-mail filing and stuff, there is so much--we
have had problems with the veterans' information with
information getting out. If everything on an individual's tax
return, which can include bank account numbers, all kinds of, I
mean, everything about that individual were present on any
computer anywhere and the only place it would be is within the
IRS, shouldn't we have privacy concerns with that?
Mr. Everson. This is another reason to support the
infrastructure request, because we do have money for heightened
security in there. We work very hard on this issue. It is a
constant challenge, I have to say; and it is a very important
issue. So I agree with you.
Mr. Campbell. Thank you, Mr. Chairman.
Chairman Spratt. Mr. Blumenauer.
Mr. Blumenauer. Thank you, Mr. Chairman; and, Mr.
Commissioner, we appreciate you being here.
I don't happen to think you are one of the most unpopular
people in the country. I get a little embarrassed when people
joke about it. Because what you said is true. Our tax system is
the envy of the civilized world.
When you don't have a tax system that people can have
confidence in, then you have bribery, then you have
underfunding of government services, then you have back-channel
activities, you have corruption. This is an indice of
civilization and a democratic function.
Mr. Everson. I agree with you entirely, sir.
Mr. Blumenauer. I just personally find it offensive that
people make the IRS sort of a second-class citizen, not just
casual jokes. But what we saw this Congress do--I saw it when I
first came here--vilifying the IRS, the people who worked for
it, exaggerating pretty dramatically some problems and
resulting in what we saw in terms of severely restricting your
ability to manage the agency, you and your predecessors,
resulted in lots of money being lost and corners being cut.
There are people who are saying, well, this is confusing,
and so certainly there is problems. But if it were just a
matter of confusion, then we would see as many people being
confused and overpaying as underpaying.
It seems there is a pretty systematic problem with a lot of
people who are confused in ways that cheat the government and
put their competitors who play by the rules--and most business
people do--put them at a disadvantage.
Mr. Everson. I agree with that as well, sir.
Mr. Blumenauer. So the fact that this Congress under
Republican control, I am sad to say, while you were increasing
the complexity of the Tax Code, talking about it being too
complex but adding thousands of pages of regulation and new
taxes, starve the ability of IRS for compliance.
So I am pleased that our leadership is bringing you here
before the Budget Committee. I hope you will have a better
reaction from the Ways and Means Committee now so that we don't
pile on all sorts of things, while claiming we are for
simplification, making your job more difficult, doing it in the
back room and the dark of the night at the last minute so that
it is a nightmare for you to even try to comply with what
Congress passes.
Mr. Everson. The only thing I would say is I have been on
the job 4 years, and I think I have been treated fairly and the
service has been treated fairly by both sides of the aisle
during that period of time.
Mr. Blumenauer. I think you are a very generous man. I
think the record of what happened--and it happened just before
your watch----
Mr. Everson. It happened back in the 1990s.
Mr. Blumenauer [continuing]. In terms of dragging people
in, flogging them, making all sorts of goofy and outrageous
actions.
I recently met with about a dozen tax professionals in my
community, top-drawer people, some of whom I have known for
years, some who are new friends, seeking advice and counsel.
There was one that had had an audit in the last 8 years. They
were saying, you know, it is fascinating in terms of what
doesn't happen any more. They had suggestions in terms of our
having some sense of the positions that are funded, in terms of
the revenue they generate, that that is what a business would
do. Because this pattern of mistakes is not random, it is
purposeful.
Mr. Chairman, my question, as much to the committee as to
the Commissioner, deals with the bizarre notion of scoring.
What is being suggested to us is that, by giving the resources
to the IRS to do things like having just gross amounts of money
reported as a little bit of enforcement action, a little bit of
infrastructure, is going to produce far more tax revenue than
it costs; and everybody will agree to that at some level. Yet
under the way that our budget rules work, that is a cost right
now. It is a difficulty for our budget--for our appropriators.
It is difficult for you in terms of crafting the budget, even
though in the 10-year budget window it will pay for itself
many, many, many times over.
I have talked to the Director of CBO about some of these
areas where our scoring rules have a perverse effect of
actually costing money and misstating the economic impact over
a 5- or 10-year period. I would hope that there would be some
way working, for example, with the Commissioner of IRS and with
CBO and with the certified smart people and the staff on both
sides of the aisle that we could go back and look at some of
these scoring conventions from a present-value perspective.
Because I think it is perverse. I think it is costing us money.
It is preventing investments that make sense.
We are starting to do that in some areas of government
finance, and it is something that I planned on bringing to the
committee later. I want to bring it up now. It is cheaper for
the government to spend billions of dollars cleaning up after a
disaster than spending a couple----
Chairman Spratt. Mr. Blumenauer, that is why we are holding
this hearing, to lay the basis for a lot of things like that.
Mr. Blumenauer. It is the scoring, Mr. Chairman, is
something that I would like to address.
Chairman Spratt. I understand, but this is part of the
exploration of that issue.
Mr. Conaway.
Mr. Conaway. Thank you, Mr. Chairman; and I would like to,
curiously, agree with my good colleague, Mr. Blumenauer's rant
about the Ways and Means Committee. We have got a bill on the
floor today, 976, that does exactly what he said: It was done
in the dark of night and done--and I agree with my colleague.
Mr. Blumenauer. Will the gentleman yield?
Mr. Conaway. No, I won't. You had about 8 minutes on your 5
minutes. I am using mine.
Compliance audits that--in other words, for the research
that you do--and, again, thank you for being here. I appreciate
that. John and I are colleagues in another realm. Appreciate
you being here.
Would you describe what a compliance audit looks like? Is
it unfair to describe it as a colonoscopy?
Mr. Everson. I think that was the way the research had been
done in 1988, and I think that was one of the contributing
factors that got this to stand down. We worked pretty hard in
this last cycle to make sure we weren't going to ask for
information that we already had or that was out of line. So we
very much revised the procedures, and we didn't get but a
handful of complaints in terms of those 46,000 reviews that we
did.
Mr. Conaway. We are now 6 years away from that research.
Tax rates are lower now than they were in 2001, which I believe
personally contributes to better compliance when the penalty
for reporting or the result of reporting is not as draconian at
the rates we currently have applied as the rates before.
When do you think you will do your next round.
Mr. Everson. Right now, we are working on the 1120-Ses,
trying to get some better numbers of the corporations. But we
will start later in the next year on updating some of the work
on individuals. And what we will do, instead of just doing a
huge number like that, we are going to try to do a smaller
sample and try to get different elements on it and get updated
on a continuing basis.
But I am sorry to say it takes several years. Because by
the time you go through all of the audits and then what you
have to do is you do the work and then you have got to massage
the data. Because it is different if you get Bill Gates' return
rather than mine in your random sample.
Mr. Conaway. I would have thought, given your position,
they would have been about the same.
Mr. Everson. I wish it worked that way. It is not a sheriff
in a county.
Mr. Conaway. With respect to this industry that we have
created in effect as a result of a very complex Internal
Revenue Code, which the IRS has nothing to do with other than
just trying to implement it and enforce the rest of us to
comply with it--and I will leave some of it out--all of the
various businesses out there that seek to assist us--I use
ProSeries or not a commercial--but, technically, I could do my
return without a computer. I would never want to really even
try it, because it wouldn't be close to being right.
Does IRS work with these various preparers to make sure
that they--the system they put in place in which millions of
taxpayers seek to honestly comply with, that they are, in fact,
getting it correct? Is there some sort of exchange with them?
Mr. Everson. We work very close with them, and it gets to
the point of the late action by the Congress on the extenders.
One of the issues on this is we have to work and test their
software and make sure it interacts and everything else. So we
go through a whole series of routines to make sure that those
products interact with us correctly.
Mr. Conaway. I know that is on the e-filing piece but on
the way they compute.
Mr. Everson. The way they interpret the law? No. I would
suggest to you that it doesn't matter whether that would be a
vendor of a computerized product or a big accounting firm.
Practitioners--we depend on practitioners in this country to
help taxpayers understand the law, and that gets to the number
of--this question your colleague asked a few minutes ago. It is
another point. Some people say, well, if only the IRS was doing
this, that would be very distasteful. So that is why there is
some resistance to this idea of getting a portal where the IRS
interprets the law for you.
Mr. Conaway. I want to commend you for your reluctance to
embrace an IRS-computed tax return, because I do think the
private sector does it better. It is more nimble.
For example, the changes made in December, there are
certain pieces on that that 1040 itself doesn't provide for and
you have had to issue some additional instructions. But the
software providers have had to fold that into their system, and
I think they are much more nimble as a result.
Mr. Everson. They are assuredly more nimble.
Mr. Conaway. And that is not to denigrate the IRS, but you
have just got a different side of the table.
In the spirit of keeping within my 5 minutes, I would yield
back.
Chairman Spratt. Mr. Andrews of New Jersey.
Mr. Andrews. Thank you very much for your very thorough and
comprehensive answers this morning. Your daughter should be
very proud of you. I am glad she is here this morning.
Sir, what was the number you gave us as to your forecast of
revenue gain off this idea of the gross receipts of the credit
card companies?
Mr. Everson. The number that is in the current estimate is
about 10 or 11 billion over a period of several years and----
Mr. Andrews. I wanted to ask you how it is derived. If we
look at the data from the 2001 study on underreporting and if
we put aside a State tax, excise tax, and employment tax and
simply look at corporate returns and individual returns, my
data indicate that there is a 200--the 2001 study indicated
$227 billion a year of underreporting. Do you have any estimate
as to how much of that underreporting might be at least put
into question or identified if we made this reform with the
gross receipts of the credit cards being reported to IRS?
Mr. Everson. I think that is what we are saying. You would
recover that. That is a number over a period of years, as
opposed to an annual number, and I would have to get you what
the annual number is. It ramps up a little bit. It ramps up
very quickly. But it goes after this underreported business
income of a $109 billion and the understatement of the gross
receipts by largely Schedule C filers.
Mr. Andrews. So is it your estimate that the underreporting
is $109 billion?
Mr. Everson. That is on the individual income tax side,
sir. If you want to--do you have that breakout of the 110?
Mr. Andrews. Here is what I am trying to square here. The
2001 study talked about annual underreporting of $227 billion
and the two categories that I talked about. And I assume that a
lot of that is people that are getting cash income and not
reporting it.
Mr. Everson. There is some cash, and what this does here,
that takes the biggest piece of that chart, the 110, and says
where it is.
Mr. Andrews. And this idea that you have, which I applaud,
is a way to sort of identify the most likely targets who are
exploiting that. In other words, if I run a business and you
know I am reporting that 85 percent of my receipts come from
credit cards and history tells us in that kind of business is
really 50-50, to use that example, I am a likely target for an
audit, as I understand it.
Mr. Everson. Obviously, different businesses run at
different ratios.
Mr. Andrews. But there would be profiles. For example, in
dry cleaning, if the normal is 50-50 credit to cash, and I file
a return and it shows that 85 percent--if you look at the
credit card receipts, 85 percent of my receipts are credit card
and only 15 percent is cash, you are probably going to take a
look at me--that is the idea--IRS.
I guess what you would do, it depends on what information
we would get coming in, and I think what you are getting at is
this doesn't get a cash--as an--but what it would do, though,
it would give you the most prime targets for audits, I would
think. It is a targeting tool, isn't it?
Mr. Everson. It has got two things. One, it would indicate
problem areas, but, two, this very real change in behaviors
that would take place, people who know the information is
coming to us, they respond more honestly.
Mr. Andrews. All which makes me think this: You may be
rather significantly underestimating the value you may get from
this. Why is the number so low that you would get from this?
Mr. Everson. I don't do the estimate, sir; and I do believe
the estimates are conservative. I wouldn't put a precise number
on them, but I think what you get is there is an historical
reluctance to overstate the numbers. And I think JCT would feel
that way, the joint committee, and part of it is that sometimes
we will put a provisional law there and the IRS won't follow
up.
Mr. Andrews. I think this is wise to underestimate, but I,
frankly, believe that those estimates significantly understate
the value of this idea. Because if you had sufficient
infrastructure and you had sufficient auditors, this would be a
very effective targeting system as to who was understating
income, which would let you chase cash, which would have a
deterrent effect on people running more of a cash business and
have the trooper sitting under the bridge.
I will close with one other comment. Has the Service looked
at State governments who have been particularly effective in
reducing their own tax gaps? Have you looked at States who have
had success in this area?
Mr. Everson. We work very closely with the States. As you
appreciate, most States, their income tax system thrives off of
the Federal system. We work with them on a continuing basis
and, an actual fact, we are in the--particularly in the shelter
area, we are now leveraging our work with them where States
like California and New York will--if we can't get after
something, they will pursue an investigation, and we will ride
their assessment, instead of the other way around.
Mr. Andrews. My time is about up, but I would ask if you
could submit for the record any best practices that you have
identified from the States that the committee could take a look
at.
Mr. Everson. Certainly, sir.
[The information follows:]
We have identified the following best practices from the states.
California
The IRS and California Franchise Tax Board (FTB) have a long
history of working together. Examples include:
Compliance detection and enforcement efforts to address
the tax shelter problem.
A Voluntary Compliance Initiative (VCI) in 2004 which
allowed California taxpayers engaged in potentially abusive tax
avoidance transactions to correct their state income tax returns. The
final results of the FTB VCI were 1,202 taxpayers who reported $1.4
billion in additional tax liabilities by filing 2,289 amended tax
returns for tax years 1990 though 2002. Results were provided to IRS
and federal assessments were made based upon the state findings.
The State of California Board of Equalization (BOE) started
publishing a list of the top delinquent taxpayers who owe sales and use
taxes. The information is published on the agency web site and includes
the taxpayer's name, address, and lien filing date. Since published,
one taxpayer has paid in full and several others have come forward to
request payment arrangements.
FTB has adopted the same method for delinquent taxpayers who owe
personal income taxes. The agency is issuing warning letters to the top
250 delinquent taxpayers prior to publishing the list on the agency web
site.
The City & County of San Francisco Office of the Assessor-Recorder
is interested in providing a monthly listing of all taxpayers who
transferred their real property by recording no consideration or
quitclaim deed and claiming that it was a gift.
Virginia
The Virginia Department of Taxation sorts information received from
the IRS on Forms 1099-MISC and W-2 prepared by a business by volume,
which is then compared to the business return. If the business return
is not compatible with the IRS documents, an assessment is made.
The Department of Taxation also matches real estate property
transactions received from counties to information received from the
IRS. High dollar transactions are researched to determine if the Forms
W-2, 1099 and 1098 information is consistent with the transactions.
Montana
The state of Montana publishes a listing in major city newspapers
of the top delinquent taxpayers which results in payment of accounts.
Chairman Spratt. Thank you.
Mr. Porter of Nevada.
Mr. Porter. Thank you, Mr. Chairman.
Please don't take this personal, but I think most Americans
and most Nevadans would rather have a root canal than a visit
by the IRS. I appreciate what you are doing. I think things
have improved significantly. But American people are scared to
death of having an IRS agent show up at their door, and I know
they are all hard-working individuals that work for the IRS.
Mr. Everson. I still twinge when I get a letter from the
IRS, and it is usually on my health benefits.
Mr. Porter. Well said.
Then you take into account small businesses or mom-and-pop
businesses or the chief cook or bottle washer, they are in at 6
o'clock and they go home at midnight and they are having
trouble with paperwork, making sure they stay on top of
everything. They are afraid they are going to have any wages
garnished by employees. Tax Code 17,000 pages, Tax Rule 66,000
pages. The rich seem to benefit from the complexity of the tax
laws because they can afford to hire people to take care of
them; and, in the reports for OMB, it is 6.4 billion hours that
are spent.
But I guess my question is, is how has the Tax Code changed
really fundamentally since the 1980s and do you think it has
gotten more complex?
Mr. Everson. First, I agree with your observation that,
basically, that we have got to be careful here or the inference
I think you are making because of a perception about the IRS.
We are the government to many people and there is a wariness,
and we don't want to overdo the enforcement, very clearly.
The second point, clearly, the Code has gotten more
complex.
I also agree with your point that it is the well-to-do, the
rich and the big companies that can find ways around this.
I tell people--I have told this story so often, and I will
probably never be invited back. But I gave a speech 2 years ago
to the New York State Bar Association Taxation Section. There
were 98 tables of 10 there, and those people are not
representing EITC taxpayers.
Mr. Porter. Wouldn't it just be simpler to make a
fundamental reform to make it easier so more and more Americans
can report accurately?
Mr. Everson. I certainly am a big advocate of simplifying.
Mr. Porter. Out of 10 returns, 10 are going to be
different. There are 10 different experts;
As we talk about a tax gift, I think most Americans would
pay if it would be much easier.
My next question is, part is underreported by undocumented
and illegals that are in this country? What amount of taxes are
we losing because they have been undocumented?
Mr. Everson. I don't have a number for that, sir; and, in
some ways, because what we do is our approach is we want your
money whether you are here legally or not. The way the law
works, if it provides a protection, we get--we do have several
million of filers who are filing with an ITIN, and they are
meeting their obligation. They are filing their taxes even
though they may not be entitled to be in the country. So they
are following that obligation.
But I don't have a precise number on people who are
illegally here and who are not meeting that obligation.
Mr. Porter. So would you have for a later date any
estimates on the amount of revenues that are being lost? Is
there a way you can compile that?
Mr. Everson. I don't think we would be able to answer that
in the short term.
Mr. Porter. Thank you, Mr. Chairman.
Chairman Spratt. Mr. Etheridge of North Carolina.
Mr. Etheridge. Thank you, Mr. Chairman.
Thank you, Commissioner, for being here; and let me say as
a Member of Congress who served at several levels and has been
in business for 19 years, most businesses don't like to see you
come, but it makes sure you clean your books up and get them in
order. Been there, done that.
But let me ask you one question: You mentioned the tax gap
is a difference between taxes owed and taxes paid timely.
Mr. Everson. Yes, sir. If you go back to that----
Mr. Etheridge. I want to make sure I had the definition
accurate. Because timely is different than taxes paid.
Mr. Everson. That is exactly right, sir.
Mr. Etheridge. There is a difference.
Mr. Everson. That is when you file a return and you owe us
$5,000 and you only send us $1,000.
Mr. Etheridge. Now, let me ask the question a little
differently, because it gets to--just some information. You
said that you would have the 2006 and 2007 update finished.
When will that be finished and available?
Mr. Everson. You mean when we next update our research? It
would be several years later. We are looking at how long it is
going to take us to do that now. We will try to speed it up
compared to what we did in the past, but if we are working on
2007, it would certainly be several years.
Mr. Etheridge. Would you share that with the committee?
Mr. Everson. We absolutely will, sir, and we will have new
numbers on the 1120-Ses. We are finishing up those.
Mr. Etheridge. That would be helpful. Thank you.
In looking at the data you had talked about earlier, that
roughly 54, 55 percent of current individuals are filing
electronically----
Mr. Everson. That has increased steadily.
Mr. Etheridge [continuing]. Do you have a number of the
percent of corporate filers who are filing electronically?
Mr. Everson. What we did was--I don't have an overall
number. What we did was we mandated at the end of 2004 that the
big companies, those that were in a certain asset class and
filed 250 returns, that includes employment returns they had to
file electronically, and they all came in this last year, and
this will have a huge and positive impact on our work because
we will be able to array the data and only look at things that
are really out of line.
Mr. Etheridge. Let me ask you a question as it relates to--
you touched on earlier I think, before. Is there a mechanism in
the Code or in your office--I am a small business person. I
collect Social Security, FICA taxes on my employees. If I don't
turn it in, that is not my money. That money belongs to the
employees who may collect it and then match it.
Mr. Everson. Yes.
Mr. Porter. Is there a trigger at some point if I don't
send that money in--if I haven't filed I guess you won't know.
If I haven't filed, is there a trigger?
Mr. Everson. Yes. This is an area in terms of our
collection workforce we look at the most rigorously. Because
what happens is this can pyramid and compound very rapidly.
What happens is, typically, I would say more often than
not, a small business gets extended, they get in trouble, and
they say I am not going to send it in this quarter because
things are going to get better the next quarter. There are very
few people who are intentionally using the government as a
bank, but it compounds quickly, and it is very hard to work
your way out of it.
So our revenue officers, they get right on this to the best
of their capability, and they work. And what they do, sir--and
I have been out with a couple of them--they try to make a
determination of whether the business can pay it off or not.
What they say is, first of all, can you make current
payments. If you are not capable of making the payments from
now forward, then what they will do is they will basically end
up shutting the business down itself.
Mr. Etheridge. The reason I ask this question is that an
employee who gets in some trouble but the employees, depending
on who they are, how many, they have lost their quarters for
Social Security.
Mr. Everson. Yes.
Mr. Etheridge. And that is delay. If it is a year, they
lost a whole year in their retirement earnings towards Social
Security benefits, correct, because it is not paid?
Mr. Everson. If it is not recorded, that would be correct.
I am not sure exactly how it works on the Social Security end.
Mr. Etheridge. Anyway, I think that is correct. The reason
I ask that question because I think it is important that we
trigger that.
Let me touch one more piece, because my time is running
out. One of the things I think that bothers taxpayers the
most--and we just had a case in our State of a person who was
of some substantial position and an attorney wound up doing
time for tax evasion using the Tax Code illegally and is going
to spend some time thinking about it now that they have been
caught.
My point is that every time one of these pops up, it really
has people losing faith in our system. Because if somebody gets
away with at least a little, people lose faith.
Let me thank you for your paying attention to that. Because
I think it does help and, by and large, it helps the little guy
who is paying every month, who has no choice.
Mr. Everson. Thank you.
Mr. Etheridge. Thank you, Mr. Chairman. I yield back.
Chairman Spratt. Thank you.
Mr. Bishop.
Mr. Bishop. Thank you, Mr. Chairman.
Commissioner, it is nice to see you again. Thank you.
I have a just a couple of questions. First, an observation.
I guess I am surprised to hear the question raised, is it worth
it? I mean, as I understand it, there is $350 billion on the
table in one form or another. And I mean I am just quite
surprised to hear that the question raised of is it worth it to
go after that or some portion of it. I cannot imagine us having
any other problem of that magnitude either on the revenue side
or on the expenditure side of our budget where we would ask
that question. So my own answer is, yes decidedly, it is worth
going after.
Mr. Everson. Yes, sir.
Mr. Bishop. The first question I have is, the corporate
income tax piece of that $350 billion is, if I got your numbers
correctly, approximately $250 billion in large corporations and
approximately $5 billion in small corporations. I think that is
what your chart said.
Mr. Everson. That is what I said, sir.
I also added the fact that that was not based--as you can
see, these are older estimates and so I believe that was
clearly understated.
Mr. Bishop. My question is, I know the concern that we have
is does enhanced enforcement run the risk of impairing the
dynamic that exists between taxpayers and the IRS and will we
be creating more problems than we are solving. But isn't going
after large corporations, doesn't that constitute low-hanging
fruit? Are we really worried about our relationship with large
corporations who have the capacity to employ the very best tax
advice, the very best legal advice and are thriving in our
economy? I mean, do we really worry about whether or not
increased enforcement is going to somehow impair their ability
to do business?
Mr. Everson. I think there is a different dynamic between
the relationship between the IRS and the large corporations
than there is between the IRS and the individuals.
We have very high audit rates, as we talked about before.
We are doing a lot in that area. We want to do more. There is
$26 billion in the enforcement moneys that would go towards the
corporations. We have got a pretty aggressive program on them.
Mr. Bishop. If I remember your numbers right now, I think
we are auditing something like 17 percent of returns of large
corporations. Is that----
Mr. Everson. That is correct, but that is the number which
has the 10 million up--if we look at the biggest players, that
number is much higher. It is about double that.
Mr. Bishop. And with the increased moneys that you are
requesting for the fiscal year 2008 budget, how will you be
able to move that number?
Mr. Everson. I don't think the number itself would move as
a percentage that dramatically. It would be the way we deploy
that money and the kinds of issues we would be going after. But
you are not going to see that dramatically ramp up their----
Mr. Bishop. One more question. The unreported business
income, if I remember correctly, was estimated at about $109
billion; and the credit card reporting proposal that you have,
would you think it is a conservative effort, but it would pick
up about 11 percent of that.
Mr. Everson. But those are apples and oranges there. The
109 or 110, that is an annual number, whereas the credit card
number, that is over the period of the budget.
Mr. Bishop. So $11 billion is the cumulative number.
Mr. Everson. That is the cumulative number over the 10-year
life of the projection.
Mr. Bishop. So it is only about 1 percent then.
Mr. Everson. I would have to look at the individual years.
We have been talking about 2010. I would have to take a look at
what we would project for that.
Mr. Bishop. I am not trying to be difficult here, but I am
focusing on a number here. If it is $11 billion cumulative over
the course of the budget window, that is about a billion a
year. So that would be about 1 percent of the total problem; is
that about right?
Mr. Everson. I understand your math, yes.
Mr. Bishop. One thing I can do--and my question is, can't
we do better? If we have a $109 billion problem, can't we come
up with a set of these potential solutions that allow us to
knock that down by more than 1 percent?
Mr. Everson. We haven't gotten into it too much today.
There are some who have said these are major proposals. The
Secretary and I have gone over this. We are pretty clear on
this. We want to get the funding for the IRS and sustain that.
Then we want to get these proposals. And if these proposals,
which I think are going to generate, sir, quite a bit of
controversy, as you have seen here this morning----
I was in the Small Business Committee last year, and it
pretty well shut down because of this credit card proposal. I
think that we will come back, and we will work with the
Congress. If we get these through, we will talk about doing
some more, but I think those are important steps.
Mr. Bishop. Thank you.
Chairman Spratt. Mr. Boyd.
Mr. Boyd. Thank you very much, Mr. Chairman; and,
Commissioner Everson, thank you for being here.
I want to start, Mr. Chairman--I am sorry that Mr. Ryan
stepped out of the room and also that Mr. Conaway and Mr.
Blumenauer have left. I wanted to start by correcting the
record.
I was a little bit amazed at the statements or the rancor
between Mr. Conaway and Mr. Blumenauer. But let the record
reflect that the vote that we are going to take on the bill,
the tax bill today, is a bill that was developed and written
and cosponsored by the Democratic chairman, Charlie Rangel, and
the Republican Ranking Member, Jim McCrery, and working
together with each other and passed out of the Ways and Means
Committee without a dissenting vote. So one of the things, Mr.
Chairman, that many Members of this Congress have exhorted, you
and the leadership of this new Congress, is to stop the
partisan rancor and rhetoric and lower it a little bit; and I
would challenge all of those in this committee to do that. I am
sorry, again, that Mr. Ryan is not here, but I am sure we can
talk about that some other time.
Commissioner Everson, I strongly support the statements of
many, including Mr. Porter from Nevada, who favor
simplification. You said it best: Simplification is something
that you strongly favor. You made an argument for that by
saying that complexity hurts those who wanted to comply and
helps those who want to cheat.
Mr. Everson. Correct, sir.
Mr. Boyd. I think that is what you said.
Mr. Everson. Yes.
Mr. Boyd. Given the tax gap.
So as to my question, though, given the tax gap and ways
that you can solve this, I don't think there has been any
discussion today about the private collection initiative.
Mr. Everson. Yes, that is right.
Mr. Boyd. Could you talk a little bit about that and
address, number one, I know how that is working, what they are
trying to collect. I know the taxpayer advocate has some
problems with it, what are his problems and how you are trying
to address them.
Mr. Everson. Certainly, sir. I think you will hear from the
advocate in the next panel.
The simple truth here is that, even because of attrition,
government attrition is quite high now. It is high within the
IRS as well. There are only so many people you can bring on and
hire at any given time, so that even with the increment that we
have got in the budget proposal, even if we--we are pretty well
maxed out on what we can bring on, and it would be a period of
years, a period of years of adding people to the IRS before we
would get to a capacity where we could work some of these cases
that we are giving to the private collection agency.
This was passed into law--I think it was in the Jobs Act at
the end of 2004. What we are doing is we are implementing this.
We have implemented starting in September. Got about $11
million, came in January. We have a set of standards that we
hold the contractors to that are comparable to what the IRS has
held, and I would say to you my assessment is so far so good. I
know that there are many who want to stop it.
I had a conversation with Chairman Rangel on this up in
Harlem just a week or two ago, but I think--I was with Senator
Grassley on that--we should give this a chance to work and see
how it goes. We are working very hard on it. The people I have
on it meet with me monthly to tell me how it is going, and I
think we should stick with it for a while and see how it goes.
Mr. Boyd. So, to refresh everybody here, that you are only
going after taxes that people have admitted that they owe,
return files, file returns but just didn't pay the bill.
Mr. Everson. That is absolutely correct.
One of the challenges that we have in our collection area
now that--as we brought up the other enforcement and we are
doing more audits. You audit somebody and you make an
assessment and you have to collect that money. So our
collection people are busier because we brought back the
enforcement. What the collection agencies are working on is
really the simplest thing, where somebody has agreed that they
owe that amount of money.
Mr. Boyd. Thank you very much. I yield back.
Chairman Spratt. Thank you, Mr. Boyd.
Mr. Ryan would like a moment for clarification.
Mr. Ryan. I stepped out of the room for a second when you
mentioned the Ways and Means Committee. I didn't hear what you
mentioned, but I wanted to just certify and clarify that the
tax bill we are considering was done in regular order in the
Ways and Means Committee. It was done in a bipartisan way. I
serve in Ways and Means. We marked it up in the middle of the
day in the committee in regular order. Ms. Schwartz was there.
So that, in fact, was the case. I was going to mention to the
gentleman who mentioned it that that was, in fact, the case. So
I want to get that for the record.
Mr. Boyd. Thank you very much.
Chairman Spratt. Ms. Schwartz from Pennsylvania.
Ms. Schwartz. Thank you, Mr. Ryan, for correcting that. You
may want to mention to Mr. Conaway that--he mentioned it was
done in the dark of night, and it wasn't. I agree when we can
work in a bipartisan way. When we agree, why fight about that?
So thank you.
I wanted to follow up on some of Mr. Boyd's comments, and
nice to meet you, Mr. Commissioner.
Mr. Everson. Thank you for waiting.
Ms. Schwartz. Thank you.
There is a specific issue I wanted to follow up on private
collections, how that is working. As you may know, I represent
the 13th Congressional District in Pennsylvania. There is a
rather large IRS facility in my district, and I visit that
facility. In spite of some of the negative comments about how
people might feel about IRS workers, I can tell you that,
meeting with those workers, they are very proud of the work
they do. They feel good about it. They would like to continue
doing it.
The fact that there are 2,800 employees that are going to
be laid off in that one facility in my district is very
significant; and given these are employees, some of whom, as I
understand it, would need some retraining to do some of the
kind of work that is now being contracted out to private
collection agencies and, actually, we are paying far more for
those private collection agencies than we do if we are going to
do it in-house, my staff gave me some information on this.
They were talking about a net return when the IRS does it
itself. So it is a compliment to you, I guess, and to workers.
About $0.97 cents on the dollar. It costs about $0.03 on the
dollar when we do it in-house. By contracting it out to these
private collection agencies, the net return is $0.76 on the
dollar. So that we are losing $0.21 on the dollar.
Now these are taxpayer dollars, also. These cents add up,
that we are actually spending more to collect these dollars.
So my question to you is really two-fold, is that why not
use the 2,800 people in my district who are going to lose their
jobs who want to stay, might need some retraining, to do this
next--this different level of job but would like to do that and
why not use them? Particularly when we know that two factors,
one, we are spending more when we use private collection
agencies, not getting the dollars back that we might, and there
have been issues raised on the other side that I agree with.
There are concerns about the potential confidentiality of very
personal information being out there.
You know, one of the things, we actually may not like to
hear from the IRS, but you kind of trust you keep this
information to yourself. That is one of the aspects I think
most Americans do believe in.
So if you would address specifically, you know, the
decision that has been made--it is an option--but the decision
that has been made to substantially downsize our IRS workers or
employees who are dedicated and knowledgeable and want to
continue to do the good work in order to spend more taxpayer
dollars by using private agencies outside.
Mr. Everson. I presume you are in Philadelphia?
Ms. Schwartz. Yes.
Mr. Everson. I think there are a couple of issues in there
that are getting a little bit mixed.
We have talked this morning about the increase in
electronic filing, and as the number of returns that are filed
electronically has increased, that has resulted in a phasing
down, obviously fewer paper returns and a smaller footprint of
workforce in our submission processing pipeline. We have
already--Mr. Bishop's area has a center, and we have worked
through in Memphis as well, and Philadelphia is in line and,
ultimately, we will get down to a much smaller footprint.
Ms. Schwartz. What percentage of those 2,800 is that? All
of those people?
Mr. Everson. I don't know of exact--that is a new number
for me. I will certainly take a look at this hearing at
Philadelphia, but we have had a long-standing plan to phase
out, to consolidate submission processing of paper returns as
that grows down.
As we have done that, we have tried to make sure that we
are anchoring as much work in those centers and add work to
those centers from other areas where we can. And, as you know,
we are also making an investment in moving into the post office
there in Philadelphia. The campus right now in Philadelphia is
probably our worst facility of the big campuses. We want to do
the same thing there that we have done in Kansas City, where we
just reopened a much modernized, great facility.
Ms. Schwartz. I was not impressed with the facility. I was
impressed with the workers.
Mr. Everson. We are delighted that we are going to be able
to go down downtown and upgrade the post office.
We are working where we can to, obviously, find opportunity
for those individuals. We are committed to that, and I will
relook at it since you are raising it in terms of
opportunities.
But, again, as to collection itself, we do have issues as
to how many people you can bring on and train and get going.
And I would say to you again, as I just said to your colleague,
we do--it would be a period of several years before we would be
able to change our employment profile and get after the same
kinds of accounts that we are doing now in the private
collection agency.
I don't challenge--I am not the author of that $0.03 cost
figure, so I am not vouching for that, but I have said readily
that this could be done more cheaply by our people.
Ms. Schwartz. My time is almost up now, but if you had the
option, which you do not, but if you had the option to do it
in-house would that--you would be able to do that. You would be
pleased to do it. I am not sure what we are----
Mr. Everson. We happily take on all duties that the
Congress assigns us.
Ms. Schwartz. I do appreciate the opportunity to follow up
with you about the IRS.
Mr. Everson. Maybe we can visit sometime and see how the
work progresses in the new facility.
Ms. Schwartz. Thank you, Mr. Chairman.
Chairman Spratt. One housekeeping deal as we wrap up.
I ask unanimous consent that any member who did not have
the opportunity to ask questions today or who would like
clarification be given authority to submit questions for the
record. We would appreciate your cooperation in providing us
answers.
Mr. Everson. Certainly, sir.
Chairman Spratt. You were an excellent witness. We
appreciate your forthrightness and your full answers as well as
your forbearance. Thank you very much for coming, and we look
forward to working with you on these objectives that are set
out in the budget this year.
Mr. Everson. Thank you, Mr. Chairman. I appreciate the
opportunity to be here.
Chairman Spratt. The next panel will consist of Russell
George, who is the IG for Tax Administration; Michael Brostek,
who is the Director of Tax Issues; GAO Nina Olson, the National
Taxpayer Advocate, IRS; and Chris Edward, who is with the Cato
Institute.
I welcome all of you before our committee, and I will say
to each one of you that, if you have written testimony, we will
accept it for the record and make it, in its full, as part of
the record and allow you to summarize as we go forward. You
have been patient to wait. You have been good to prepare and to
come here for this hearing.
We are notified that we need to be on the floor at around
1:00 o'clock, so we are going to try to wrap this up in an hour
if we can.
Mr. George, just for a good starting point, let us start
with you, if you will.
STATEMENTS OF THE HON. J. RUSSELL GEORGE, INSPECTOR GENERAL FOR
TAX ADMINISTRATION, U.S. DEPARTMENT OF THE TREASURY; MICHAEL
BROSTEK, DIRECTOR, TAX ISSUES, STRATEGIC ISSUES TEAM, U.S.
GOVERNMENT ACCOUNTABILITY OFFICE; NINA E. OLSON, NATIONAL
TAXPAYER ADVOCATE, INTERNAL REVENUE SERVICE; AND CHRIS EDWARDS,
DIRECTOR OF TAX POLICY STUDIES, CATO INSTITUTE
STATEMENT OF THE HON. J. RUSSELL GEORGE
Mr. George. Thank you, Mr. Chairman, and at the outset, may
I say it is an honor to appear before you. As you may recall,
you and I worked together almost a dozen years ago when I was
Staff Director of Chairman Stephen Horn's subcommittee and you
were a member of that committee, and even at that time we
looked at issues such as the very one that we are discussing
today.
Chairman Spratt, Ranking Member Ryan, members of the
committee, thank you for the invitation to appear before you
today to discuss opportunities for closing the tax gap. The tax
gap is a complicated subject which at times appears simpler
than it really is. It is generally accepted that, every year,
the IRS fails to receive roughly $345 billion owed to the
Federal Government. As has been noted, that figure is
considered the gross amount not received. The net amount of the
tax gap is thought to be approximately $290 billion. TIGTA,
however, has expressed some doubts about the accuracy of these
figures. We are concerned that the IRS does not have a complete
picture of the magnitude of the problem, which is an essential
starting point to addressing the problem. Nonetheless, in 2006,
the IRS updated its estimate of the tax gap based on data from
the 2001 tax year.
While the updated information on individuals is important
since they comprise the largest segment of the tax gap, there
is no new information about employment, corporate and other
taxpayer segments. The Service does not have firm plans to
update the information study for these segments, as you heard
earlier. There are opportunities for the IRS to pursue new
initiatives related to the tax gap.
In our reviews of IRS programs, we have made
recommendations that would enhance the effectiveness and the
efficiency of the IRS' tax compliance programs. The IRS has
appropriately refocused audit attention on high-income
taxpayers. However, this has been done through an increase in
correspondence examinations as opposed to face-to-face reviews.
Correspondence examinations limit the tax issues that can be
addressed. High-income households typically have a large
percentage of their income that is not subject to third party
reporting and withholding. Without additional third-party
reporting, it is difficult to determine whether these taxpayers
have reported all of their income.
To improve tax compliance and business tax filings, TIGTA
has recommended that the IRS establish a comprehensive document
matching program for the various business documents it receives
similar to its program for verifying individual wage earnings.
Although implementing such a program among businesses would be
difficult, it could identify significant pockets of
noncompliance among business taxpayers.
Over the years, the IRS has had several strategies for
reducing the tax gap attributable to individual nonfilers.
Unfortunately, the IRS, since it was reorganized in 2002, each
IRS business division has been responsible for tracking and
monitoring its own action items. There is no formal system in
place for coordinating and tracking across all IRS business
divisions. In response to a 2005 audit report, the IRS took
some steps to improve efficiency in working nonfiler cases,
including the development of a nonfiler work plan. However, the
IRS still does not have a single executive charged with
overseeing its nonfiler efforts. It needs one.
In 1993, the IRS developed a voluntary compliance program
for the food and beverage industry, which was extended to the
cosmetology industry. The program has been successful. In tax
year 1994, $8.52 billion in tip wages were reported. In tax
year 2004, the amount exceeded $19 billion. Despite this
success, the IRS has not expanded the program to include other
industries which I believe will further enhance tax receipts.
The IRS needs to focus more attention on its role as a
collector of Social Security and Medicare taxes. These taxes
are primarily paid through payroll taxes with help from
employees, matching amounts paid by employers as well as
through self-employment taxes. However, the procedures the IRS
uses to implement this program have flaws. TIGTA recently
conducted a review of tax returns that were processed in 2005.
We estimated that the IRS has assessed $20 million in taxes,
but with changes to the procedures, the IRS could have assessed
approximately $20 million more. We recommended several changes
to this process which could result in an additional $108
million in Social Security and Medicare taxes each year.
Finally, to better address a growing number of investments
made abroad by U.S. residents estimated at $7.2 trillion in
2003, TIGTA has recommended that the IRS make better use of the
foreign source information it receives from tax treaty
countries. We have also recommended that prior to issuing
refunds to foreign partners, the IRS implement an automated
cross-check of withholding claims against available credits for
partnerships with foreign partners.
Mr. Chairman, while the IRS clearly needs the resources it
has requested, it also must use the resources it has more
efficiently and effectively.
Chairman Spratt. Let me just stop you at that point and
make a point.
Has your office submitted any legislation, proposed
legislation, to reduce these recommendations to recommendations
that were submitted to Congress or are they simply held
internally within the Internal Revenue Service?
Mr. George. Well, within the budget, the Department in
conjunction with the IRS submitted legislative proposals that
we have not had a role in, Mr. Chairman, and we have not
independently submitted legislation.
Chairman Spratt. Are the recommendations you just
enumerated part of the requests that the administration has
made to Congress this year----
Mr. George. Part of the budget----
Chairman Spratt [continuing]. The 15 or 16 different things
that the Commissioner just----
Mr. George. We are in the process of reviewing those, Mr.
Chairman.
Chairman Spratt. Okay. Excuse me. Go ahead.
Mr. George. Actually, that concludes my oral testimony,
sir.
[The prepared statement of J. Russell George follows:]
Prepared Statement of Hon. J. Russell George, Treasury Inspector
General for Tax Administration
introduction
Chairman Spratt, Ranking Member Ryan, and Members of the Committee,
I appreciate the opportunity to appear before you today to discuss the
tax gap.
The objective of our tax system is to fund the cost of government
operations. The Internal Revenue Service (IRS) attempts to meet this
objective by administering a tax system that provides adequate funding
for the Federal Government while ensuring fairness to all taxpayers.
But, as we know, the system has failed to capture a significant amount
of the tax revenue that is owed, which we call the tax gap. The IRS
defines the tax gap as ``the difference between what taxpayers are
supposed to pay and what is actually paid.'' \1\
It is worth noting, that if we were to capture the estimated annual
tax gap of $345 billion, it would completely offset the projected
fiscal year (FY) 2007 budget deficit of $172 billion and provide a
surplus of $173 billion.\2\ Considering it in those terms, the tax gap
poses a significant threat to the integrity of our voluntary tax
system. Therefore, one of my top priorities for TIGTA is to identify
opportunities for improvements to the IRS' administration of our tax
system. Similar to nearly all other Federal agencies, the IRS has
limited resources to apply to the objectives it seeks to achieve.
Nevertheless, the IRS must face the challenge of trying to increase
voluntary compliance and reduce the tax gap.
When I testified on the tax gap last year, I reported that some of
the most challenging barriers to closing the tax gap are tax law
complexity, incomplete information on the tax gap and its components,
and reduced IRS enforcement resources. These same barriers exist today.
However, while tax law simplification may help close the tax gap, a
portion of the tax gap may also be closed through more effective tax
administration and enforcement, as well as a commitment of additional
resources for those efforts.
My remarks will briefly discuss the size and source of the tax gap
and then present some of TIGTA's significant findings and
recommendations to improve tax administration and help reduce the tax
gap.
the tax gap: its size and sources
The IRS describes the tax gap as having three primary components--
unfiled tax returns, taxes associated with underreported income on
filed returns, and underpaid taxes on filed returns.\3\ Within the
underreported income component, the IRS has further delineated specific
categories of taxes, such as individual, corporate, employment, estate,
and excise taxes.\4\
In 2006, the IRS updated its estimate of the tax gap, which had
been based on data for tax year (TY) 1988. The new estimate was based
on data obtained from the National Research Program (NRP) for TY 2001
individual income tax returns.\5\ Data from the NRP were used to update
the 2001 tax gap figures. The IRS' most recent gross tax gap estimate
is $345 billion with a corresponding voluntary compliance rate (VCR) of
83.7 percent.
In any discussion about whether a specific VCR goal can be met, the
logical starting point would be an assessment of the reliability of the
measurement data. In April 2006, my staff reported results of a review
to determine whether the IRS' compliance efforts and strategies will
enable it achieve a greater VCR by 2010.\6\ In all three compliance
areas across the major tax gap segments--nonfiling, underreporting and
non-payment--TIGTA has concerns about whether the tax gap projections
are complete and accurate.\7\ While TIGTA has concerns about the
overall reliability of the tax gap projections, the review of the tax
gap estimates was not meant to be critical of the efforts the IRS took
in re-establishing compliance measurement. On the contrary, TIGTA
commended the IRS for restoring these critical measurements and for
designing them to be much less burdensome to taxpayers than previous
efforts. The IRS' updated estimate is based on the best available
information.
When considering the updated tax gap estimate, TIGTA found it
instructive to analyze what additional amounts the IRS would have had
to collect to increase voluntary compliance at different estimated
intervals for TY 2001. Figure 1 shows the range for TY 2001 based upon
the total tax liability for TY 2001, as estimated in February 2006. The
IRS has proposed in the FY 2007 budget that the VCR will be raised from
83.7 percent to 85 percent by 2009. Accordingly, if the total tax
liability remained constant, the IRS would have to collect, on a
voluntary and timely basis, $28 billion more in TY 2009, thus reducing
the gross tax gap to $317 billion. To reach 90 percent voluntary
compliance by TY 2010,\8\ the amount voluntarily and timely collected
for TY 2010 would be an additional $134 billion, thus reducing the
gross tax gap to $211 billion if the total tax liability remained
constant.
Figure 1: Additional Voluntary and Timely Payments Required to Reach
Specified VCR Levels\9\
Source: Treasury Inspector General for Tax Administration
In summary, TIGTA concluded in its review of the updated tax gap
estimate that the IRS still does not have sufficient information to
completely and accurately assess the overall tax gap and the VCR.
Although having new information about TY 2001 individual taxpayers is
better when compared to the much older TY 1988 information from the
last TCMP survey, some important individual compliance information
remains unknown. Additionally, although individuals comprise the
largest segment of taxpayers and were justifiably studied first, no new
information about employment, small corporate, large corporate, and
other compliance segments is available. With no firm plans for further
studies or updates in many areas of the tax gap, the current tax gap
estimate is an unfinished picture of the overall tax gap and
compliance.
the irs needs to overcome institutional impediments to more effectively
address the tax gap
Institutional impediments in this context of tax administration are
the established policies, practices, technologies, businesses processes
or requirements that add unintended costs or are no longer optimal
given changes to strategies, goals, and technologies. The costs of
these impediments include lost opportunities and the delayed
development of innovative solutions.
Impediments can also be perceived as opportunities. The removal of
an impediment creates opportunities to achieve increased efficiency and
effectiveness in tax administration. TIGTA's perspective is that the
current institutional impediments the IRS faces can give way to
beneficial opportunities.
incomplete compliance research
Performing a compliance measurement program is expensive and time
consuming. The estimated cost for performing the TY 2001 individual
taxpayer NRP was approximately $150 million. According to IRS
officials, resource constraints are a major factor in NRP studies and
affect how often the NRP is updated. Operational priorities must be
balanced against research needs. From FY 1995 through FY 2004, the
revenue agent workforce declined by nearly 30 percent while the number
of returns filed grew by over 9 percent. This shortfall in examiner
resources makes conducting large-scale research studies problematic.
The IRS' budget submission to the Department of the Treasury for FY
2007 requested funding to support ongoing NRP reporting compliance
studies. The IRS Oversight Board \10\ supports ongoing dedicated
funding for compliance research. Unfortunately, funding for those
resources in previous fiscal years did not materialize. Without a
resource commitment for continual updating of the studies, the
information will continue to be stale and less useful in measuring
voluntary compliance.
The IRS' National Research Program (NRP) is designed to measure
taxpayers' voluntary compliance, better approximate the tax gap, and
develop updated formulas to select noncompliant returns for
examination. The first phase of this program addressed reporting
compliance for individual taxpayers, and data from this phase were used
to produce the updated estimates of this portion of the tax gap. These
initial findings should enable the IRS to develop and implement
strategies to address areas of noncompliance among individual
taxpayers.
The second phase of the NRP, which has begun, focuses on Subchapter
S corporations (Forms 1120S). TIGTA recently reviewed the on-going NRP
study of Subchapter S corporations and reported that the study was
effectively planned.\11\ The NRP study is on target, with just over 17
percent of the examinations closed as of November 3, 2006. Revenue
agents conducting the examinations received appropriate and timely
training. A multi-layered quality review process is in place, and
feedback is provided when appropriate to resolve any problems
identified. The study should provide valuable data when completed.
While the IRS is actively involved in managing and monitoring the
NRP study, TIGTA noted some areas in which there can be further
improvement. Some NRP study results may not be complete, accurate, or
provide information sufficient to update existing return selection
formulas.
The NRP study instructions contained criteria for line
items on tax returns that are mandatory to select for examination.
Eleven of 61 tax returns that TIGTA reviewed contained these line
items, but the items were not identified for examination.
The NRP study process includes capturing demographic
information about each business examined. This information was
available in 9 of the 62 cases reviewed (the data were not always
available because TIGTA reviewed in-process cases). In two of the nine
cases, some of this information was inaccurate.
The Examination function relies in part on selection
formulas to identify tax returns that have greater potential for tax
adjustment. An independent review of this NRP study's sampling
methodology and sample size\12\ expressed concern that the sample size
may not be large enough to update the current selection formulas, and
recommended that other techniques be explored to analyze the results.
The three concerns TIGTA noted could reduce the reliability of the
NRP study results. However, the IRS is taking or has planned actions
that should reduce these risks. Final decisions on how to address these
concerns cannot be made until more of the examinations are completed.
As a result, TIGTA did not recommend any additional actions the IRS
should take. However, TIGTA will monitor the adequacy of the IRS'
decisions and actions to address the concerns in future reviews.
The individual and Subchapter S corporation NRP initiatives allow
the IRS to update return-selection models for more effective return
selection for its compliance efforts.
In 2005, TIGTA reported that the return-selection formulas,
developed in the 1980s, only accounted for the selection of 22 percent
of the corporate returns selected for examination in FY 2004.\13\
Updated selection models should contribute to more effective use of the
IRS' compliance resources.
In April 2006, TIGTA recommended that the IRS Commissioner continue
to conduct NRPs on a regular cycle for the major segments of the tax
gap.\14\ TIGTA also recommended that the IRS augment the direct
measurement approach, and devise indirect measurement methods to assist
in quantifying the tax gap. The IRS agreed with these recommendations,
subject to available resources. In addition, TIGTA recommended that the
IRS Commissioner consider establishing a tax gap advisory panel that
includes tax and economic experts to help identify ways to better
measure voluntary compliance. The IRS agreed to look into establishing
such an advisory group with the intent of using it to validate and
improve estimation methods.
increase the economy, efficiency and effectiveness of compliance
strategies
TIGTA has made several recommendations to improve the efficiency
and effectiveness of IRS operations. These improvements would help the
IRS address the tax gap. Some of TIGTA's more significant
recommendations concern:
Less Effective Examination Techniques Used for High-Income
Taxpayers.
Incomplete Document Matching.
Regulations for Granting Extensions of Time to File Delay
the Receipt of Taxes Due.
Uncoordinated Nonfiler Strategy.
Limited Tip Program Expansion.
Unclear Offer in Compromise Program Requirements.
Incomplete Payroll Tax Assessments.
less effective examination techniques used for high-income taxpayers
In July 2006, TIGTA reported the results of its review of the IRS'
increased examination coverage rate\15\ of high-income taxpayers.\16\
The increased coverage has been due largely to an increase in
correspondence examinations,\17\ which limit the tax issues the IRS can
address in comparison with face-to-face examinations. In addition, the
compliance effect may be limited because over one-half of all high-
income taxpayer examination assessments are not collected timely.
The examination coverage rate of high-income taxpayers increased
from 0.86 percent in FY 2002 to 1.53 percent in FY 2005. Included in
this statistic is an increase in the examination coverage rate of high-
income tax returns, Forms 1040 with a Schedule C. This examination
coverage rate increased from 1.45 percent in FY 2002 to 3.52 percent in
FY 2005. However, the increase in examination coverage is due largely
to an increase in correspondence, rather than face-to-face,
examinations. While face-to-face examinations increased by 25 percent
from FY 2002 through FY 2005, correspondence examinations increased by
170 percent over the same period.
As a result, the percentage of all high-income taxpayer
examinations completed through the Correspondence Examination Program
grew from 49 percent in FY 2002 to 67 percent in FY 2005. The increase
in correspondence examinations for high-income taxpayers who filed a
Schedule C was even larger. Examinations closed by correspondence
comprised about 30 percent of all high-income taxpayer Schedule C
examinations from FYs 2002 through 2004. In FY 2005, approximately 54
percent of all high-income taxpayer Schedule C examinations were
conducted by correspondence.
High-income households typically have a large percentage of their
income that is not subject to third-party information reporting and
withholding. The absence of third-party information reporting and
withholding is associated with a relatively higher rate of
underreporting of income among business taxpayers. It is difficult to
determine through correspondence examination techniques whether these
taxpayers have reported all of their income.
In FY 2004, the IRS assessed more than $2.1 billion in additional
taxes on high-income taxpayers through its Examination program. This
figure includes assessments of $1.4 billion (66 percent) on taxpayers
who did not respond to the IRS during correspondence examinations.
Based on a statistical sample of cases,\18\ TIGTA estimates that
approximately $1.2 billion (86 percent) \19\ of the $1.4 billion has
been either abated \20\ or not collected after an average of 608 days--
nearly two years after the assessment was made. Our conclusion is that
the Examination and Collection programs for high-income taxpayers may
not be positively affecting compliance, given the substantial
assessments that have been abated or not collected.
TIGTA recommended that the IRS complete its plan to maximize the
compliance effect of high-income taxpayer examinations. TIGTA also
recommended that the plan should include the mixture of examination
techniques, issues examined, and collection procedures. The IRS agreed
with our recommendations.
incomplete document matching programs
TIGTA has also identified improvements that should be made to
improve compliance in business tax filing.\21\ The GAO has reported
that more than 60 percent of U.S.-controlled corporations and more than
70 percent of foreign-controlled corporations did not report tax
liabilities from 1996 through 2000.\22\ Although individual wage
earners who receive a Wage and Tax Statement (Form W-2) have their
wages verified through a matching program, a similar comprehensive
matching program for business documents received by the IRS does not
exist. TIGTA has recommended that the IRS evaluate all types of
business documents it receives to determine whether this information
can be used to improve business compliance. In its response to our
recommendations, the IRS wrote that it could not implement this
recommendation at that time. However, the IRS also shared its belief
that ongoing efforts would provide the results that our recommendation
hoped to achieve and asked for the opportunity to continue its efforts.
An IRS study, based on TIGTA recommendations, found that in FY
2000, business information documents\23\ reported $697 billion of
potential taxable income.\24\ Furthermore, business information
documents identified 1.2 million unresolved IRS business nonfiler tax
modules. An IRS tax module contains records of tax liability and
accounting information pertaining to the tax for one tax period. TIGTA
has also reported on issues related to the increasing global economy.
Investments made abroad by U.S. residents have grown in recent years,
nearly tripling from $2.6 trillion in 1999 to $7.2 trillion in 2003. To
address the tax compliance challenges presented by foreign investments,
TIGTA recommended that the IRS make better use of the foreign-source
income information documents received from tax treaty countries. TIGTA
also recommended that, prior to issuing refunds to foreign partners,
the IRS implement an automated crosscheck of withholding claims against
available credits for partnerships with foreign partners.\25\
Implementing a comprehensive matching program to identify
noncompliance among businesses would be difficult and could require
some legislative changes, but it could identify significant pockets of
noncompliance among business taxpayers.
regulations for granting extensions of time to file delay the receipt
of taxes due
Taxpayer payment compliance means that the amounts owed are paid on
time. However, for decades, the IRS has allowed taxpayers with extended
return filing due dates to send in late payments and pay only interest
and small failure-to-pay penalties. Obtaining an extension of time to
file a tax return does not extend the due date for tax payments, and
failure-to-pay penalties are typically assessed when payments are made
late, even if the taxpayer has received an extension.
In 1993, IRS management eliminated the requirement to pay all taxes
by the payment due date in order to qualify for an extension of time to
file. Once an extension has been granted, the taxpayer is exempt from a
5 percent per month delinquency penalty\26\ for the period of the
extension. TIGTA evaluated the impact of these rules on individual and
corporate taxpayers and found that 88 percent of untimely tax payments
for returns filed after April 15 were attributable to extended-due-date
taxpayers.\27\ Corporations are required to pay estimates of their
unpaid taxes in order to be granted extensions. However, TIGTA found
corporate estimates to be highly flawed; in calendar year (CY) 1999
alone, approximately 168,000 corporations received an extension, yet
failed to pay $1.8 billion in taxes when they were due.
TIGTA projected that the tax gap from extension-related individual
income tax underpayments would amount to approximately $46.3 billion in
CY 2008, of which approximately $29.8 billion would not be paid until
after the end of FY 2008. Due to the more complex nature of corporate
taxes, similar figures were not available for corporations, although
TIGTA estimated that by TY 2008, approximately $768 million in
additional corporate taxes would be timely paid if TIGTA's
recommendations were adopted. The IRS agreed to study TIGTA's
recommendations.
uncoordinated nonfiler strategy
According to the IRS' February 2006 tax gap estimate, individual
and estate tax non-filers accounted for about 8 percent of the total
tax gap\28\ for TY 2001. Corporate income, estate and excise tax non-
filing estimates were not available. The IRS study, together with
previous IRS studies, indicates the tax gap for individual non-filers
almost tripled from $9.8 billion in TY 1985 to about $27 billion\29\ in
TY 2001.
In the past, the IRS has had several strategies for reducing the
tax gap attributable to individual non-filers. The most recent National
Non-filer Strategy, which was developed for FY 2001 through FY 2003,
was made obsolete in July 2002 when the IRS was reorganized. Since
then, each IRS business division has been responsible for tracking and
monitoring completion of its own action items. Consequently, there has
been no formal system in place for coordinating and tracking all
actions across all IRS divisions.
In November 2005, TIGTA reported that as increasing voluntary
compliance remains an organization-wide effort, the individual business
divisions within the IRS have taken steps to improve efficiency in
working non-filer cases.\30\ The actions taken by business divisions
included:
Consolidation of the Automated Substitute for Return
Program\31\ into one campus.\32\
Computer programming changes to enhance automated
processing of returns created by the IRS for non-filing businesses, as
authorized under Section 6020(b) of the Internal Revenue Code.\33\
Refinement of the processes for selection and modeling of
non-filer cases each year through risk-based compliance approaches. The
intention is to identify and select the most productive non-filer work
and to apply appropriate compliance treatments to high-priority cases.
Increased outreach efforts by the SB/SE Division through
its Taxpayer Education and Communication function.
An increase in the number of cases recommended for
prosecution by the Criminal Investigation Division from 269 in FY 2001
to 317 in FY 2004 (an increase of 17.8 percent).
However, these were not coordinated activities that were planned
and controlled within the framework of a comprehensive strategy. Since
FY 2001, each business division has independently directed its own non-
filer activities. The IRS did not have a comprehensive, national non-
filer strategy or an executive charged with overseeing each business
division's non-filer efforts. TIGTA concluded that the IRS needed
better coordination among its business divisions to ensure resources
are being effectively used to bring non-filers into the tax system and
ensure future compliance. The IRS also needed an organization-wide
tracking system to monitor the progress of each business division's
actions.
In addition to better coordination and an organization-wide
tracking system, the IRS also needed measurable program goals. TIGTA
suggested three measurable goals that could be established:
The number of returns secured from non-filers.
Total payments received.
The recidivism rate.
Without such measurable program goals, the IRS is unable to
determine whether efforts to improve program efficiency and
effectiveness are achieving desired results. The IRS agreed with all of
TIGTA's recommendations. For FY 2006, the IRS developed its first
comprehensive non-filer work plan.
limited tip program expansion
Historically, the IRS has been concerned about employees not
reporting tips earned in industries in which tipping is customary. An
IRS study showed that the amount of tip income reported in CY 1993 was
less than one-half of the tip income, leaving over $9 billion
unreported. To address this underreporting, the IRS developed the Tip
Rate Determination and Education Program (the Tip Program), which is a
voluntary compliance program originally designed for the food and
beverage industry. It was modeled after the tip compliance agreement
used by casinos in the former IRS Nevada District. The Tip Program
offers employers multiple voluntary agreement options designed to
provide nonburdensome methods for employers and employees to comply
with tip reporting laws. The Tip Program was extended to the
cosmetology industry in 1997 and the barber industry in 2000.
Since the Tip Program was introduced, voluntary compliance has
increased significantly. In TY 1994, tip wages reported were $8.52
billion. For TY 2004, the amount exceeded $19 billion. To date, over
16,000 employers, representing over 47,000 individual establishments,
have entered into tip agreements.
TIGTA reviewed the Tip Program and reported that the IRS has not
consistently monitored the establishments in the food and beverage and
cosmetology industries that had entered into tip agreements since FY
2000 to determine if tip agreements secured actually increased tip
income for these establishments.\34\ Additionally, due to the voluntary
nature of participation and limited IRS resources, disparity with the
number of tip agreements secured between various locations across the
country is an issue.
In FY 2006, the IRS did not plan to actively solicit any new tip
agreements beyond the gaming industry. The majority of FY 2006 Tip
Program staffing was to be expended on soliciting and monitoring tip
agreements with the gaming industry and on audits of casino employees.
Recognizing that the Tip Program has not reached some small
businesses in the food and beverage industry, the IRS developed the
Attributed Tip Income Program (ATIP). The Department of the Treasury
approved the ATIP Revenue Procedure on July 11, 2006 and the ATIP
Revenue Procedure was issued on July 28, 2006. The ATIP Revenue
Procedure aims at increasing tip reporting for small businesses that
report at least 20 percent of their tip income as charged tips. It
should provide benefits similar to those of previous tip reporting
agreements for employers and employees who report tips at or above a
minimum level of gross receipts.
The IRS plans to test the ATIP with the food and beverage industry
for three years. The ATIP Revenue Procedure was designed as a three-
year pilot to provide time to assess its impact on tip reporting
compliance. It will take up to this length of time to assess whether
the ATIP Revenue Procedure has achieved its goal and to consider
whether it is appropriate to expand and modify it for other industries.
TIGTA recommended several improvements to the IRS' Tip Program,
including expansion to the cosmetology and taxi/limo industries. The
Tip Program has not expanded to the taxi/limo industry. TIGTA estimated
that the IRS could achieve $342 million in additional tax assessments
over five years if it resumes soliciting new tip agreements with the
cosmetology industry and expands the agreements to the taxi/limo
industry.
The IRS agreed with TIGTA's recommendations, including
consideration of expanding the Tip Program after evaluating the results
of the ATIP with the food and beverage industry. If the ATIP proves
successful, the IRS should develop similar procedures for specific
industries, including the cosmetology and tax/limo industries.
unclear offer in compromise program requirements
The IRS has the authority to settle or compromise Federal tax
liabilities by accepting less than full payment under certain
circumstances. This is accomplished through an Offer in Compromise
(OIC). An OIC is an agreement between a taxpayer and the Federal
Government that settles a tax liability for payment of less than the
full amount owed. Improving the methods for identifying candidates for
the OIC could result in substantial benefits since taxpayers generally
do remain in compliance when offers are accepted. However, between FYs
1996 and 2005, only approximately 24 percent of the 1.1 million offers
received by the IRS were accepted. Over this same 10-year period, 50
percent either did not meet preconditions of filing an offer or were
returned to the taxpayer (e.g., for missing information) during the
offer evaluation.
Taxpayers who wish to participate in the program initiate an offer;
however, this attracts offer applications from taxpayers who do not
qualify for the program or taxpayers who do not fully understand the
depth of financial verification the IRS conducts before accepting an
offer. TIGTA analyzed offer dispositions and reported the following:
\35\
A significant number of offer applications do not meet the
preconditions of filing an offer. Those offers not meeting the
preconditions are returned to the taxpayers (as not-processable
returned offers) without further consideration. However, the IRS must
evaluate the processability of all offers received except those based
upon Doubt As to Liability.\36\
The IRS returns a substantial number of the offers
determined to meet the preconditions to taxpayers during the offer
evaluation process, without having fully evaluated the offers. This
occurs, for example, when taxpayers no longer meet the preconditions of
offer filing or did not provide information requested during the course
of the offer evaluation. The IRS closes these cases as processable
returns.
The high rates of returned offers occurred because requirements of
the OIC program were not always clear to taxpayers. In addition,
taxpayers had little to lose; if their offers were not accepted,
collection of their taxes was, in effect, delayed. The OIC application
fee implemented by the IRS during FY 2004 was intended to reduce the
number of frivolous offers; however, this fee is not applicable to
offers that are considered to be not-processable. Also, in light of the
potential benefit of a fresh start, the fee may not be significant to
some taxpayers.
The IRS effectively monitors accepted offers to ensure compliance
with the terms of the offers. TIGTA reviewed a sample of 84 taxpayers
whose offers were accepted during FY 1999. The IRS had identified
noncompliance in 33 (39 percent) instances and took appropriate action
to resolve the noncompliance. At the time of TIGTA's review, 96 percent
of the 84 taxpayers were in compliance with the OIC payment terms and
the five-year compliance requirements for filing their returns and
paying the taxes due.
The IRS conducted a more comprehensive analysis\37\ of individual
taxpayer compliance with filing and paying requirements for offers
accepted during CYs 1995 through 2001. According to that analysis,
approximately 80 percent of the individual taxpayers remained in
compliance. This includes taxpayers who received the first collection
notice but did not receive any subsequent notices.
Also, taxpayers remain in compliance after the five-year monitoring
period. TIGTA's review of a sample of 245 taxpayers whose offers were
accepted between October 1, 1994, and December 31, 1998, determined
that 220 taxpayers (90 percent) were compliant with filing and payment
requirements on tax periods subsequent to the five-year monitoring
period.\38\
incomplete payroll tax assessments
Social Security and Medicare taxes are paid to the Department of
the Treasury from two primary sources (1) payroll taxes consisting of
amounts withheld from employees and matching amounts paid by employers
and (2) self-employment taxes. Employers are generally required by law
to withhold from their employees' incomes the employees' shares of
Social Security and Medicare taxes. Included in the employer's
calculation of these taxes are wages earned by the employees and tips
received by the employees and reported to the employer. One-half of the
calculated tax amount is withheld from the employee's wages and the
employer pays a matching amount. Self-employed taxpayers must pay the
entire amount of Social Security and Medicare taxes themselves in the
form of self-employment taxes.
Social Security and Medicare Tax on Unreported Tip Income (Form
4137) was originally designed to calculate only the Social Security and
Medicare taxes owed on tips not reported to an employer, including any
allocated tips\39\ shown on the Wage and Tax Statement (Form W-2).
Forms 4137 are filed as attachments to U.S. Individual Income Tax
Returns (Form 1040). Form 4137 has the effect of assessing only the
worker's share of these taxes on the tip income. Although not
originally developed for this purpose, Form 4137 is also used by
certain taxpayers to report wages other than tips.\40\ These taxpayers
include employees whose employers are granted Section 530\41\ relief
and workers in dispute with their employers as to their employment
status (employee or self-employed).
Because Form 4137 can be used to report wages, it is possible for
some taxpayers to use the form inappropriately. This occurs when
taxpayers who are truly independent contractors or self-employed
individuals use the form to avoid paying their full share of Social
Security and Medicare taxes. By using the form inappropriately,
taxpayers reduce their share of these taxes by almost one-half. Self-
Employment Tax (Schedule SE), not Form 4137, should be used by these
taxpayers to pay their legitimate share of Social Security and Medicare
taxes. Even when taxpayers rightfully report wages on Form 4137 because
their employers have misclassified them as self-employed, Social
Security and Medicare taxes are underpaid, in this case by the
employers who failed to pay their share of the taxes.
TIGTA reviewed a statistical sample of 350 Forms 1040 with 357
Forms 4137 attached (each Form 1040 can have up to two Forms 4137
attached) processed in CY 2005 and determined that:
The IRS is not assessing the employer's share of Social
Security and Medicare taxes on unreported tip income. TIGTA estimated
$20 million in Social Security and Medicare taxes on tips were
assessed, and the IRS could have assessed approximately $20 million
more in Social Security and Medicare taxes on tips reported on Form
4137.
The lack of a specific form or adequate written
instructions increases the burden on taxpayers trying to report Social
Security and Medicare taxes on wages. TIGTA estimated this burden
increase affected about 377,850 taxpayers filing Forms 4137 during CY
2005.
Many taxpayers appear to be reporting self-employment
income as wages on Form 4137 to pay less Social Security and Medicare
taxes. TIGTA estimated the IRS could have assessed approximately $88
million more in Social Security and Medicare taxes on these wages each
year.\42\
TIGTA recommend that the IRS revise Form 4137 to capture the data
necessary to properly assess the employer's share of Social Security
and Medicare taxes on unreported tip income, revise instructions
regarding use of the form, and revise IRS training and procedures to
reflect the changes. Using the revised Form 4137, the IRS should
develop a compliance program to assess the employer's share of taxes on
the unreported tip income. In addition, TIGTA recommended that the IRS
create a new form to properly assess the worker's share of Social
Security and Medicare taxes on wage income, provide instructions
regarding use of the form, create IRS training and procedures regarding
the form, and develop a compliance program to ensure the form is used
properly and the appropriate amounts of Social Security and Medicare
taxes are assessed.
As the tax collectors for the Social Security program, the IRS must
help taxpayers meet their tax responsibilities by assessing and
collecting the proper amount of employment taxes in this area. By
making TIGTA's recommended changes, the IRS could assess an additional
estimated $108 million\43\ in Social Security and Medicare taxes each
year.
increase resources in the irs enforcement functions
Increased resources would help the IRS with its efforts to close
the tax gap. However, in addition to increased resources, the IRS must
also focus its efforts on ways to increase the economy, efficiency, and
effectiveness of its operations, which would allow the IRS to devote
more resources to its efforts to close the tax gap.
In September 1979, the GAO testified before Congress that ``The
staggering amount of income, at least $135 billion, on which taxes are
not paid is shocking.'' \44\ The GAO's testimony focused on the actions
the government should take. The recommended actions included ensuring
that the level of the IRS' audit activity did not decline.
Unfortunately, while there have been periods of increases in compliance
staffing, the IRS has also experienced declines over the years.
The combined Collection and Examination functions enforcement
personnel \45\ declined from approximately 22,200 at the beginning of
FY 1996 to 14,500 at the end of FY 2005, a 35 percent decrease. Even
though the IRS has started to reverse many of the downward trends in
compliance activities, the Collection and Examination functions'
enforcement staffing level is not much higher than the 10-year low
experienced in FY 2003. The President's FY 2008 proposed budget for
enforcement is approximately 5.7 percent more than the FY 2007
Continuing Resolution (CR) and requests an additional $246 million to
expand enforcement activities. Without this additional funding, the IRS
will not be positioned to increase enforcement activity above the level
provided for in the FY 2007 CR. Additionally, the FY 2007 CR amount for
enforcement is almost $48 million less than the FY 2006 funding.
Figure 4: Examination Staffing
Source: TIGTA analysis of IRS' Audit Information Management System
Table 37
The numbers in the preceding chart represent the number of
Examination function staff conducting examinations of tax returns,
excluding management and overhead staff. During FY 2005, revenue agent
and tax compliance officer (formerly referred to as tax auditor)
staffing decreased, and the combined total is now nearly 35 percent
lower than it was at the beginning of FY 1996.
Figure 5: Collection Function Staffing
Source: IRS Collection Reports
The numbers in the preceding chart represent the Collection field
function staffing at the end of each FY 1995 through 2005. The number
of revenue officers working assigned delinquent cases, excluding
management and overhead staff, decreased slightly during FY 2005 and is
nearly 38 percent fewer than at the start of FY 1996.
One effect of the lack of resources in the Collection function is
that the Queue,\46\ has increased significantly since FY 1996. In FY
1996, there were over 317,000 balance-due accounts worth $2.96 billion
in the Queue. In FY 2004, these figures had increased to over 623,000
balance-due accounts worth $21 billion. Additionally, the number of
unfiled tax return accounts in the Queue increased from over 326,000 in
FY 1996 to more than 838,000 in FY 2004.
The number of balance-due accounts ``shelved,'' or removed from the
Queue altogether because of lower priority, has also increased
significantly. In FY 1996, less than 8,000 of these balance due
accounts were shelved, but in FY 2004, more than 1 million of these
accounts were removed from inventory. From FY 2001 to FY 2004,
approximately 5.4 million accounts with balance-due amounts totaling
more than $22.9 billion were removed from Collection function inventory
and shelved. Additionally, in FY 2004 alone, more than 2 million
accounts with unfiled returns were shelved.
If increased funds for enforcement are provided to the IRS in
upcoming budgets, the resource issues in the Enforcement functions will
be addressed to some degree. In addition, use of Private Collection
Agencies is allowing the IRS to collect more outstanding taxes. The IRS
needs to be vigilant in overseeing these contractors to ensure that
abuses do not occur. However, past experiences with lockbox thefts and
insufficient contractor oversight provide valuable lessons toward
reducing the likelihood of similar issues occurring when contracting
out collection of tax debt.\47\
Overseeing the IRS' private debt-collection initiative is a top
priority for TIGTA. TIGTA has coordinated with the IRS during the
initial phases of implementation of this initiative by addressing
security concerns with the contracts and protection of taxpayer rights
and privacy, and by developing integrity and fraud awareness training
for the contract employees. TIGTA has also developed a three-phase
audit strategy to monitor this initiative and provide independent
oversight.
There are many areas in which increased enforcement could address
noncompliance. For example, a TIGTA audit found that a significant
number of single shareholder owners of Subchapter S corporations
avoided paying themselves salaries to avoid paying employment
taxes.\48\ We estimated this would cost the Treasury approximately $60
billion in employment taxes over five years. Under current law, the IRS
must perform an examination of these taxpayers to determine reasonable
compensation. To accomplish this on any scale would require significant
compliance resources.
Additional resources might also help the IRS address the growth in
fraudulent returns filed by incarcerated individuals. On June 29, 2005,
I testified before the House Committee on Ways and Means' Subcommittee
on Oversight about this growing problem.\49\ Although prisoner tax
returns account for only 0.43 percent of all refund returns, they
account for more than 15 percent of the fraudulent returns identified
by the IRS. Refund fraud committed by prisoners is growing at an
alarming rate. The number of fraudulent returns filed by prisoners and
identified by the IRS' Criminal Investigation function grew from 4,300
in processing year 2002 to more than 18,000 in processing year 2004 (a
318 percent increase).\50\ During that same period, all fraudulent
returns identified grew by just 45 percent.
The IRS' Fraud Detection Centers screen tax returns based on
criteria that identify potentially fraudulent filings. The number of
returns screened is based on these criteria and the available
resources. During processing year 2004, Fraud Detection Centers
screened about 36,000 of the approximately 455,000 refund returns
identified as filed by prisoners. Resources were not available to
screen the remaining 419,000 tax returns. Those returns claimed
approximately $640 million in refunds and approximately $318 million of
Earned Income Tax Credit (EITC). For those unscreened returns, over
18,000 prisoners incarcerated during all of CY 2003 filed returns with
a filing status as ``Single'' or ``Head of Household'' and claimed more
than $19 million in EITC. Since prisoners were incarcerated for the
entire year, they would have had neither eligible earned income to
qualify for the EITC nor a qualified child who lived with them for more
than six months.
The IRS also needs to focus efforts on improving the economy,
efficiency and effectiveness of its operations. For example, in 2002,
the IRS decided to reduce the number of its human resource positions
and to consolidate some of its support operations. The IRS determined
that 741 Full-Time Equivalents (FTE) \51\ could be eliminated from its
headquarters and field offices. This was just one part of a series of
initiatives the IRS intended to use to realign approximately 12,000
positions to front-line tax professional positions over the following
two years.
Through the use of early retirements, buyouts, normal attrition,
placements elsewhere, and involuntary separations,\52\ the IRS was able
to meet its desired reduction of human resource positions. However, the
IRS does not track vacated and reassigned individual positions. While
the other IRS initiatives involved in the effort to reassign 12,000
positions to the front-line were not reviewed, TIGTA determined that
from FY 2003 to FY 2005, the number of employees in mission critical
positions\53\ increased by only 1,216, far short of the goal the IRS
documented in its request to the OPM.\54\ TIGTA did not determine why
the IRS did not achieve its goal.
In a plan submitted to the OPM, the IRS cited specific benefits
that would be realized if it received authorization to offer early
retirements and buyouts. The plan indicated that the IRS would save an
average of $2,746 per employee. However, neither TIGTA nor the IRS
could determine if savings were realized. The IRS' Human Capital Office
did not prepare any analysis to determine the total costs of, or any
savings associated with, offering the early retirements and buyouts.
After the IRS was granted the early retirement and buyout authorities,
it did not formally assign responsibility for overseeing the
reorganization to any single office or individual. As a result, no one
was responsible for monitoring the reorganization to ensure that the
benefits outlined in the plan to the OPM, such as the realignment of
staff to mission critical positions and cost savings, were actually
achieved.
TIGTA recommended that the IRS monitor and report on the progress
of any IRS reorganization initiative, including how effectively the IRS
achieves proposed reductions or staffing realignments. TIGTA also
recommended that the IRS identify and track all costs incurred and any
savings realized and that the IRS follow all early retirement and
buyout rules and regulations. The IRS agreed with TIGTA's
recommendations.
The FY 2008 IRS proposed budget shows a net increase of $409.5
million to enhance the IRS' infrastructure and invest in modernization.
This increased investment in the IRS infrastructure is necessary to
ensure the capability to administer the tax laws, collect the revenue
and to better position the IRS to reduce the tax gap.
According to the IRS, the $409.5 million will allow the IRS to
increase enforcement revenue by $699 million by 2010. The legislative
proposals contained in the budget are projected to increase revenue by
approximately $2.9 billion a year. At these levels, the tax gap will
not be seriously reduced. Even if these initiatives indirectly
increased compliance 10 fold, the tax gap would still exceed $300
billion.
The budget also contains $41 million for non-NRP research. TIGTA
believes that by employing enhanced research methods, the IRS will be
better positioned to develop more effective and efficient solutions to
non compliance, which should lead to reductions in the tax gap.
Although increasing enforcement is important in addressing the tax
gap, the IRS must exercise great care not to emphasize enforcement at
the expense of taxpayer rights and customer service. Customer service
goals must be met and even improved upon, or people will lose
confidence in the IRS' ability to meet part of its mission to provide
America's taxpayers with quality service by helping them understand and
meet their tax responsibilities.
conclusions
The IRS faces formidable challenges in completely and accurately
estimating the tax gap and also in finding effective ways to remove
institutional impediments and optimize its opportunities to increase
voluntary compliance. Strategies have been identified to decrease the
tax gap and improvements can be realized; however, sufficient resources
are needed to ensure compliance with the tax laws.
Mr. Chairman and members of the committee, I appreciate the
opportunity to share my views on the tax gap and the work TIGTA has
done in this area. I would be happy to answer any questions you may
have.
endnotes
\1\ Hearings on Bridging the Tax Gap Before the Senate Committee on
Finance, 108th Cong. (2004) (statement of Mark Everson, Commissioner of
Internal Revenue).
\2\ In January 2007, the Congressional Budget Office estimated that
if today's laws and policies did not change, Federal spending would
total $2.7 trillion in 2007 and revenues would total $2.5 trillion,
resulting in a budget deficit of $172 billion. The additional funding
that is likely to be needed to finance military operations in Iraq and
Afghanistan would put that deficit in the vicinity of $200 billion.
\3\ This definition and the associated categories have evolved over
time. IRS tax gap estimates in 1979 and 1983 included unpaid income
taxes owed from illegal activities such as drug dealing and
prostitution. That practice was discontinued in the 1988 estimate.
Reasons given for excluding this category are: 1) the magnitude of the
illegal sector is extremely difficult to estimate; and 2) the interest
of the government is not to derive revenue from these activities, but
to eliminate the activities altogether. Earlier tax gap figures such as
those for 1965 and 1976 only included underreporting. While figures for
more recent years (1992, 1995, 1998 and 2001) are more comparable, they
are essentially the same estimates adjusted for the growth in the
economy. Thus, comparing the figures does not show real growth in the
tax gap. Lastly, comparisons among years are not done in constant
dollars, so any real growth in the tax gap cannot be determined through
this IRS data.
\4\ This category includes the lesser amounts of overclaimed
credits and deductions.
\5\ Prior to the National Research Program, tax gap estimates were
based on the results of the IRS Taxpayer Compliance Measurement Program
(TCMP), which was a systematic program of tax return examinations
conducted to facilitate the compilation of reliable compliance data.
The last TCMP process involved TY 1988 individual income tax returns.
\6\ Some Concerns Remain About the Overall Confidence That Can Be
Placed in Internal Revenue Service Tax Gap Projections (TIGTA Reference
Number 2006-50-077, dated April 2006.
\7\ The IRS defines the gross tax gap as the difference between the
estimated amount taxpayers owe and the amount they voluntarily and
timely pay for a tax year. The portion of the gross tax gap that is not
eventually collected is called the net tax gap.
\8\ This is the amount previously described in this report that was
called for by Senator Baucus. See Some Concerns Remain About the
Overall Confidence That Can Be Placed in Internal Revenue Service Tax
Gap Projections (TIGTA Reference Number 2006-50-077, dated April 2006.
\9\ Payment of the $55 billion estimated by the IRS as late or
enforced payments does not affect the VCR. However, it does affect the
total amount collected by the IRS. Therefore, TIGTA developed the
Eventual Compliance Rate term that shows the effect of these payments
when coupled with additional voluntary and timely payments that do
affect the VCR.
\10\ According to the IRS Oversight Board Web site
(irsoversightboard.treas.gov), it is an ``independent body charged to
oversee the IRS in its administration, management, conduct, direction,
and supervision of the execution and application of the internal
revenue laws and to provide experience, independence, and stability to
the IRS so that it may move forward in a cogent, focused direction.''
\11\ The National Research Program Study of S Corporations Has Been
Effectively Implemented, but Unnecessary Information Was Requested From
Taxpayers (TIGTA Reference Number 2007-30-027, dated January 30, 2007).
\12\ An Evaluation of The Sample Design for The National Research
Program Study of Subchapter S Corporations (Mathematica Policy Research
Inc., dated May 12, 2005).
\13\ The Small Business/Self-Employed Division Is Beginning to
Address Challenges That Affect Corporate Return Examination Coverage
(TIGTA Reference Number 2005-30-130, dated August 2005).
\14\ Some Concerns Remain About the Overall Confidence That Can Be
Placed in Internal Revenue Service Tax Gap Projections (TIGTA Reference
Number 2006-50-077, dated April 2006).
\15\ The examination coverage rate is calculated by dividing the
number of examined returns in a category by the number of returns in
the same category filed in the previous year.
\16\ While Examinations of High-Income Taxpayers Have Increased,
the Impact on Compliance May Be Limited (TIGTA Reference Number 2006-
30-105, dated July 25, 2006).
\17\ Correspondence examinations are important compliance
activities focusing on errors and examination issues that typically can
be corrected by mail. They are conducted by sending the taxpayer a
letter requesting verification of certain items on the tax return.
These examinations are much more limited in scope than office and field
examinations in which examiners meet face to face with taxpayers to
verify information.
\18\ TIGTA selected the sampled cases from those completed in FY
2004 to provide sufficient time for collection activities.
\19\ Margin of error + 5.05 percent.
\20\ Abatement occurs when the IRS reduces an assessment, in this
case from reversing examination findings that had uncovered apparent
misreported income, deductions, credits, exemptions, or other tax
issues.
\21\ The IRS Should Evaluate the Feasibility of Using Available
Documents to Verify Information Reported on Business Tax Returns (TIGTA
Reference Number 2002-30-185, dated September 2002).
\22\ General Accounting Office, Pub. No. GAO-04-358, TAX
ADMINISTRATION: Comparison of the Reported Tax Liabilities of Foreign-
and U.S.-Controlled Corporations, 1996-2000 (2004).
\23\ The IRS receives over 30 different types of business
information documents yearly. Most of these forms have a legal
requirement for issuance to corporations. The three information
documents most often issued to business nonfilers are Forms 1099-B
(Proceeds from Broker and Barter Exchange Transactions), 1099-MISC
(Miscellaneous Income), and 4789 (Currency Transaction Reports).
\24\ Internal Revenue Service, Report of BMF IRP Nonfilers for TY
2000 (Corporations, Partnerships, and Trusts), Research Project
02.08.003.03, SB/SE Research (July 2004).
\25\ Stronger Actions Are Needed to Ensure Partnerships Withhold
and Pay Millions of Dollars in Taxes on Certain Income of Foreign
Partners (TIGTA Reference Number 2001-30-084, dated June 2001);
Compliance Opportunities Exist for the Internal Revenue Service to Use
Foreign Source Income Data (TIGTA Reference Number 2005-30-101, dated
July 2005).
\26\ The Delinquency Penalty is also known as the Failure-to-File
Penalty, although it only applies to taxpayers who both file late and
fail to pay all taxes by the tax payment deadline.
\27\ The Regulations for Granting Extensions of Time to File Are
Delaying the Receipt of Billions of Tax Dollars and Creating
Substantial Burden for Compliant Taxpayers (TIGTA Reference Number
2003-30-162, dated August 2003); Changes to the Regulations for
Granting Extensions of Time to File Corporate Returns Are Needed to
Alleviate Significant Problems With Administering the Tax Laws (TIGTA
Reference Number 2004-30-106, dated June 2004).
\28\ The non-filer tax gap is the dollar amount of taxes not paid
timely on delinquent and non-filed returns.
\29\ The estimated tax gap of $27 billion in TY 2001 was comprised
of $25 billion for individual income tax non-filing and $2 billion
associated with estate and gift tax. The estimate is developed from
other tax gap data sources and is not derived from direct data sources.
So, the growth in the dollar amounts in the estimate track the
increases in other tax gap estimates.
\30\ The Internal Revenue Service Needs a Coordinated National
Strategy to Better Address an Estimated $30 Billion Tax Gap Due to Non-
filers (TIGTA Reference Number 2006-30-006, dated November 2005).
\31\ The Automated Substitute for Return Program focuses on high-
income taxpayers who have not filed individual income tax returns but
appear to owe significant income tax liabilities based on available
Information Reporting Program information.
\32\ The campuses are the data processing arm of the IRS. They
process paper and electronic submissions, correct errors, and forward
data to the Computing Centers for analysis and posting to taxpayer
accounts.
\33\ Internal Revenue Code Section 6020(b) (2005) provides the IRS
with the authority to prepare and process certain returns for a non-
filing business taxpayer if the taxpayer appears to be liable for the
return, the person required to file the return does not file it, and
attempts to secure the return have failed.
\34\ Additional Enhancements Could Improve Tax Compliance of
Employees Who Receive Tips (TIGTA Reference Number 2006-30-132, dated
September 15, 2006).
\35\ The Offer in Compromise Program Is Beneficial but Needs to Be
Used More Efficiently in the Collection of Taxes (TIGTA Reference
Number 2006-30-100, dated July 2006).
\36\ Offers submitted on the basis of Doubt As to Liability
represent disputes over the existence or amount of the tax liability
and apply to the specific tax periods that are in question.
\37\ IRS Offers in Compromise Program, Analysis of Various Aspects
of the OIC Program, September 2004.
\38\ The number of tax years for which taxpayers were compliant
after completion of the offer monitoring period varies based on the
offer acceptance date. At the time of TIGTA's review, taxpayers in the
sample had been compliant from one to five tax years after the offer
monitoring period.
\39\ When the amount of tips reported by an employee of a large
food or beverage establishment is less than 8 percent (or an approved
lower rate) of the gross receipts, other than nonallocable receipts,
for the given period, the employer is required to allocate tips to the
employee. If the employee is reporting more than the 8 percent, there
would be no allocated tip amount.
\40\ For tax purposes, tips are generally considered to be wages.
However, for purposes of this report, wages are defined as compensation
other than tips paid to an employee.
\41\ Revenue Act of 1978, Pub. L. No. 95-600, Section 530, 92 Stat.
2763, 2885-86 (current version at Internal Revenue Code Section 3401
note).
\42\ Draft Report: Social Security and Medicare Taxes Are Not Being
Properly Assessed on Some Tips and Certain Types of Wage Income (TIGTA
Audit Number 200630005, dated February 13, 2007).
\43\ This is comprised of approximately $20 million in Social
Security and Medicare taxes on tips and approximately $88 million in
Social Security and Medicare taxes on wages.
\44\ Statement of Richard L. Fogel, Associate Director, General
Government Division before the Subcommittee on Commerce, Consumer and
Monetary Affairs of the House Committee on Government Operations,
September 6, 1979.
\45\ Collection and Examination function staff located in field
offices, excluding management and overhead staff.
\46\ An automated holding file for unassigned inventory of lower
priority delinquent cases that the Collection function does not have
enough resources to immediately assign for contact.
\47\ Federal Requirements Need Strengthening at Lockbox Banks to
Better Protect Taxpayer Payments and Safeguard Taxpayer Information
(TIGTA Reference Number 2002-30-055, dated February 2002); Insufficient
Contractor Oversight Put Data and Equipment at Risk, (TIGTA Reference
Number 2004-20-063, dated March 2004).
\48\ Actions Are Needed to Eliminate Inequities in the Employment
Tax Liabilities of Sole Proprietorships and Single-Shareholder S
Corporations (TIGTA Reference Number 2005-30-080, dated May 2005).
\49\ Hearing to Examine Tax Fraud Committed by Prison Inmates,
109th Cong. (2005) (statement of J. Russell George, Inspector General)
and The Internal Revenue Service Needs to Do More to Stop the Millions
of Dollars in Fraudulent Refunds Paid to Prisoners (TIGTA Reference
Number. 2005-10-164, dated September 2005).
\50\ Processing year refers to the year in which taxpayers file
their returns at the Submission Processing Sites. Generally, returns
for 2003 were processed during 2004, although returns for older years
were also processed.
\51\ A measure of labor hours in which 1 FTE is equal to 8 hours
multiplied by the number of compensable days in a particular fiscal
year. For FY 2005, 1 FTE was equal to 2,088 hours. For purposes of this
report, we are using the terms FTEs, employees, and positions
synonymously.
\52\ An involuntary separation is any separation against the will
and without the consent of the employee, other than for misconduct or
delinquency. The most common cause for an involuntary separation is a
reduction in force.
\53\ The IRS uses the term mission critical occupations to define
occupations deemed critical to front-line operations as well as those
occupations that provide direct support to front-line operations.
Mission critical positions are specific positions within those
occupations.
\54\ Staff Reductions in Support Operations Did Not Result in
Significant Increases in Mission Critical Positions (TIGTA Reference
Number 2006-10-175, dated September 28, 2006).
Chairman Spratt. Thank you very much.
Ms. Olson.
STATEMENT OF NINA E. OLSON
Ms. Olson. Thank you, Mr. Chairman, Mr. Ryan and members of
the committee. Thank you for inviting me to testify today about
the tax gap. I believe there are three principal steps that can
be taken to address this gap.
First, Congress should simplify the Tax Code. Corporate tax
shelters and abusive schemes pursued by individual taxpayers
exist solely because there are ambiguities and complex laws
that they can exploit. At the same time, tax law complexity
confounds taxpayers and is responsible for the significant
majority of taxpayer reporting errors.
Second, Congress should consider expanding third-party
information reporting and, in certain situations, withholding
requirements. IRS data show a direct correlation between third-
party information reporting by payers of income and tax
reporting compliance by the recipients of income. Where tax is
withheld from income, taxpayer reporting compliance is above 99
percent. Where income is reported to the IRS, such as interest
on dividends on a Form 1099, taxpayer reporting compliance is
above 95 percent. Where income is not reported to the IRS,
taxpayer reporting compliance drops below 50 percent. Expanded
information reporting would reduce the tax gap significantly,
and backup withholding can be used where taxpayers repeatedly
underpay their taxes, but both must be done with care to avoid
placing undue burdens on the payers of income tax. I discuss
this issue in more detail in my written statement.
I will devote the rest of my testimony today to my third
point because it falls squarely within your committee's
jurisdiction.
I believe the rules by which the IRS is funded need to be
fixed so that the IRS receives adequate resources to collect
taxes. As a starting point, we should keep in mind that the IRS
functions as the Accounts Receivable Department of the Federal
Government. On a budget of about $10.6 billion, the IRS
currently collects about $2.24 trillion a year. That translates
to an average return on investment, or ROI, of about 210 to 1,
but the congressional budget rules do not recognize the IRS'
unique role as the revenue generator for the Federal
Government. Rather, the budget rules treat spending for the IRS
exactly the same way they treat spending for all other Federal
programs. The IRS is placed within a category of spending
programs that is subject to a spending ceiling, and the
relevant appropriations subcommittee then allocates dollars
between the IRS and the other agencies. Thus, the IRS competes
dollar for dollar against classic spending programs for
resources, and there is no explicit mechanism in the budget
process for recognizing the revenue that the IRS collects.
These procedures make little sense. If the Federal Government
were a private company, its management clearly would fund the
Accounts Receivable Department at a level that it believed
would maximize the company's bottom line.
Since the IRS is not a private company, maximizing the
bottom line is not and in and of itself should not be an
appropriate goal, but the public sector analogy should be to
maximize tax compliance, especially voluntary tax compliance,
with due regard for protecting taxpayer rights and minimizing
taxpayer burden. No one seems to dispute this premise, but the
current budget rules treat the IRS as a classic spending
program, and a change in the rules will be required if the IRS
is to be treated the way a company would treat its Accounts
Receivable Department.
In the last 3 years, the administration has proposed and
Congress has considered a mechanism known as ``program
integrity caps'' to give the IRS additional funding. While
these cap adjustments are better than nothing, they suffer from
two flaws. First, they do not address the fundamental problem I
am raising, which is that decisions about IRS funding levels
should be made on the basis of maximizing tax compliance, not
fitting within a cap. Second, the program integrity caps have
generally been used to provide additional funding for tax law
enforcement without providing any additional funding for
taxpayer service. This is happening because the IRS can
document that it collected $48.7 billion through direct
enforcement actions last year, and budget crunchers can compare
this figure with the dollars spent on enforcement to compute a
positive return on investment.
The problem with this approach is that $48.7 billion is
only 2 percent of the revenue that the IRS collected. The
remaining 98 percent of revenues were collected through some
combination of taxpayer service and the indirect or deterrent
effects of enforcement. The IRS current strategic plan is based
on the formula of taxpayer service plus enforcement equals
compliance, but there are no data that show whether there is a
greater need at this time for service or enforcement. In the
absence of such data, I think it is misguided to provide
disproportionate increases to enforcement simply because we
have measurement tools to compute the ROI with respect to 2
percent of our collections.
In my written statement, I describe some recent and
expected reductions in taxpayer service and the negative
effects these reductions could have on compliance.
In conclusion, I urge the committee to consider making
changes to the budget rules to provide funding for the IRS at a
level designed to maximize tax compliance and that does not
short-change taxpayer service as taxpayer service may provide
an equal or greater ROI than enforcement. In focusing on what
the IRS can do to reduce the tax gap, I suggest that giving the
IRS the tools to do the job in conjunction with proper
oversight is the single most helpful step Congress can take.
Thank you.
[The prepared statement of Nina E. Olson follows:]
Prepared Statement of Nina E. Olson, National Taxpayer Advocate
Mr. Chairman, Ranking Member Ryan, and distinguished Members of the
Committee, thank you for inviting me to testify today about ``The IRS
and the Tax Gap.''\1\ In the National Taxpayer Advocate's 2006 Annual
Report to Congress, issued last month, I made a recommendation to
address the tax gap that falls squarely within the jurisdiction of the
Budget Committee--namely, to change the budget rules by which IRS
funding decisions are made to provide funding at whatever level will
maximize tax compliance, with due regard for protecting taxpayer rights
and minimizing taxpayer burden. I will describe my proposal in more
detail below after first summarizing the components of the tax gap and
describing my perspective on the best strategies to address it.
I. Why the Tax Gap Matters
In my 2006 report, I designated the tax gap as the second most
serious problem facing taxpayers (after the alternative minimum tax).
From a taxpayer perspective, I am deeply concerned that compliant
taxpayers are paying a great deal of money to subsidize noncompliance
by others. Using data from the IRS's 2001 National Research Program
study, if we divide the estimated 2001 net tax gap of $290 billion\2\
by the estimated 108,209,000 households that existed in the United
States in that year\3\ we see that each household was effectively
assessed an average ``surtax'' of about $2,680 to subsidize
noncompliance.\4\ That is an extraordinary burden to ask our nation's
compliant taxpayers to bear every year, and it is imperative that we
take steps to reduce that burden.\5\
Noncompliance has a corrosive effect on tax compliance. If
compliant taxpayers believe that everyone else is paying his or her
fair share, they are likely to remain compliant. But no one wants to
feel like a ``tax chump.'' If compliant taxpayers feel like they are
overpaying, some will reach a point where they resent it and stop
complying or comply at a lower level.
In other words, there is a degree to which compliance breeds more
compliance and noncompliance breeds more noncompliance. That is largely
why each additional dollar the IRS collects is thought to increase
federal revenue by substantially more than a dollar. Greater
compliance--whether brought about through taxpayer service or
enforcement--can pay for itself many times over.
II. Overview of the Primary Causes of the Tax Gap
Last year, the IRS substantially updated its tax gap estimates as a
result of a set of audits it performed on individual income tax returns
filed for 2001. The results of the audits show that withholding and
third-party information reporting are the key drivers of tax
compliance. Reporting compliance rates are about 99 percent on wages
subject to withholding and third-party information reporting, about 96
percent on income subject to full third-party information reporting
(e.g., interest and dividends)--yet less than 50 percent on income not
subject to third-party information reporting.\6\
At the same time, the complexity of the tax code is a driver of
noncompliance because it creates loopholes that aggressive taxpayers
can exploit. Corporate tax shelters and abusive schemes pursued by
individual taxpayers exist largely because of ambiguities in the law.
Tax-law or procedural complexity is also responsible for the
significant majority of taxpayer reporting errors.\7\
Finally, the lack of funding provided to the IRS to maximize
taxpayer service (especially outreach and education) and enforcement
(where the IRS was only able to conduct face-to-face audits of one out
of every 435 taxpayers last year) prevents the IRS from maximizing tax
compliance.\8\
III. Broad Strategies to Address the Tax Gap
Broadly speaking, I have advocated three strategies for closing the
tax gap: (1) fundamental tax simplification, with an emphasis on making
economic transactions more transparent; (2) expanded third-party
information reporting and, in certain situations, tax withholding on
non-wage income; and (3) a more robust IRS compliance program that
appropriately balances taxpayer service and enforcement.
a. tax simplification
In my annual reports to Congress, I have highlighted numerous
examples of tax law complexity and described the consequences of that
complexity for taxpayers and tax administration. For taxpayers seeking
to comply with the law, complexity presents a huge obstacle. To cite a
few examples, the alternative minimum tax (AMT) and the earned income
tax credit (EITC) affect millions of taxpayers yet present substantial
compliance burdens. The sheer number of alternative incentives that the
tax code provides for saving for education and retirement baffles many
taxpayers, including sophisticated taxpayers.
For taxpayers seeking to exploit loopholes, complexity presents
countless opportunities. Many law firms, accounting firms, and
investment banking firms have made tens of millions of dollars by
scouring the Code for ambiguities and then advising taxpayers to enter
into transactions, with differing levels of business purpose or
economic substance, to take advantage of those ambiguities. The IRS
devotes significant resources to identifying these transactions and
challenging them, where appropriate, but many are legitimate under
existing law and many more fall into a grey area.
A simpler tax code could reduce these administrative challenges
enormously.
Moreover, traditional economic analysis focuses on the goals of
equity and efficiency in writing the tax laws. To those, I would add
transparency. To the extent we can revise the Code to provide greater
transparency of payments of income without imposing undue burden on
taxpayers, the higher compliance rates associated with third-party
information reporting can be more readily achieved in a broader array
of transactions.
b. expanded third-party information reporting
Expanding third-party information reporting would clearly improve
compliance, but we must be realistic in taking into account the burden
third-party information reporting imposes on payors of income. If our
sole objective were to maximize the amount of tax revenue, we could
simply require that anyone making a taxable payment to another person
report the payment to the IRS. But requiring everyone making a taxable
payment to file a report with the government would impose more burden
than most of us would be willing to bear. No one wants to be obligated
to file a document with the IRS every time he takes a cab ride, has
someone mow his lawn, or calls a plumber to fix a broken faucet.
To address the tax gap, we should begin by identifying various
categories of transactions that currently are not subject to
information reporting and determine, on a case-by-case basis, whether
the benefits of requiring reporting outweigh the burdens such a
requirement would impose. In many cases, we will ultimately decide that
it is inappropriate to impose a reporting requirement. But in some
cases, we may decide that requiring reporting is appropriate.
To cite one example, I recommended in my 2005 Annual Report to
Congress that Congress consider requiring broker-dealers to track and
report their customer's cost-basis in stocks and mutual funds when
sales are made. Under existing rules, brokers are required to file a
Form 1099-B (Proceeds from Broker and Barter Exchange Transactions)
with the IRS whenever a customer sells a security. However, the
reporting rules only require the broker to report the gross proceeds
the customer receives upon the sale. The broker does not have to report
the customer's cost basis in the security. That omission is significant
because a taxpayer's gain or loss on the sale of a security is measured
by the excess of gross proceeds over cost basis. Thus, the absence of
cost-basis reporting provides an opportunity for noncompliance that the
IRS rarely will detect without an audit.
The absence of a requirement that brokers track and report
customers' cost basis in securities has two consequences. First, it
often imposes significant compliance burdens on taxpayers who may not
have kept track of their cost basis. To illustrate, a taxpayer who has
held AT&T stock since the 1980s has received shares in more than a
dozen companies over the years, and on each such occasion, the
taxpayer's cost basis had to be split between his existing holding and
the spun-off company. Similarly, most mutual fund customers elect to
have dividend and capital gain distributions automatically reinvested,
and the customer's aggregate basis in a mutual fund holding changes
upon each such distribution. If taxpayers don't have complete records,
they will be unable to determine or substantiate their basis in many
instances. We recommended requiring brokers to track and report cost
basis primarily because it would make compliance much easier for honest
taxpayers.
But the second consequence of the absence of cost basis reporting
is that it affords less honest taxpayers with significant opportunities
to overstate their basis and therefore understate their tax
liabilities. Reliable estimates of the amount of underreporting in this
area are difficult to come by, but two professors have sized the
problem at about $25 billion a year.\9\ IRS officials studying the NRP
data believe the revenue loss is substantially lower, but they agree
that the level of underreporting reaches into the billions of
dollars.\10\ We have spoken with representatives of the brokerage
industry and believe on balance that the revenue benefits of requiring
brokers to track and report cost basis exceed the burdens the
requirement would impose.
I am pleased that bills were introduced in both the House and the
Senate last year to implement our proposal, and I am pleased that the
Treasury Department has included it among the revenue proposals it sent
to Congress earlier this month. Bipartisan bills have been introduced
in the new Congress by Congressmen Rahm Emanuel and Walter Jones in the
House and by Senators Evan Bayh, Tom Coburn and 11 other original co-
sponsors in the Senate. I strongly urge Congress to enact this measure.
Another example: Under current law, an individual taxpayer can
escape information reporting by incorporating. This is true even if the
taxpayer is performing the same services that would be subject to Form
1099-MISC (Miscellaneous Income) reporting if the taxpayer were
conducting business as an unincorporated entity.
For Form 1099-MISC information reporting purposes, I believe there
should be no distinction between taxpayers providing the same services
for compensation merely because one taxpayer has incorporated and
another has not. There are, of course, many valid reasons for choosing
to conduct business as a corporation, but information-reporting
avoidance should not be such a reason. Corporate taxpayers who intend
to comply with the tax law should have no objections to receiving a
Form 1099-MISC for compensation for services performed or to IRS
awareness of this compensation. Thus, we recommend that corporate
taxpayers (including Subchapter S corporations) be subject to Form
1099-MISC reporting requirements to the same extent that unincorporated
businesses are today.
We also recommend that Congress consider requiring information
reporting on gross proceeds from sales conducted on Internet auction
and sales sites. As with current rules governing Form 1099 reporting,
such reports could be subject to a de minimis annual exemption (say,
$600). One recent study found that 700,000 Americans reported that eBay
sales constitute their primary or secondary source of income.\11\ The
IRS must have the tools needed to address under-reporting of this
income.
My office has made a number of proposals to reduce the tax gap both
through more third-party information reporting and through other
methods. The Exhibits that follow my statement summarize our main
recommendations.
c. a more robust irs compliance program that appropriately balances
taxpayer service and enforcement measures
The IRS can do more--much more--to improve tax compliance.
Despite a finding by a leading IRS researcher that the direct and
indirect benefits of IRS's preparing tax returns for low income
taxpayers pays for itself many times over,\12\ the IRS has reduced by
about half the number of tax returns it helps low-income taxpayers
prepare in its walk-in sites.\13\ Despite the challenges individuals
who start small businesses face in learning for the first time about
the legal requirements they face as employers (including the payroll
responsibilities of income and employment tax withholding, paying over
tax to the IRS, reporting to the IRS, and reporting to the employee),
the IRS has substantially reduced its field outreach operation.\14\
Despite the number of taxpayers in certain states with taxable income
from farming activities, the IRS has apparently declared questions
about farm income and expenses ``out of scope'' for IRS walk-in sites
in those areas.\15\
On the enforcement side, the IRS is currently conducting face-to-
face audits of only about one out of every 435 tax returns.\16\ It does
not have the resources to pursue a significant percentage of its
accounts receivable. And the private debt collection initiative, a
controversial program that is projected to raise only about $1.4
billion over the next 10 years,\17\ results from the IRS's lack of
resources to pursue these cases itself.
IV. A Proposal to Revise the Congressional Budget Rules to Improve IRS
Funding Decisions
a. overview of the problem of irs underfunding
The Internal Revenue Service is effectively the Accounts Receivable
Department of the United States Government. On a budget of about $10.6
billion,\18\ the IRS currently collects about $2.24 trillion a
year.\19\ That translates to an average return-on-investment (ROI) of
about 210:1.\20\
Rather than recognizing the IRS's unique role as the revenue
generator for the federal government, however, the congressional budget
rules treat spending for the IRS exactly the same way they treat
spending for all other federal agencies.
The current budget procedures work essentially as follows: Early
each year, a spending ceiling is established for a category of programs
that in recent years included the Department of Transportation, the
Department of the Treasury (of which the IRS is a part), the Department
of Housing and Urban Development, the Judiciary, the District of
Columbia, and independent federal agencies.\21\ The House and Senate
Appropriations subcommittees with jurisdiction over this grouping of
federal programs must apportion the total number of dollars it receives
among them. If more funding was provided for transportation programs,
for example, less funding was available for the IRS. Thus, the IRS
competes dollar-for-dollar against many other federal programs for
resources.
These procedures make little sense. The IRS collects about 96
percent of all federal revenue.\22\ The more revenue the IRS collects,
the more revenue Congress may spend on other programs or may use to cut
taxes or reduce the deficit. The less revenue the IRS collects, the
less revenue Congress has available for other purposes.
If the federal government were a private company, its management
clearly would fund the Accounts Receivable Department at a level that
it believed would maximize the company's bottom line.
Since the IRS is not a private company, maximizing the bottom line
is not--in and of itself--an appropriate goal. But the public sector
analogue should be to maximize tax compliance, especially voluntary
compliance, with due regard for protecting taxpayer rights and
minimizing taxpayer burden. If the IRS were given more resources,
studies show the IRS could collect substantially more revenue.
Former IRS Commissioner Charles Rossotti has written:
When I talked to business friends about my job at the IRS, they
were always surprised when I said that the most intractable part of the
job, by far, was dealing with the IRS budget. The reaction was usually
``Why should that be a problem? If you need a little money to bring in
a lot of money, why wouldn't you be able to get it?'' \23\
Yet obtaining a little extra money to bring in a lot of extra money
remains an intractable challenge for the IRS. Over the past few years,
Congress has focused increasing attention on the ``tax gap''--the
difference between taxes owed and taxes paid. As part of this
discussion, it should be recognized that the IRS currently suffers from
a ``resources gap,'' and the IRS's lack of resources is a significant
impediment to its ability to help close the tax gap and thereby reduce
the federal budget deficit.\24\
b. the consequences of underfunding the irs
The failure to fund the IRS at appropriate levels leads to two sets
of consequences. First, the IRS lacks the resources to collect a
significant amount of unpaid tax, resulting in a larger tax gap and a
larger budget deficit. Second, the lack of resources often leads the
IRS to take steps that are, in my judgment, unwise from the standpoint
of tax compliance and taxpayer rights.
1. Failure to Collect Unpaid Taxes
In his final report to the IRS Oversight Board in 2002, former
Commissioner Rossotti presented a discussion titled ``Winning the
Battle but Losing the War'' that detailed the consequences of the lack
of adequate funding for the IRS. He identified 11 specific areas in
which the IRS lacked resources to do its job, including taxpayer
service, collection of known tax debts, identification and collection
of tax from non-filers, identification and collection of tax from
underreported income, and noncompliance in the tax-exempt sector.
Commissioner Rossotti provided estimates of the revenue cost in
each of the 11 areas based on IRS research data. In the aggregate, the
data indicated that the IRS lacked the resources to handle cases worth
about $29.9 billion each year. It placed the additional funding the
agency would have needed to handle those cases at about $2.2
billion.\25\
Significantly, this estimate reflects only the potential direct
revenue gains. Economists have estimated that the indirect effects of
an examination on voluntary compliance provide further revenue gains.
While the indirect revenue effects cannot be precisely quantified, two
of the more prominent studies in the area suggest the indirect revenue
gains are between six and 12 times the amount of the proposed
adjustment.\26\
I want to emphasize that the existing modeling in this area is not
especially accurate, and estimates of both the direct and indirect
effects of IRS programs vary considerably. As I will discuss below, the
IRS needs to develop better modeling to produce more accurate return-
on-investment estimates. But I also want to emphasize that almost all
studies show that, within reasonable limits, each additional dollar
appropriated to the IRS should generate substantially more than an
additional dollar in additional federal revenue assuming the funding is
wisely spent.
2. Bad Results
a. Outsourcing Tax Collection
In the same report, former Commissioner Rossotti reported the IRS
was receiving sufficient resources to work only 40 percent of some 4.5
million accounts receivable cases each year. IRS research estimated
that with an additional $296.4 million, the agency could collect $9.47
billion.\27\ That translates to a return on investment of 32:1. Among
collection cases handled solely through phone calls, the IRS has
estimated an ROI of about 13:1.\28\
Because Congress has not provided IRS with sufficient funding to
work these accounts, the Administration requested the authority to
outsource the collection of certain tax debts to private collection
agencies. Congress granted the requested authority in 2004,\29\ and the
IRS began to send cases to private debt collectors in September of
2006.
Under the terms of the program, the IRS is paying out commissions
of up to 25 percent of each dollar collected to the private collection
agencies. The IRS is also bearing significant additional costs to
create, maintain, and oversee the program.\30\
Internal IRS estimates show that the IRS, if given the funding,
could generate a substantially higher ROI than private contractors
receiving commissions of nearly 25 percent can produce. For each dollar
a PCA collects, the IRS will receive about 75 cents and the PCA will
keep about 25 cents, resulting in an ROI of, at best, about 3:1. The
significant administrative costs the IRS is incurring to run the
program, including the opportunity costs of pulling experienced IRS
personnel off higher dollar work to assist with this initiative, reduce
the ROI further. Despite supporting the use of private debt collectors
because of IRS resource limitations, IRS Commissioner Mark Everson has
repeatedly acknowledged that IRS employees could collect unpaid taxes
more cheaply and efficiently.\31\
The result of underfunding the IRS in this area is that the
government is not maximizing its revenue collection and the risk of
taxpayer rights violations has been heightened due to the use as
collectors of non-governmental employees who will receive only limited
taxpayer-rights training.\32\
b. Neglect of Important Taxpayer Service Programs
The IRS has long acknowledged that taxpayer service plays a
significant role in promoting tax compliance. In fact, its current
strategic plan is based on the principle: ``Service + Enforcement =
Compliance.'' \33\ Yet two examples illustrate the neglect of important
services that likely is resulting in a higher tax gap.
Tax Return Preparation. The IRS historically has prepared tax
returns for low income taxpayers at its walk-in sites (called
``Taxpayer Assistance Centers,'' or ``TACs ''). Low income taxpayers
generally qualify for the earned income tax credit (EITC), which is a
refundable credit that caps out at $4,536 in 2006. Studies show that
the average overclaim rate for EITC benefits is between 27 percent and
32 percent.\34\ IRS personnel who prepare tax returns are trained to
ask questions that minimize the likelihood of EITC overclaims and thus
can save the government hundreds of dollars per return. Yet to free up
resources for other program initiatives, the IRS has substantially
reduced return preparation at its TACs. The number of tax returns it
prepared dropped from 665,868 in FY 2003 to a projected 305,000 in FY
2006.
IRS data for tax years 2002 through 2004 suggest that EITC returns
prepared by IRS TACs may be significantly more compliant than self-
prepared and commercially prepared returns. Discriminant Function (DIF)
scores\35\ for self-prepared returns were between 21 and 26 percent
higher than returns prepared at the TACs and between 25 and 31 percent
higher than returns prepared by commercial preparers.\36\
These findings are corroborated by examination results for EITC
returns for these tax years. As compared with TAC-prepared returns,
average audit assessments among EITC returns for tax years 2002--2004
ranged from about $640 to $1,300 higher for self-prepared returns and
from about $820 to $1,300 higher for commercially prepared returns.\37\
Similarly, a study conducted in 1996 that examined the relationship
between IRS return preparation and compliance over a ten-year period
showed that an increase in the number of returns prepared by the IRS
correlates with improvements in compliance among filers of individual
returns.\38\
Small Business Outreach. IRS data show that self-employed taxpayers
account for the largest chunk of the tax gap and indicate that the tax
compliance rate for self-employed taxpayers runs at about 43
percent.\39\ Much of the underreporting is deliberate, but some is not.
For example, many small businesses are started by individuals who lack
detailed knowledge of the tax laws and do not have the resources to
hire tax attorneys or accountants. When they hire a few workers, they
often do not realize that they are assuming tax reporting, tax
withholding, and tax payment obligations, and they often do not
understand enough about the details of complying with the requirements
to do so with reasonable effort.
After the IRS Restructuring and Reform Act of 1998, the IRS
developed a function known as Taxpayer Education and Communications, or
``TEC.'' TEC was the IRS's outreach arm to small businesses to try to
educate them about the complexity of their tax obligations. For 2002,
TEC was named the Small Business Administration's agency of the year
for what the SBA called its outstanding progress in creating an
effective education and compliance assistance program for small
business and self-employed taxpayers.\40\ Yet in the name of achieving
``efficiencies,'' TEC was ``realigned'' in February 2005 through a
merger with other outreach functions and redesignated as ``Stakeholder
Liaison.'' Prior to the realignment, TEC had 536 employees. After the
realignment, Stakeholder Liaison staffing included 219 employees.\41\
In my view, the reduction in TEC staffing will reduce tax compliance
and place a greater burden on IRS enforcement personnel.
I cite these examples to make two points. First, although I
disagree with certain decisions the IRS has made, the failure to
provide the IRS with adequate resources to collect taxes has forced the
IRS to cut corners in places where corners should not have to be cut.
Second, I cite the examples of tax return preparation and TEC to
underscore the important role taxpayer service plays in promoting tax
compliance. As I discuss below, additional funding for the IRS should
be provided in a balanced manner. The revenue derived from direct
enforcement actions may be easier to measure, but the effects of
taxpayer service may be equally significant and perhaps more
significant.
c. recommendations
1. Congress should consider revising its budget rules in a manner that
allows the budget and appropriations committees to make a
judgment about the answer to the question: ``What level of
funding will maximize tax compliance, particularly voluntary
compliance, with our nation's tax laws, with due regard for
protecting taxpayer rights and minimizing taxpayer burden?''
and then set the IRS funding level accordingly, without regard
to spending caps.
This recommendation, in my view, boils down to simple common sense.
Just as a business could not survive if it did not seek to maximize
revenue collection, the federal government has less revenue to spend
(or use to reduce the deficit or cut taxes) if it fails to optimize tax
collection. Taxes are truly the lifeblood of government, for without
tax revenue, there would be no government programs. As the National
Taxpayer Advocate, I will be the first to raise objections if the
pursuit of revenue proceeds without due regard for protecting taxpayer
rights and minimizing taxpayer burden. But the existing budget rules,
which pit the revenue center of the government in direct competition
with cost centers and do not have a mechanism for explicitly taking
into account the revenue the IRS is likely to generate, are not
logical. The congressional budget rules are the one piece of the tax
gap over which your committee has direct control, and I urge you to
consider improvements to the process.
One way to implement the proposal I have outlined would be to keep
the IRS within its existing appropriation bill but break that bill into
two parts--one providing a funding cap for the IRS and one providing a
funding cap for all other programs under that bill. The budget
committees would set the funding cap for the IRS.\42\ The
appropriations committees then would retain discretion to appropriate
funds at the cap or at a lesser level and to provide direction
concerning how the funds are to be spent. The rules should explicitly
authorize the committees to set the cap at a level that they believe
will maximize tax compliance, especially voluntary compliance, with due
regard for the protection of taxpayer rights and minimization of
taxpayer burden. In setting the cap and making funding decisions, the
budget and appropriations committees would consider the President's
budget request as well as input from the tax-writing committees, the
Congressional Budget Office, the Joint Committee on Taxation, the
Government Accountability Office, the Congressional Research Service
and any other office that they choose to consult to obtain revenue
estimates and guidance concerning the likely return on IRS spending.
We offer this approach only as an illustration of a way to
implement the general principle we are recommending. We do not have
sufficient expertise in the congressional budget process to craft a
comprehensive solution, and we are cognizant of the important roles
that the budget committees, the appropriations committees, and the tax-
writing committees play. Our overriding recommendation is simply that
the committees of jurisdiction collaborate to devise and implement
procedures that reflect the general principles we have outlined.
We note that in each of the past three years, the Administration
has proposed a contingent budgetary mechanism known as a ``program
integrity cap'' in an attempt to provide the IRS with additional
funding. Under this mechanism, additional funding for tax-law
enforcement would have been provided if, but only if, Congress agreed
to fund at least the existing base of enforcement activities. The
Senate has endorsed the concept, but the House did not go along.
Although there may have been subtle differences in detail, a similar
approach was used in FY 1995 to give the IRS additional funding.\43\
Because the Budget and Appropriations committees have become familiar
with this mechanism, it may be a viable way to channel additional
funding to the IRS.
However, we have two concerns about the use of program integrity
caps. First, the mechanism operates simply to mitigate the effects of
what we are arguing is a flawed conceptual approach to funding the IRS.
It would not alter the existing framework under which the IRS competes
for funding against other government programs, and it would not peg
future IRS funding decisions to the goal of maximizing tax compliance.
I believe a change to the process along the lines of what I am
recommending would be far preferable in the long run and would be more
likely to result in a consistent ramp-up in funding year-over-year.
Second, the mechanism in the past has been proposed solely to boost
enforcement spending (i.e., the additional funding could be used only
for tax-law enforcement and would only be provided if Congress agreed
to fund at least the existing base of enforcement activities). As
discussed below in more detail, tax compliance is a function not only
of enforcement but also of taxpayer service, and it is important to
maintain a balanced approach between the two. If program integrity caps
are used in the future, we urge that consideration be given to
providing additional funding for taxpayer service as well as
enforcement.
2. In allocating IRS resources, Congress should keep in mind that tax
compliance is a function of both high quality taxpayer service
and effective tax-law enforcement, and it is essential that the
IRS continue to maintain a balanced approach to improving tax
compliance.
As noted, recent attempts to give the IRS additional funding beyond
the levels provided under the spending caps have focused exclusively on
providing additional funding for enforcement activities. That is so
largely because the direct ROI resulting from enforcement actions is
somewhat susceptible to measurement, while the deterrent effect of
enforcement actions and the effect of taxpayer service are too
amorphous to quantify. However, it is important to emphasize that
direct enforcement revenue in FY 2006 came to only $48.7 billion, or 2
percent, of total IRS tax collections of $2.24 trillion.\44\ The
remaining 98 percent of IRS tax collections resulted from a combination
of taxpayer service programs and the indirect (i.e., deterrent) effect
of IRS enforcement actions. To make budgeting decisions by striving to
maximize the 2 percent of collections without grappling adequately with
what is required to maximize the remaining 98 percent of collections is
a bit like letting the tail wag the dog.
The Administration's FY 2008 budget request acknowledges this
dilemma. It states: ``The IRS cannot currently measure either the
impact of deterrence or service, but they are positive.'' \45\ In fact,
there are no reliable data that show whether the IRS would achieve a
greater ROI if it spends additional funds on service or on enforcement.
In the absence of such data, one might think the government would err
on the side of assisting taxpayers in complying with the law rather
than disproportionately ramping up enforcement. If Congress continues
to provide the IRS with greater increases for enforcement each year
simply because the ROI of direct enforcement can be quantified, the
cumulative effect of those increases over time will be to relatively
shift the IRS away from taxpayer service and toward tougher
enforcement--with no evidence that such a shift will increase revenues
and with the possibility that such a shift might decrease revenues.
As former Commissioner Rossotti has written:
Some critics argue that the IRS should solve its budget problem by
reallocating resources from customer support to enforcement. In the
IRS, customer support means answering letters, phone calls, and visits
from taxpayers who are trying to pay the taxes they owe. Apart from the
justifiable outrage it causes among honest taxpayers, I have never
understood why anyone would think it is good business to fail to answer
a phone call from someone who owed you money.\46\
Because of recent budget pressures and additional service
obligations brought about by the late passage of the tax extenders bill
and the administration of telephone excise tax refunds, the IRS is
actually expecting that it will reduce the percentage of phone calls it
answers from the mid-80s to the mid-70s this year, if not lower. The
IRS has been working hard on a five-year taxpayer service strategic
plan, developed in response to a Senate Appropriations directive in FY
2006. This plan was developed in collaboration with my office and the
IRS Oversight Board. It is an excellent product, and it describes well
how the IRS can improve its ability to meet taxpayer service needs.
I urge you to keep in mind that taxpayer service provides a
positive ROI, and the ROI of taxpayer service may even exceed the ROI
of enforcement. The budget rules should be crafted to ensure that the
ability to score direct revenue gains resulting from enforcement does
not drive results that may be counterproductive. Perhaps the
``scorekeepers'' could use a blended ROI of taxpayer service and
enforcement actions to support a balanced approach to additional IRS
funding.
Many aspects of taxpayer service are akin to a wholesale operation
that reaches groups of taxpayers (e.g., outreach and education), while
IRS audits constitute a far more costly retail operation that requires
individual taxpayer contact. The IRS should pursue a balanced approach
to tax compliance that puts priority emphasis on improving IRS outreach
and education efforts, while reserving targeted enforcement actions to
combat clear abuses and send a message to all taxpayers that
noncompliance has consequences.\47\
3. Congress should provide increases in IRS personnel funding at a
steady but gradual pace, perhaps two percent to three percent a
year above inflation. We do not think the IRS can ramp up its
staffing more quickly without encountering significant
transitional difficulties. However, Congress should consider
providing more rapid funding increases for technology and
research improvements, as the transitional challenges of
absorbing additional resources are probably less significant in
these areas and the potential exists to generate substantial
productivity gains.
In former Commissioner Charles Rossotti's final report to the IRS
Oversight Board in 2002, he described the serious total staffing
shortages the IRS was facing. He stated that the IRS needed ``steady
growth in staff in the range of 2 percent per year.''\48\ The context
shows he was discussing real increases (i.e., increases above those
required to maintain current services).
At first blush, real annual staff growth of two percent might
appear to be an extremely limited request, but the IRS faces
significant challenges in adding and training staff. Examination and
collection procedures, in particular, are complex, as is the underlying
tax law, and experienced personnel must be pulled off revenue-producing
priority cases to provide extensive training to new hires. Moreover,
new hires generally have lower productivity rates and require
significantly closer supervision than experienced employees to ensure
they do not take incorrect actions, including actions that impair or
violate taxpayer rights.
However, the IRS probably can absorb more rapid funding increases
in technology and research, both of which have the potential to
increase IRS productivity substantially.
Better technology would allow the IRS to achieve significant
efficiencies in a broad range of taxpayer service and enforcement
areas. For example, it would allow the IRS to offer taxpayers a wider
range of e-filing options to increase the number of taxpayers who file
their returns electronically rather than on paper (which would save IRS
the cost of manually entering data from the roughly 64 million
individual income tax returns it received on paper in FY 2005),\49\ and
it would allow the IRS to expand its document-matching capabilities,
which tend to produce high returns on investment because automated
processes are relatively inexpensive to operate and maintain.
Better research would allow the IRS to assess the most cost
effective ways of meeting taxpayer service needs and to target its
limited enforcement resources to maximize its return on investment. We
discuss the importance of obtaining more accurate ROI estimates for the
IRS's major categories of work under Recommendation #4 below.
In the past, congressional support for additional IRS funding has
come in fits and starts. It will not be helpful to provide too much
additional funding immediately. It also will not be helpful to provide
additional funding for a year or two and then to change direction. To
maximize the IRS's ability to do its job, the IRS needs to receive
gradual but steady real increases in its total funding every year for
at least the next five to ten years.
4. To assist Congress in performing its oversight responsibilities and
determining the appropriate IRS funding level in future years,
Congress should require the IRS to provide annual or semiannual
reports detailing IRS's progress in handling all significant
categories of work, including the known workload, the
percentage of the known workload the IRS is able to handle and
the percentage of the known workload the IRS is not able to
handle, the additional resources the IRS would require to
perform the additional work, and the likely return-on-
investment of performing that work.\50\
In this connection, Congress should consider directing the IRS to
undertake additional research studies, perhaps utilizing the expertise
of outside experts, to improve the accuracy of its ROI estimates for
various categories of work, especially taxpayer service and the
indirect effect of enforcement actions, including the downstream costs
of such work. Improved methods should also be developed to verify,
retrospectively, the marginal ROI that the IRS has achieved for each
category of work.
To provide Congress with meaningful information, the IRS will need
to conduct more research to improve the accuracy of its ROI
calculations. As we have noted above, direct enforcement revenue
constitutes only about two percent of the revenue the IRS collects.
Ninety-eight percent of the revenue the IRS collects derives from its
taxpayer service programs and the indirect deterrent effect of its
enforcement activities. Yet the IRS currently does not have adequate
data on which to make accurate estimates of the ROI of its various
categories of work, including taxpayer service programs and the
indirect effect of its enforcement activities as a whole and broken
down by their key components. Developing better data should be made a
priority objective. Moreover, ROI estimates should include costs
relating to the downstream consequences--such as increased phone calls
or correspondence, Appeals conferences, and Taxpayer Advocate Service
cases--of the various categories of IRS work.
We acknowledge that developing reasonably accurate modeling is a
significant challenge and will require a commitment of resources.
Nonetheless, we have recommended in the past and continue to believe
that this information will aid the IRS substantially in making resource
allocation decisions and will provide Members of Congress with
additional information on which to base future funding decisions.\51\
V. Conclusion
The tax gap is a serious problem because it deprives the government
of revenue it needs and it creates inequities between compliant
taxpayers and noncompliant taxpayers. There is no silver bullet that
will eliminate the tax gap. I believe significant progress can be made,
however, by following an approach that emphasizes fundamental tax
simplification, expanded third-party information reporting, and a more
robust IRS compliance program.
The Budget Committee has the jurisdiction to change the existing
budget rules that, in my view, have unreasonably constrained IRS
funding and limited the agency's ability to maximize tax compliance. I
urge the Committee to use its jurisdiction to improve the process by
which IRS funding decisions are made.
VI. EXHIBIT A: CASH ECONOMY--ADMINISTRATIVE RECOMMENDATIONS
------------------------------------------------------------------------
Recommendation Summary Reason
------------------------------------------------------------------------
1 Expand use of Send self- Self-employed taxpayers who
Electronic employed want to comply with their
Federal Tax taxpayers estimated tax payment
Payment System a letter obligations sometimes fail
(EFTPS) to remind because they have
them when difficulty estimating
estimated income, remembering oddly
tax spaced payment dates (April
payments 15, June 15, September 15
are due and January 15), and saving
and offer enough money each quarter.
the When they fail to pay
option of enough estimated taxes,
paying they are more likely to
electroni understate their liability.
cally, by
phone or
via
automatic
monthly
(or
biweekly)
withdrawa
ls from
the
taxpayer'
s bank
account
free of
charge.------------------------------------------------------------------------
2 Revise Form 1040, Include This revision would
Schedule C separate encourage taxpayers to
lines report income even if it is
showing not subject to information
(1) the reporting. Taxpayers are
amount of more likely to report
income income that is reported to
reported the IRS by third parties on
on Forms information returns, such
1099 and as Forms 1099. Some
(2) other taxpayers appear to believe
income that income not reported on
not information returns is not
reported subject to tax or at least
on Forms that the IRS will not
1099. notice if they do not
report it. Separating out
gross receipts on the
income tax form as we
propose would likely
improve compliance by
emphasizing to taxpayers
that income not reported on
information returns is
still subject to tax. It
may also suggest to them
that the IRS will notice if
they do not report any
other income. Another
benefit of such a revision
is that it would allow the
IRS to match the income
reported on Schedule C with
income reported on Forms
1099 more easily.------------------------------------------------------------------------
3 Revise business Include These two questions would
income tax two encourage taxpayers to
return forms questions comply with information
: (1) Did reporting requirements.
you make They would also suggest to
any taxpayers that the IRS is
payments looking at information
over $600 reporting compliance and
in the that there is additional
aggregate risk to avoiding the
during information reporting
the year requirements by paying
to any contractors ``under the
unincorpo table.'' Payments reported
rated to the IRS on information
trade or returns are much more
business? likely to be reported on
(2) If the payee's income tax
yes, did return. Thus, increased
you file information reporting
all compliance would cause
required contractors (payees) to
Forms report more of their
1099? income.------------------------------------------------------------------------
4 Implement more Encourage Research shows that
voluntary taxpayers taxpayers are most
withholding to enter compliant in paying taxes
agreements into on income subject to
voluntary withholding. Unlike
withholdi payments to employees,
ng payments to independent
agreement contractors are generally
s by not subject to withholding.
agreeing Businesses sometimes have
not to difficulty determining
challenge whether service providers
the should be classified as
classific employees or independent
ation of contractors and the IRS
workers often challenges such
who are a determinations. These
party to agreements could reduce
such an both underreporting by
agreement payees and the controversy
. associated with worker
(Statutor classification.
y
authority
exists
under IRC
sss
3402(p)(3
), but
the IRS
may need
to work
with the
Treasury
Departmen
t to
issue
regulatio
ns before
it can
use its
authority
and may
prefer
additiona
l
legislati
ve
authority
.)------------------------------------------------------------------------
5 Institute backup Require By the time a payor receives
withholding more mandatory a backup withholding notice
quickly backup from the IRS, the payee
withholdi (service provider) may no
ng to longer be receiving
begin payments from the service
more recipient. Thus, the IRS
quickly has lost the opportunity
when for backup withholding. For
taxpayers additional information see
provide National Taxpayer Advocate
an 2005 Annual Report to
invalid Congress 238-248 (MSP:
TIN to Limited Scope of Backup
the Withholding Rules).
payor.------------------------------------------------------------------------
6 Use more Use more The IRS currently uses
available of the information from Forms 8300
information informati to identify returns that
on may have unreported income.
available It also receives and uses
from state income tax audit
state and reports as well as sales
local tax records, which a cross-
governmen functional team has
ts as concluded could be used
well as more consistently and
informati effectively. States and
on from localities also impose
Forms business license taxes or
8300 require different classes
(Report of licenses, which are
of Cash sometimes based on gross
Payments receipts. Such information
Over may be useful in detecting
$10,000 unreported income. Local
Received property taxes are also
in a based on the value of real
Trade or and personal property.
Business) Taxpayers whose property
when holdings are
selecting disproportionately large in
returns comparison to the income
for audit reported on their federal
and when income tax returns may be
auditing underreporting their
them. income. The IRS could
combine all of this
information, perhaps in
conjunction with the UI-DIF
(or to improve it), for
selecting returns for audit
and auditing them.------------------------------------------------------------------------
7 Establish local A local Because tax compliance
compliance planning trends and norms are
planning organizat frequently local, it will
organizations ion could be difficult for the IRS to
work to effectively address them
identify without local feedback
local about how its strategies
complianc are affecting taxpayers in
e a given community. The IRS
challenge needs such information and
s, direct feedback so that it can
the IRS's adjust its strategy to
local effectively address local
response, compliance issues. If
and noncompliance is so
measure commonplace in a local
its market that the price of a
effective good or service does not
ness. reflect tax compliance
costs, suppliers may be
unable to both pay their
taxes and compete. However,
if the IRS could motivate a
critical number of
businesses in a given
market to report their
income, then the market
price for their goods or
services would increase so
that businesses could both
compete and pay their
taxes. As the IRS's
activity starts to affect
market prices, research
suggests it could produce a
dramatic increase in
voluntary compliance in the
local cash economy as it
changes local norms. A
national cash economy
program office could
replicate successful local
strategies nationwide.------------------------------------------------------------------------
8 Create a cash The cash The EITC Program Office
economy program economy coordinates EITC related
office program activities, measures the
office results of its initiatives
would and takes responsibility
coordinat for ensuring that the
e program works as intended,
research, even though it relies on
outreach, many other parts of the IRS
and to achieve its goals. As
complianc with EITC initiatives,
e efforts responsibility for
aimed at initiatives that may
improving improve income reporting by
income cash economy participants
reporting is dispersed throughout the
complianc IRS. Nobody at the IRS with
e among the authority to coordinate
cash research, outreach, and
economy compliance efforts takes
participa primary responsibility for
nts, as reducing underreporting
the EITC among cash-economy
program participants. As a result,
office the IRS is not as effective
has done as it could be in improving
with compliance among cash-
respect economy participants. For
to EITC example, a cash-economy
complianc program office could work
e. with IRS Research to
measure the impact of
initiatives to reduce
underreporting by cash-
economy participants. TIGTA
and GAO generally agree
that such measures would
help the IRS to reduce the
tax gap. A cash-economy
program office could also
be justified on the basis
that the EITC has a program
office and the amount of
the tax gap attributable to
cash-economy participants
dwarfs the amount of the
tax gap attributable to
EITC claimants.------------------------------------------------------------------------
9 Educate cash Educate In addition to the
economy cash satisfaction of obeying the
participants economy law and avoiding potential
participa civil and criminal
nts about penalties and interest
the charges, such benefits may
benefits include, for example, an
of increase in retirement
reporting benefits; disability
their benefits; survivors
income benefits; Medicare
and study benefits; access to credit;
the earned income tax credits;
effect of and the ability to gain
such admission to the U.S. or a
efforts visa-status adjustment for
to family members or
determine employees. The IRS could
whether test this concept by
they are educating taxpayers through
cost outreach and various media
effective targeting cash-economy
. participants in communities
where compliance is low and
such benefits are not well
known. Researchers have
suggested that publicity
about such benefits, when
combined with other
enforcement initiatives,
may significantly improve
reporting compliance in a
given community.------------------------------------------------------------------------
10 Obtain more and Sponsor IRS researchers have
better research research previously estimated that
to the indirect effect of an
identify average examination on
the most voluntary compliance is
effective between six and 12 times
use of the amount of the proposed
IRS adjustment. However, not
resources all audits have the same
after effect on compliance. A
taking dollar spent auditing cash
into economy industries with
account high rates of noncompliance
the may have a very different
direct effect than a dollar spent
and auditing corporate tax
indirect shelters. On the other
effects hand, a dollar spent on
of IRS making it easier for
activitie taxpayers to comply with
s on tax their tax obligations, for
revenue. example by revising forms,
improving EFTPS, and
answering tax law
questions, has a positive
indirect effect on
compliance. The IRS does
not have current research
to show where the next
dollar is best spent. We do
not even know whether the
next dollar is better spent
on enforcement or taxpayer
service. Thus, in the
absence of better research,
the IRS cannot make fully
informed resource-
allocation decisions.
------------------------------------------------------------------------
VII. EXHIBIT B: CASH ECONOMY--LEGISLATIVE RECOMMENDATIONS
------------------------------------------------------------------------
Recommendation Summary Reason
------------------------------------------------------------------------
1 Amend IRC sss Amend IRC sss 3406 to Withholding is
3406 to create a three- not required on
encourage pronged reporting and payments to non-
compliance in payment system that employees, and
certain cash- encourages compliance skirting
economy by: information
transactions Instituting reporting
backup withholding on requirements for
payments to taxpayers payments to
who have demonstrated independent
``substantial contractors is
noncompliance''; easy and
Releasing relatively
backup withholding on painless.
payments to taxpayers Payors wishing to
who become comply with
``substantially their
compliant'' and who information-
agree to schedule and reporting
make future payments obligations may
through the be reporting
Electronic Funds payments to
Transfer Payment independent
System (EFTPS); contractors who
Providing have supplied
that payors will not invalid TINs.
be required to Under existing
institute backup provisions,
withholding on these payors may
taxpayers who present not know that a
payors with a valid payee's TIN is
IRS ``Compliance invalid until
Certificate''.Current several payments
withholding and have been made.
information-reporting Furthermore, the
provisions do not motivation to
adequately capture comply with
income from current Forms
transactions in the 1099-MISC and W-
cash economy. 9 requirements
Unreported payments is not
include: particularly
Deliberate compelling. The
``under the table'' toll charge for
cash payments. a missing or
Payments incorrect Form
that are reported 1099-MISC or W-9
with an invalid TIN is $50.
or payee/TIN
mismatch.
Payments
subject to
information reporting
that are not
reported.------------------------------------------------------------------------
2 Amend IRC sss Current law requires Making estimated
6302(h) to IRS to use EFTPS to tax payments can
require IRS to collect at least 94 be cumbersome,
promote percent of depository particularly for
estimated tax taxes. In contrast, self-employed
payments the IRS received less taxpayers. EFTPS
through EFTPS. than one percent of has the
Amend IRC sss all estimated tax potential to
6302(h) to payments through alleviate some
require IRS to EFTPS in tax year estimated tax
promote 2004. problems because
estimated tax it is convenient
payments and relatively
through EFTPS easy to use.
and establish a Moreover,
goal of taxpayers can
collecting at use EFTPS to
least 75 schedule
percent of all automatic
estimated tax estimated
payment dollars payments.
through EFTPS
by FY 2012.------------------------------------------------------------------------
3 Amend IRC sss Amend IRC sss Some independent
3402(p)(3) to 3402(p)(3) to contractors may
specifically specifically wish to enter
authorize authorize voluntary into withholding
voluntary withholding between agreements with
withholding independent their payors. It
between contactors and is currently
independent service-recipients unclear,
contractors and (as defined in IRC however, whether
service- sss 6041A(a)(1)), and statutory
recipients. to specify that authority exists
independent to enter into
contractors who enter such agreements.
into voluntary IRC sss
withholding 3402(p)(3) is
agreements with payor silent on
service recipients voluntary
will be treated as withholding
employees only to the agreements in
extent specified in the independent
the agreements, and contractor/payor
allow such context. Section
independent 3402(p)(3) is
contractors to the only section
continue to deduct under which a
ordinary and voluntary
necessary business withholding
expenses under IRC agreement
sss 162(a). between a payor
and an
independent
contractor would
be permitted.------------------------------------------------------------------------
4 Amend IRC sss Taxpayers report 96 For Form 1099-
6041A to percent of income MISC information-
require third- from transactions reporting
party subject to purposes, there
information information should be no
reporting for reporting. The distinction
applicable percentage of between
payments to reported income taxpayers who
corporations. decreases are incorporated
Amend IRC sss significantly, and those who
6041A to however, when are not.
require third- transactions are not
party subject to
information information
reporting for reporting. Under
applicable current law, an
payments to individual taxpayer
corporations, can escape Form 1099-
as defined in MISC information-
IRC sss reporting by
7701(2)(3) incorporating. A
(including taxpayer attempting
corporations to avoid 1099-MISC
electing to be reporting need only
taxed under include in its
subchapter S of business name an
the Internal indication that it is
Revenue Code). doing business as a
corporation in order
to release the
service-recipient
from the IRC sss
6041A reporting
requirements.
------------------------------------------------------------------------
VIII. EXHIBIT C: REQUIRING BROKERS TO TRACK AND REPORT COST BASIS--
LEGISLATIVE RECOMMENDATION
------------------------------------------------------------------------
Recommendation Summary Reason
------------------------------------------------------------------------
1 Amend IRC sss When This proposal also
6045(a) to transactions helps taxpayers (and
authorize the are subject that was our primary
Secretary of the to reason for proposing
Treasury to information it.) Today, more
require brokers to reporting to Americans own stocks
track and report the or mutual funds than
cost basis in government, ever before. Most
connection with tax mutual fund investors
the sale of mutual compliance elect to have their
funds and stocks. is generally dividend and capital
Amend IRC sss very high-- gain distributions
6045(a) to well over 90 automatically
authorize the percent. The reinvested in their
Secretary of the opportunity funds, causing their
Treasury to for aggregate adjusted
prescribe noncomplianc bases to change upon
regulations that e upon sale each such
require brokers to of mutual reinvestment. Many
report information funds or mutual fund companies
not only regarding stocks is assist their investors
gross proceeds but considerable by keeping track of
also regarding under adjusted basis, but
adjusted basis in current law, some do not. With
connection with because the regard to stock
the sale of mutual taxpayer's investors, most
funds and stocks. basis is not brokers keep track of
To facilitate reported to purchases their
accurate basis the customers make, but
reporting, government. they do not
financial necessarily update
institutions that their basis records to
hold mutual funds reflect stock splits,
or stocks for spin-offs, and other
customers should, corporate
when a customer restructurings. While
transfers assets taxpayers are properly
to a successor required to keep
financial adequate records to
institution, be substantiate their tax
required to reporting, the reality
provide the is that some investors
customer's hold stocks or mutual
adjusted basis in funds for decades, and
the transferred it is simply not
mutual fund and realistic to expect
stock holdings to that all taxpayers
the successor will keep perfect
financial records for long
institution. periods of time.
------------------------------------------------------------------------
endnotes
\1\ The views expressed herein are solely those of the National
Taxpayer Advocate. The National Taxpayer Advocate is appointed by the
Secretary of the Treasury and reports to the Commissioner of Internal
Revenue. The statute establishing the position directs the National
Taxpayer Advocate to present an independent taxpayer perspective that
does not necessarily reflect the position of the IRS, the Treasury
Department, or the Office of Management and Budget. Accordingly,
Congressional testimony requested from the National Taxpayer Advocate
is not submitted to the IRS, the Treasury Department, or the Office of
Management and Budget for prior approval. However, we have provided
courtesy copies of this statement to both the IRS and the Treasury
Department in advance of this hearing.
\2\ See IRS News Release 2006-28, IRS Updates Tax Gap Estimates
(Feb. 14, 2006) (accompanying charts). The National Research Program
study estimated that the ``gross tax gap'' was about $345 billion and
the ``net tax gap'' (i.e., the gross tax gap reduced by late payments
and amounts collected as a result of IRS enforcement actions) was about
$290 billion. The IRS's most current estimate of the tax gap is based
primarily on audits it conducted on tax returns filed for 2001.
\3\ U.S. Census Bureau, Population Division (data as of March
2001).
\4\ The IRS's most current estimate of the tax gap is based
primarily on audits it conducted on tax returns filed for 2001.
\5\ Significantly, the IRS Oversight Board reports there is
substantial public support for an enhanced IRS compliance program
provided that it is balanced. The Oversight Board conducts an annual
survey of taxpayer attitudes and found that two-thirds of taxpayers
support additional funding for both IRS assistance and enforcement. See
IRS Oversight Board, 2005 Taxpayer Attitude Survey.
\6\ See IRS News Release 2006-28, IRS Updates Tax Gap Estimates
(Feb. 14, 2006) (accompanying charts).
\7\ When IRS auditors conducted approximately 46,000 audits of
individual taxpayers for purposes of the National Research Program, the
auditors were asked, for each issue they identified, to characterize
the reason for noncompliance. Among issues that IRS auditors examined
that resulted in a change in tax liability, the auditors listed 67
percent as inadvertent mistakes, 27 percent as computational errors or
errors that flowed automatically, and only 3 percent of errors as
intentional. Internal Revenue Service (unpublished data from National
Research Program). The precision of these data may be open to question
because it is impossible for an auditor to determine the intent of a
taxpayer at the time the taxpayer prepared a return. In the absence of
contrary data, however, these data at a minimum should persuade IRS to
conduct significant new studies on the causes of noncompliance. A
separate study by the Government Accountability Office analyzed the
misreporting of capital gains transactions. The study concluded that 33
percent of taxpayers who misreported their income from securities
transactions reported more capital gains than they actually realized.
Where misreporting is inadvertent, from a statistical standpoint, one
would expect that 50 percent of errors would be on the high side and 50
percent of errors would be on the low side. Thus, GAO's finding that 33
percent of all taxpayer errors tended to cause overpayments of tax (and
thus were clearly inadvertent) implies that an equal percentage of
inadvertent errors caused taxpayers to underpay their tax--or, put
differently, that 66 percent of all errors in capital gains
misreporting were inadvertent and only 34 percent were intentional.
Government Accountability Office, Ref. No. GAO-06-603, Capital Gains
Tax Gap: Requiring Brokers to Report Securities Cost Basis Would
Improve Compliance if Related Challenges Are Addressed at 12 (June
2006).
\8\ Internal Revenue Service, Fiscal Year 2006 Enforcement and
Service Results (Nov. 20, 2006).
\9\ Joseph M. Dodge & Jay A. Soled, Inflated Tax Basis and the
Quarter-Billion-Dollar Revenue Question, 106 Tax Notes 453 (Jan. 24,
2005).
\10\ See Department of the Treasury, General Explanation of the
Administration's Fiscal Year 2008 Revenue Proposals 64 (February 2007).
Treasury provides a 10-year revenue estimate of just $6.7 billion. We
note, however, that Treasury's proposal would not take effect until
2009, and it would only require basis reporting with regard to
securities purchased after that date. In the early years, many
securities sold would have been purchased prior to the effective date
of the proposal and thus would be exempt from reporting.
\11\ John Cassidy, Going Long, The New Yorker, July 10 & 17, 2006,
at 99 (citing an AC Nielsen study).
\12\ See Alan H. Plumley, Pub. 1916, The Determinants of Individual
Income Tax Compliance: Estimating the Impacts of Tax Policy,
Enforcement, and IRS Responsiveness 41 (Oct. 1996).
\13\ IRS Wage & Investment Operating Division, Business Performance
Review, Wage and Investment Operating Division, FY 2006; IRS Wage &
Investment Operating Division, Business Performance Review, Wage and
Investment Operating Division, FY 2005; IRS Wage & Investment Operating
Division, Business Performance Review, Wage and Investment Operating
Division, FY 2004; IRS Wage & Investment Operating Division, Business
Performance Review, Wage and Investment Operating Division, FY 2003.
\14\ IRS Small Business/Self Employed Operating Division, Response
to Taxpayer Advocate Information Request (Sept. 5, 2006).
\15\ This concern was raised by a taxpayer during a 2006 Town Hall
meeting with the National Taxpayer Advocate in Fargo, North Dakota.
\16\ Internal Revenue Service, Fiscal Year 2006 Enforcement and
Service Results (Nov. 20, 2006).
\17\ See IRS News Release IR-2006-42, IRS Selects Three Firms to
Take Part In Delinquent Tax Collection Effort (March 9, 2006).
\18\ Department of the Treasury, FY 2007 Budget in Brief at 59.
\19\ Government Accountability Office, GAO-07-136, Financial Audit:
IRS's Fiscal Years 2006 and 2005 Financial Statements at 95 (Nov.
2006). The IRS actually collected $2.51 trillion on a gross basis in FY
2006, but issued $277 billion in tax refunds.
\20\ When collecting tax from the vast majority of taxpayers who
file returns and pay all or substantially all of the tax they owe
voluntarily, the cost the IRS incurs per taxpayer is very low. As the
IRS attempts to collect tax from noncompliant taxpayers through broader
outreach efforts or through examination and collection actions, the
cost per taxpayer rises substantially. Therefore, the marginal ROI the
IRS achieves as it attempts to collect unpaid taxes is likely to be
considerably lower than the average ROI of 210:1 that the IRS achieves
on taxes paid voluntarily. But if the IRS were given more resources,
most data indicate that the IRS could generate a substantially positive
marginal ROI.
\21\ In the current Congress, the Appropriations subcommittees have
been restructured, and the IRS will be funded through the
Appropriations Subcommittee on Financial Services and General
Government.
\22\ Government Accountability Office, GAO-07-136, Financial Audit:
IRS's Fiscal Years 2006 and 2005 Financial Statements 68 (Nov. 2006).
\23\ Charles O. Rossotti, Many Unhappy Returns: One Man's Quest to
Turn Around the Most Unpopular Organization in America 278 (2005). On
pages 278-286, Mr. Rossotti presents an interesting personal
perspective on the budget process and the politics behind the chronic
under-funding of the IRS.
\24\ The chairman and ranking member of the Senate Budget Committee
supported additional funding for the IRS in the FY 2007 budget
resolution. Senator Judd Gregg acknowledged that the existing budget
procedures have the effect of shortchanging the IRS. He said: ``We've
got to talk to the [Congressional Budget Office] about scoring on
[additional funding provided to IRS]. Clearly there's a return on that
money.'' Dustin Stamper, Everson Pledges to Narrow Growing Tax Gap, 110
Tax Notes 807 (Feb. 20, 2006). Similarly, Senator Kent Conrad stated:
``Rather than a tax increase, I think the first place we ought to look
. . . is the tax gap. If we could collect this money, we'd virtually
eliminate the deficit.'' Emily Dagostino, Senate Budget Resolution
Would Increase IRS Enforcement Funding, 110 Tax Notes 1129 (Mar. 13,
2006).
\25\ Commissioner Charles O. Rossotti, Report to the IRS Oversight
Board: Assessment of the IRS and the Tax System 16 (Sept. 2002).
\26\ Alan H. Plumley, Pub. 1916, The Determinants of Individual
Income Tax Compliance: Estimating The Impacts of Tax Policy,
Enforcement, and IRS Responsiveness 35-36 (Oct. 1996); Jeffrey A.
Dubin, Michael J. Graetz & Louis L. Wilde, The Effect of Audit Rates on
the Federal Individual Income Tax, 1977-1986, 43 Nat. Tax J. 395, 396,
405 (1990).
\27\ Commissioner Charles O. Rossotti, Report to the IRS Oversight
Board: Assessment of the IRS and the Tax System 16 (Sept. 2002).
\28\ Government Accountability Office, GAO-06-1000T, Tax
Compliance: Opportunities Exist to Reduce the Tax Gap Using a Variety
of Approaches, at 17 (July 26, 2006).
\29\ Pub. L. No. 108-357, sss 881(a)(1) (enacting IRC sss 6306).
\30\ For a detailed discussion of the private debt collection
program, see National Taxpayer Advocate 2006 Annual Report to Congress
at 34-61 (Most Serious Problem: True Costs and Benefits of Private Debt
Collection).
\31\ See, e.g., Dustin Stamper, Everson Admits Private Debt
Collection Costs More, Defends Return Disclosure Regs, 111 Tax Notes 11
(Apr. 3, 2006).
\32\ Senator Max Baucus recently highlighted another example of the
counterproductive impact of shortchanging IRS funding. In FY 2006,
Congress imposed a one-percent across-the-board funding rescission on
domestic discretionary spending, and the IRS absorbed a reduction of
about $100 million as a consequence. Citing GAO data, Senator Baucus
estimated that the $100 million in ``savings'' would ultimately cost
the U.S. Treasury about $1 billion in lost tax collections. He stated:
``[E]ven small reductions in collection and taxpayer services are
penny-wise, pound-foolish. Sparing the IRS budget may be the best way
to bring in more owed revenue and end deficit spending.'' News Release,
Senator Max Baucus, $100 Million Budget Cut to IRS May Cost $1 Billion
or More in 2006 Tax Collections (May 22, 2006).
\33\ In the preface to the National Taxpayer Advocate 2006 Annual
Report to Congress, I argue that compliance should be viewed as a third
category or IRS emphasis rather than as the sum of service and
enforcement. There are many compliance activities the IRS undertakes,
such as document matching, that catch errors taxpayers make either
inadvertently or negligently. In my view, these activities should be
classified as ``compliance'' activities, and the ``enforcement'' label
should be reserved for cases of willful violation of the laws. I argue
that nomenclature matters in this area because if the IRS treats
willful and inadvertent compliance the same way, IRS personnel will
treat innocent taxpayers harshly and taxpayers will feel that the IRS
has dealt with them unfairly, perhaps alienating them from the tax
system and reducing their future compliance.
\34\ Internal Revenue Service, Compliance Estimates for Earned
Income Tax Credit Claimed on 1999 Returns 3 (Feb. 28, 2002).
\35\ The DIF score is an estimate of the likelihood of non-
compliance on a return. A higher score indicates a higher likelihood of
non-compliance.
\36\ IRS Compliance Data Warehouse, Individual Returns Transaction
File data for tax years 2002-2004.
\37\ IRS Compliance Data Warehouse, Audit Inventory Management
System data for tax years 2002-2004.
\38\ See Alan H. Plumley, Pub. 1916, The Determinants of Individual
Income Tax Compliance: Estimating The Impacts of Tax Policy,
Enforcement, and IRS Responsiveness 41 (Oct. 1996).
\39\ See IRS News Release, IRS Updates Tax Gap Estimates, IR-2006-
28 (Feb. 14, 2006) (accompanying charts).
\40\ See Closing the Tax Gap and the Impact on Small Business,
Hearing Before the House Comm. on Small Business, 109th Cong. (Apr. 27,
2005) (testimony of John Satagaj, President and General Counsel, Small
Business Legislative Council).
\41\ IRS Small Business/Self Employed Division response to Taxpayer
Advocate Service Information Request (Sept. 5, 2006).
\42\ Two caps would have to be established for total
appropriations--one for the IRS and one for all other discretionary
spending.
\43\ For FY 1995, the congressional budget resolution provided for
an adjustment of budget resolution spending levels to allow additional
funding for an ``Internal Revenue Service Compliance Initiative.'' H.
Con. Res. 218, 103rd Cong. sss 25 (1994). The provision authorized an
adjustment to reflect amounts of additional new budget authority or
additional outlays of up to $405 million per year provided certain
conditions were met. Although there is no indication the initiative
failed or generated strong opposition, control of Congress changed the
next year and the provision was subsequently repealed. H. Con. Res. 67,
104th Cong. sss 209 (1995). The joint explanatory statement
accompanying the conference report on the FY 1995 budget resolution
provision (which originated as Section 54 of the Senate amendment to
the House-passed budget resolution) provided additional information
about the specifics of the approach:
Section 54 of the Senate amendment allows for additional
appropriations for an Internal Revenue Service Compliance initiative.
If the Congress appropriates the base amounts requested for the
Internal Revenue Service in the President's budget for fiscal year 1995
and a variety of other conditions are met, then Congress can also
appropriate additional amounts for a compliance initiative without
triggering points of order that might otherwise lie against such
legislation.
Under sections 54(a) and 54(b) of the Senate amendment, upon the
reporting of an appropriation bill funding the compliance initiative
and the satisfaction of the conditions listed, the Chairman of the
appropriate Budget Committee must file revised appropriations caps,
allocations to the Appropriations Committee, functional levels, and
aggregates to clear the way for the incremental spending for the
initiative. This procedure parallels that used in reserve funds . . . ,
which allow deficit-neutral legislation to proceed without points of
order even if that legislation pays for direct spending with revenues.
Similarly, section 54 of the Senate amendment allows appropriations
legislation to proceed without points of order if it is demonstrated
that the revenues raised by those appropriations would offset the costs
of the appropriations.
The first parenthetical language in the matter after subsection
(a)(3) establishes the first condition precedent, that the Congress
appropriate the base amounts requested for the Internal Revenue Service
in the President's Budget for fiscal year 1995. Subsection (d) lists
the other conditions: enactment of a Taxpayer Bill of Rights 2,
initiation of an Internal Revenue Service educational program as
mandated by the Taxpayer Bill of Rights 1 and 2, a finding by the
Congressional Budget Office that by virtue of revenues raised, the
appropriations will not increase the deficit, and a restriction of
funds made available pursuant to this authority to carrying out
Internal Revenue Service compliance initiative activities.
The House resolution contains no such provision.
The conference agreement contains as section 25 a provision similar
to that in Section 54 of the Senate amendment. In particular, section
25(a)(2) of the conference agreement more explicitly spells out the
condition precedent that Congress first appropriate the base amounts
requested for the Internal Revenue Service in the President's Budget
for fiscal year 1995 before the provisions of this section apply.
Similarly, the conference agreement revises subsection (d), which sets
forth the other conditions precedent.
H.R. Conf. Rep. No. 103-490 at 58 (1994).
\44\ In FY 2006, IRS enforcement activities (collection actions,
examinations, and document matching) resulted in the direct collection
of $48.7 billion. Internal Revenue Service, Fiscal Year 2006
Enforcement and Service Results (Nov. 20, 2006). Total tax collection
by the IRS, after the issuance of tax refunds, was $2.24 trillion.
Government Accountability Office, GAO-07-136, Financial Audit: IRS's
Fiscal Years 2006 and 2005 Financial Statements 95 (Nov. 2006).
\45\ Department of the Treasury, FY 2008 Budget-in-Brief at 56.
\46\ Charles O. Rossotti, Many Unhappy Returns: One Man's Quest to
Turn Around the Most Unpopular Organization in America 285 (2005).
\47\ For research purposes, we believe it is important to study
inadvertent errors as well as deliberate misreporting. Knowledge about
inadvertent errors can be used to clarify ambiguous laws or
administrative guidance both to help increase future compliance and to
better apply IRS outreach, education, and other voluntary compliance
initiatives.
\48\ Commissioner Charles O. Rossotti, Report to the IRS Oversight
Board: Assessment of the IRS and the Tax System 18 (Sept. 2002).
\49\ Internal Revenue Service Data Book: 2005, table 3 (showing
that the total number of individual income tax returns filed in FY 2005
was 132,844,632) and table 4 (showing that the total number of
individual income tax returns filed electronically in FY 2005 was
68,476,328). The total number of individual income tax returns filed on
paper in FY 2005--64,368,304--is the difference between these numbers.
\50\ Much of this information was published in former Commissioner
Rossotti's final report to the IRS Oversight Board. Commissioner
Charles O. Rossotti, Report to the IRS Oversight Board: Assessment of
the IRS and the Tax System 16 (Sept. 2002). However, we have not seen
updated statistics published in this format since that time.
\51\ The congressional budget rules currently prohibit the
Congressional Budget Office or the Office of Management and Budget from
treating changes in discretionary appropriations to the IRS as giving
rise to scorable increases in tax receipts. See H.R. Conf. Rep. No.
101-964 (1990). See also Office of Management and Budget, OMB Circular
No. A-11, Part 8, Appendix A, Principle 14 (2006). Since changes to IRS
funding levels undoubtedly have an impact on tax collections, this
prohibition seemingly reflects the practical difficulty of devising
accurate estimates. Yet accurate estimates obviously would be helpful
to Congress, and we believe the IRS should make developing better
estimates a priority objective.
Chairman Spratt. Thank you very much for your excellent
testimony. Mr. Brostek.
STATEMENT OF MICHAEL BROSTEK
Mr. Brostek. Chairman Spratt and members of the committee,
I am pleased to participate in today's hearing on the tax gap.
My statement focuses on the multiple approaches that are needed
to successfully reduce the gap, including the importance of
quality services to taxpayers. It then covers potential
reductions in the tax gap that could ensue from simplifying and
reforming the Tax Code, providing the IRS more tools to deal
with noncompliance and dedicating more resources to tax
enforcement.
The tax gap is a persistent problem. Although measurement
methodologies have varied over time, the rate at which
taxpayers pay their taxes voluntarily and on time has tended to
range between 81 and 84 percent over the past 3 decades. This
suggest that materially reducing the tax gap is going to be
challenging. Because the tax gap has multiple causes and spans
different types of taxes and taxpayers, no one strategy is
likely to be fully and cost-effectively efficient at reducing
the gap. We need to try new approaches and to expand current
effective approaches. In many cases, Congress will need to
participate in the solution either through providing IRS new
tools or additional resources.
Providing quality services to taxpayers is a necessary
foundation for high levels of voluntary compliance. Quality
services help taxpayers who wish to comply but who do not
understand their obligations, and such services are needed even
in pursuing other approaches to reduce the tax gap. For
instance, even if tax laws are simplified, the IRS needs to
educate taxpayers and to answer the questions they are likely
to have. Regarding tax simplification or tax reform, there is
no reliable estimate of how much simplification could actually
reduce the tax gap. One indication of the potential is that the
IRS has estimated a 2001 revenue shortfall of about $32 billion
due to errors taxpayers made in claiming various credits and
deductions. Over the decades, more and more special provisions
have been added to the Tax Code with the number of credits,
deductions and the like doubling in number between 1974 and
2005.
By making the rules across tax provisions more uniform, by
merging multiple related provisions and deleting provisions
that may not be accomplishing their intended purpose at an
acceptable revenue cost, the Tax Code could be simplified. If
so, both intentional and unintentional noncompliance should
decline. Further, the IRS would be able to reallocate its
resources to other more problematic compliance problems.
Tax reform also has the potential to reduce the tax gap,
but it is most likely to do so if any reform system has few, if
any, tax preferences or complex provisions and taxable
transactions are transparent to the tax agency. These
characteristics are difficult to achieve, and to my knowledge,
all tax systems have tax gaps.
Tax withholding and information reporting are among the
most powerful tools for promoting compliance. If we can spread
these tools over more types of income that are major
contributors to the tax gap, tax reductions might be achieved.
Our recent work suggests that requiring information reporting
on the basis for securities sales, like stock transactions, has
the potential to improve compliance with capital gains
reporting. Importantly, a key additional benefit would be less
taxpayer burden to understand and comply with the basis
reporting rules.
Finally, devoting additional resources to enforcement has
the potential to reduce the tax gap by billions of dollars. In
part, devoting greater resources to enforcement could reduce
the tax gap because, every year, the IRS identifies far more
cases of probable noncompliance than it can address. How much
the tax gap could be reduced by dedicating more resources to
enforcement depends critically on how well the IRS can manage
these resources. Here, information is key.
Which taxpayers are noncompliant? Why are they
noncompliant? What amount of noncompliance can be corrected for
an additional dollar of investment in IRS?
We and others have frequently called for improved
information like this. In part, this is why we encouraged the
IRS to undertake compliance studies like the most recent one of
the tax gap. We are heartened that the President's 2008 budget
calls for annual tax gap research.
As a caution, if additional resources are devoted to
enforcement, returns on that investment are likely to lag as
the IRS hires and trains new personnel, and we see that in the
budget estimates for the President's new budget.
Also, several years can elapse between the time the IRS
actually assesses a tax and when those taxes are collected. For
instance, in a study we had done earlier, we had found that 5
years after taxes were assessed against individuals with
business income only 48 percent of the assessed taxes had been
collected.
This concludes my statement. I would be happy to answer
questions.
[The prepared statement of Michael Brostek follows:]
Chairman Spratt. Thank you very much.
Now Mr. Edwards.
STATEMENT OF CHRIS EDWARDS
Mr. Edwards. Thank you, Mr. Chairman and Mr. Cooper, for
holding these important hearings today on the tax gap, and
thanks to both of you over the years for your strong support of
fiscal responsibility.
Compliance with our tax system, as we have heard, stands at
about 86 percent. I think, to most people, that sounds like a
pretty high number. We rarely get 100 percent compliance with
any law. I looked up ``compliance'' yesterday on the Internet,
on the Department of Transportation site, regarding automobile
seatbelt laws, and the nationwide compliance rate with
automobile seatbelt laws is only 81 percent, and that is after
many years of education on that issue.
International evidence also suggests that the U.S. tax
compliant rate is very high. Frederick Snyder, who has
completed detailed studies for the IMF on the size of
underground or shadow economies in different countries, finds
that the U.S. tax compliance rate, or the U.S. shadow economy
is very low. He finds that the average size of the shadow
economy in the OECD countries is 16 percent of GDP. The U.S.
shadow economy, according to his studies, is only 8 percent of
GDP, the lowest in the OECD. So Americans do seem to be highly
law-abiding when it comes to reporting government taxes and
complying with regulations.
As we have heard earlier, the size of the U.S. tax gap does
not seem to have increased over time. The GAO says that the tax
gap has been about the same rate over the last 3 decades.
For these reasons, the current intense focus in Congress
over the tax gap is perplexing. Americans, of course, should
pay the taxes that erode, but the tax gap, in my view, is far
down the list of important tax system issues that we should be
dealing with.
I think Congress should instead focus on issues such as
America's high corporate tax rate and how uncompetitive it is,
especially in the globalized economy we live in, and of course
the enormous complexity of the Tax Code. The number of tax
expenditures, as I think we had heard earlier, has doubled
since 1975. This is a huge problem, and I think we need to deal
with that before we get to the issue of the tax gap.
Interestingly, if you compare the FICA or payroll tax
compliance, according to the IRS numbers we saw earlier, there
is a very high compliance rate. Of course, we have got
withholding there, but it is also a flat, simple tax with no
deductions. Compare that to the very low compliance with the
Federal estate tax. The Federal estate tax gap is about 28
percent of the amount of revenue collected by that tax because
it is a grossly complex, inefficient tax.
Americans have a responsibility to pay their taxes, but
Congress also has a responsibility to make tax laws that are
simple and easy to comply with. I think Congress is failing in
that responsibility. I say let us make the Tax Code coherent
first before we put on more regulations to close the tax gap.
There are a few observations on the tax gap estimates from
the IRS that I think are interesting. The IRS data shows that
corporations create only 9 percent of the tax gap, and yet we
constantly hear about supposed rampant corporate tax evasion.
In recent remarks, Senator Kent Conrad talked about the
hemorrhaging of tax revenues from cheating by corporations with
offices in the Cayman Islands, but corporate tax cheating is
not such a black-and-white affair as many think, and the
complexity of the Tax Code makes it very difficult to determine
how much companies should actually be paying.
Interestingly, the Joint Committee on Taxation's report on
Enron a couple years ago, which was over 2,000 pages long,
found hundreds of Enron subsidiaries in the Cayman Islands, but
the Joint Committee had a very hard time showing that the
firm's tax structures were actually illegal. They were abusive,
but they had a very hard time saying that they were actually
illegal, and as I think was raised by Mr. Everson earlier,
corporate tax revenues have soared in recent years. In 2007,
corporate tax revenues will be $342 billion, up 65 percent from
the peak reached in 2000. So corporate tax revenues are not
hemorrhaging. It is the small business sector that would bear
much of the brunt of the burden of new regulations to reduce
the tax gap, but studies have found that small businesses
already pay higher tax compliance costs, much higher compliance
costs, compared to revenue collected than big businesses, and
the IRS Taxpayer Advocate in the past has found that the heavy
compliance burden on small businesses is one of the most
serious problems with the Tax Code. So it seems to me that
targeting small businesses with more tax gap regulations seems
very unfair.
To conclude, the great attention being placed on the tax
gap I think is out of place given that U.S. tax compliance is
high compared to other countries and it has remained stable
over time. Federal revenues are above historic norms at 18.5
percent of GDP this year, and as you may know, data for the
first 4 months of fiscal 2007 show a 10 percent increase in
Federal revenues over the same period last year. So the fiscal
problem in Washington is not a lack of revenue.
In his famous book A Wealth of Nations, Adam Smith argued
that, quote, ``subjecting the people to the frequent visits and
odious examination of tax gatherers exposes them to much
unnecessary trouble, vexation and oppression,'' unquote.
So, rather than imposing more vexation on the taxpayers, I
think we should reform the Tax Code to reduce marginal rates
and special preferences, and I think a positive side effect
would be to reduce the tax gap.
Again, thanks a lot for holding these hearings.
[The prepared statement of Chris Edwards follows:]
Prepared Statement of Chris Edwards, Director of Tax Policy Studies,
Cato Institute
Mr. Chairman and members of the committee, thank you for inviting
me to testify today regarding the ``tax gap,'' which is the difference
between the amount of taxes owed and the amount of taxes actually paid.
The net tax gap, after enforcement, is $290 billion, or 14 percent
of what is owed, according to the Internal Revenue Service.\1\ Put
another way, compliance with the federal tax system stands at 86
percent. I think to most people, that compliance rate would sound quite
high. After all, we rarely get 100 percent compliance with any law.
Consider automobile seatbelt laws. The national compliance rate with
seatbelt laws was 81 percent in 2006, and that is despite large
education campaigns on that issue.\2\
International evidence also suggests that the federal tax
compliance rate is high. Friedrich Schneider, a professor of economics
at Johannes Kepler University in Austria, completed a detailed study
last year on the size of underground, or shadow, economies in 145
countries.\3\ He is perhaps the world's top expert on underground
economies and tax evasion. Schneider defines the shadow economy to
include legal activities that are not reported to governments in order
to avoid taxes and regulations. Reviewing the literature, he finds that
``in almost all studies, it has been found that the tax and social
security contributions are one of the main causes for the existence of
the shadow economy.'' \4\
Schneider finds that the shadow economies of developing countries
are much larger than those of the advanced nations of the Organization
for Economic Cooperation and Development. Looking at 21 OECD nations in
2002, he found that the average size of shadow economies was 16 percent
of gross domestic product. The United States had the smallest shadow
economy at just 8 percent of GDP, according to Schneider's analysis.
In a study for the International Monetary Fund in 2000, Schneider
similarly found that the United States had a smaller shadow economy
than nearly all other countries.\5\ In sum, Americans seem to be highly
law-abiding when it comes to government taxes and regulations.
Another factor to consider is that the size of the federal tax gap
does not seem to have increased over the years. The Government
Accountability Office noted recently that ``the rate at which taxpayers
voluntarily comply with our tax laws has changed little over the past
three decades.'' \6\ Thus, to the extent that the tax gap is a problem,
it is not getting any bigger.
For these reasons, the intense focus in Congress on the tax gap in
recent months is perplexing. Americans should pay the amount of taxes
that they owe, but the tax gap is far down on a long list of problems
with the federal tax system. Congress should focus on the following
items as more pressing problems needing attention: \7\
America's high-rate and uncompetitive corporate income
tax, which is a growing concern in our increasingly globalized economy.
The excessive taxation of savings and investment under the
income tax, which reduces the growth rate of the U.S. economy.
High marginal tax rates on individuals and businesses,
which are a hurdle to productive activities and encourage unproductive
avoidance activities.
The enormous complexity of the tax code. The number of
pages of federal tax law and regulations increased from 40,500 in 1995
to 66,498 by 2006.\8\
Increasing horizontal inequity in the tax code. The
plethora of deductions and credits added in recent years creates
unfairness by imposing different tax burdens on people with similar
incomes.
The alternative minimum tax, which threatens to hit 30
million taxpayers by the end of the decade if not reformed or repealed.
Americans have a responsibility to pay all the taxes that they owe.
But Congress has a responsibility to make sure that laws are as simple
as possible and easy to comply with.
With the tax code, Congress is utterly failing in its
responsibility. James Madison noted that ``it will be of little avail
to the people that the laws are made by men of their own choice, if the
laws be so voluminous that they cannot be read, or so incoherent that
they cannot be understood ... or undergo such incessant changes that no
man who knows what the law is today can guess what it will be
tomorrow.'' \9\
Let's make the tax code coherent first before we consider any
additional regulatory actions to close the tax gap. Focusing on the tax
gap first puts the cart before the horse. Let's reform the code to
increase economic efficiency and fairness, and an important byproduct
will be to increase tax code compliance.
observations on the tax gap estimates
Most of the tax gap regards individual taxes, not corporate taxes.
IRS data shows that the corporate tax gap is only 9 percent of the
overall gap.\10\ Yet concerns are often expressed about supposed
rampant corporate tax abuse. In recent remarks about the tax gap,
Senator Kent Conrad (D-ND) talked about the ``hemorrhaging'' of federal
tax revenues from cheating by large multinationals with offices in the
Cayman Islands.\11\
However, the problem on the corporate side is legal tax avoidance
by multinationals due to our high corporate tax rate, not illegal tax
evasion. Interestingly, the Joint Committee on Taxation report on Enron
found hundreds of Enron subsidiaries in the Caymans, but the JCT had a
hard time showing that the firm's tax machinations were actually
illegal.\12\ The corporate tax code encourages the creation of very
complex corporate tax structures that are usually legal, but they do
make tax compliance much more difficult.
Note that corporate tax revenues have soared in recent years.
Corporate tax revenues are expected to be $342 billion in fiscal 2007,
which is up a remarkable 65 percent over the peak at the end of the
last boom in fiscal 2000 of $207 billion.\13\ Corporate tax revenues
are clearly not ``hemorrhaging.''
The tax gap related to the estate tax is also worth looking at. At
$8 billion, the tax gap for the estate tax is a huge 29 percent of the
$28 billion in estate tax revenues in 2001. This large gap indicates
the large inefficiency of the estate tax, which probably drives
relatively more tax avoidance and evasion than any other federal tax.
This is one reason why many tax experts support repeal of this tax.
The federal FICA payroll tax has a very low tax gap of just $14
billion. Experts note that the FICA tax has a low tax gap because of
employer withholding. But another factor that promotes high compliance
is that the payroll tax is the simplest federal tax. It has a low, flat
rate and no deductions. It is a model to consider for reforms of the
federal income tax. Indeed, the Hall-Rabushka flat tax for individuals
would consist simply of a flat-rate payroll tax, and thus would likely
have a high compliance rate.
Major tax reforms would reduce the tax gap by reducing taxpayer
confusion and aggressive tax planning. Many taxpayers pay the wrong tax
amount because they are confused about what income is taxable and what
tax breaks are allowed. And since complex tax rules are subject to
multiple interpretations, they spur taxpayers to take risks on tax
strategies in the hope that they are not caught by the IRS. The Joint
Committee on Taxation noted that ``taxpayers may consciously choose to
'play the audit lottery' by taking a questionable position on their tax
returns, in the belief that complexity will shield them from
discovery.'' \14\ In its report on Enron, the JCT concluded that the
company ``excelled at making complexity an ally.'' \15\
The IRS estimate of the tax gap includes $32 billion related to
claiming the wrong amounts of credits and deductions. The number of
such ``tax expenditures'' has soared in recent years. Indeed, the GAO
found that the number of tax expenditures has more than doubled since
1975.\16\ Table 1 shows the number of tax expenditures relating to
energy and education have more than doubled since 1995. The explosion
of tax credits and deductions has added complexity and increased the
system's unfairness by promoting horizontal inequities.
The largest source of the tax gap is the small business and self-
employed sector of the economy. It is this sector that would bear the
burden of many proposed actions to reduce the tax gap, as it would have
to pay higher taxes and deal with greater paperwork. If Congress and
the IRS increased reporting requirements and tax regulations to try and
reduce the tax gap, most of the added compliance burden would fall on
law-abiding businesses that are already paying their full load of
taxes.
Note that individuals and businesses already spend more than 6
billion hours--or more than 3 million person-years--complying with
federal taxes. Many members of Congress, usually around April 15, decry
that large burden. Yet trying to reduce the tax gap by imposing added
paperwork on businesses would increase the time spent on unproductive
compliance activities.
Note that small businesses already have a higher ratio of tax
compliance burdens to taxes collected than do large businesses. For
small businesses, tax compliance costs can be larger than actual taxes
paid.\17\ The IRS Taxpayer Advocate has found that the heavy compliance
burden on small businesses is one of the most serious problems with the
tax system.\18\ Thus, targeting small businesses with more regulations
to try and close the tax gap seems especially unfair.
Senator Kent Conrad (D-ND) recently stated that ``closing the tax
gap is not about raising taxes on anyone.'' \19\ But in fact, it is.
Certainly, some individuals and businesses are currently not paying all
they owe. But taking actions to increase taxes paid would create all
the usual ``deadweight losses,'' or inefficiency costs, that any tax
increase would create. If a small business is required to pay more tax,
it will have less cash flow available for capital investment and hiring
workers. There is no free money sitting around for the federal
government to simply grab without negative side-effects on the economy.
conclusion
In conclusion, the great attention being placed on the tax gap
seems out of place given that the problem is not excessive compared to
other countries, nor is it getting worse over time. Federal revenues
are up above historical norms at 18.5 percent of GDP in fiscal 2007.
Indeed, data for the first four months of fiscal 2007 show a 10 percent
increase over fiscal 2006.\20\
The fiscal problem in Washington is not a lack of revenue. Thus
burdening small businesses and the economy with more tax regulations to
try and close the tax gap is the wrong way to go. In his classic work,
The Wealth of Nations, Adam Smith recognized that the total cost of
taxation is ``a great deal more'' than just the amount of revenue
collected. For one thing, he argued that ``by subjecting the people to
the frequent visits and the odious examination of the tax-gatherers, it
may expose them to much unnecessary trouble, vexation, and
oppression.''
Rather than increase odious tax-gathering activities, we should
instead reform the tax code to reduce marginal rates and eliminate
special preferences. That would be beneficial for families and the
economy, and it would have the side effect of reducing the tax gap.
Thank you for holding these important hearings. I look forward to
working with the committee on tax issues, particularly tax code
simplification and reform.
endnotes
\1\ The IRS estimates are discussed in Government Accountability
Office, ``Tax Compliance,'' GAO-07-391T, January 23, 2007. See also
U.S. Department of Treasury, ``A Comprehensive Strategy for Reducing
the Tax Gap,'' September 26, 2006.
\2\ National Highway Traffic Safety Administration, ``Seat Belt Use
in 2006: Overall Results,'' November 2006, www-nrd.nhtsa.dot.gov/pdf/
nrd-30/NCSA/RNotes/2006/810677.pdf.
\3\ ``Shadow Economies of 145 Countries all over the World: What do
we really know?'' May 2006, www.econ.jku.at/Schneider/
ShadEconomyWorld145--2006.pdf.
\4\ ``Shadow Economies of 145 Countries all over the World: What do
we really know?'' May 2006, p. 5, www.econ.jku.at/Schneider/
ShadEconomyWorld145--2006.pdf.
\5\ Friedrich Schneider and Dominik Enste, ``Shadow Economies
Around the World: Size, Causes, and Consequences,'' International
Monetary Fund, Working Paper 00/26, February 2000.
\6\ Government Accountability Office, ``Tax Compliance,'' GAO-06-
1000T, July 26, 2006, p. 1.
\7\ For a discussion of problems with the tax code, see Chris
Edwards, ``Options for Tax Reform,'' Cato Institute Policy Analysis no.
536, February 24, 2005, www.cato.org/pub--display.php?pub--id=3681.
\8\ Based on the page count of the CCH Standard Federal Tax
Reporter. See Chris Edwards, ``Income Tax Rife with Complexity and
Inefficiency,'' Cato Institute Tax & Budget Bulletin no. 33, April
2006, www.cato.org/pubs/tbb/tbb-0604-33.pdf.
\9\ James Madison, The Federalist Papers, No. 62.
\10\ For all tax gap figures, see Government Accountability Office,
``Tax Compliance,'' GAO-07-391T, January 23, 2007. See also U.S.
Department of Treasury, ``A Comprehensive Strategy for Reducing the Tax
Gap,'' September 26, 2006.
\11\ Senator Kent Conrad (D-ND), Remarks at a Senate Budget
Committee ``Hearing on President Bush's FY2008 Budget Proposals on Tax
Compliance,'' February 14, 2007.
\12\ In testifying on the Enron activities, then JCT chief of
staff, Lindy Paull, said, ``I don't know if you could call it
illegal.'' See Peter Behr, ``Enron Skirted Taxes Via Executive Pay
Plan,'' Washington Post, February 14, 2003, p. E1.
\13\ Budget of the U.S. Government, FY2008, Historical Tables, p.
30.
\14\ Joint Committee on Taxation, ``Study of the Overall State of
the Federal Tax System,'' JCS-3-01, April 2001, volume 1, p. 102.
\15\ Joint Committee on Taxation, ``Report of Investigation of
Enron Corporation and Related Entities Regarding Federal Tax and
Compensation Issues, and Policy Recommendations,'' volume 1: Report,
JCS-3-03, February 2003, p. 16.
\16\ Government Accountability Office, ``Tax Compliance,'' GAO-06-
1000T, July 26, 2006. p. 7.
\17\ Art Hall, ``Compliance Costs of Alternative Tax Systems II,''
Tax Foundation, March 1996.
\18\ Internal Revenue Service, National Taxpayer Advocate, Annual
Report to Congress, FY 1999.
\19\ Senator Kent Conrad (D-ND), Remarks at Senate Budget Committee
``Hearing on President Bush's FY2008 Budget Proposals on Tax
Compliance,'' February 14, 2007.
\20\ Congressional Budget Office, ``Monthly Budget Review,''
February 6, 2007.
Chairman Spratt. Did Adam Smith say all of those things?
Was that a quote or was that a paraphrase?
Mr. Edwards. That was a quote, yes.
Chairman Spratt. Let me ask each one of you, as a panel
together, if you have an idea.
I was trying to probe the Commissioner earlier for how much
the tax gap is today, 2006-2007, as opposed to 2001. We had a
useful clarification in the GAO testimony that it is 345 gross,
55 late payments, so the net number is 290.
Considering the 290 in 2001, what do you think the gap is
today in 2007? Mr. George.
Mr. George. Yes. Mr. Spratt, Mr. Chairman, we are not in a
position to give a definitive answer there. They do not have--
--
Chairman Spratt. Is the 2001 number scientific or is it
just a stab itself?
Mr. George. No. No. No. They did a detailed study, the
national review. They did a detailed review of this, but it is
just incomplete. They only looked at one aspect of the overall
picture.
Chairman Spratt. If we were in earnest about closing this
gap, wouldn't it be useful to have that number restated every
year, have some kind of means for at least a summary update?
Ms. Olson. Mr. Chairman, what I have advocated is--and the
IRS is moving in this direction as fast as I think it actually
can--to have a 5-year cycle of studying different components of
the tax gap so that--or the tax paying population. One year,
you would be updating your corporate numbers. One year, you
would be updating your pass-through numbers. In another year,
you would be updating some components of the individual income
tax, and as you went through those 5-year cycles, you would
also be looking at what services those different populations
needed since for so much of what we ask taxpayers to do they do
need assistance from us or others in some way, and I think if
you got on an ongoing 5-year cycle in that way, you would have
reasonably good estimates so that if there were something that
Congress had changed in the laws or had closed a loophole or
something, you could back out or add to the effect of those
changes to your bottom line estimate.
Right now, we have so many squishy numbers in the tax gap
chart that the Commissioner uses--you know, there are whole
colors that are in--these are squishy numbers. That is what I
think the blue color represents on that tax gap chart.
Chairman Spratt. Well, that is another whole problem for
this committee because we need current and up-to-date numbers,
and typically the definitive revenue collection for a given
year may not be available for as much as 12 to 18 months after
the close of the year, which is a problem for us in knowing if
there is a revenue spurt or if there was a revenue decline, and
we are not for sure looking at the numbers we all have.
Just one more question from me is a question I asked
earlier. Mr. George, back in the 1990s when we were looking
into the possibility or at least exploring this notion of
having a lot more information filing, the small business
community came down heavily on the side of saying, if you give
us all these reams of information to the Internal Revenue
Service, they do not have the wherewithal, the software or the
hardware to begin to process it, correlate it and make good use
of it. Do they now? Is the system there in such a state now
that if they did indeed have information reporting that
contractors would have to report certain payments to vendors,
suppliers and subcontractors above a certain amount? Would the
IRS have the capacity to process that meaningfully if they got
the information?
Mr. George. They currently do not have the wherewithal to
do this. There is much needed infrastructure improvements in
order to adequately address that, Mr. Chairman.
Chairman Spratt. And how long would it take to install
that?
Mr. George. That is a great question. I do not have an
answer to that.
Chairman Spratt. Is there a software design?
Mr. George. It is still in the process. As you may recall,
modernization was attempted over 12 years ago. Billions of
dollars were expended on a program that failed to do anything
that it was designed to do. It was a complete waste. They have
learned from that lesson and are now engaged in a business
systems modernization program which has had some success, is
being rolled out slowly. It has not yet delivered everything
promised. It is slightly--it is over budget, and it is not,
again, delivering everything promised, but they are working at
it.
Chairman Spratt. Other witnesses?
Ms. Olson. Mr. Chairman, you know, I have witnessed over
the last 3 years the IRS ramp-up of the private collection
agency initiative where they have spent millions and millions
of dollars both in infrastructure and staff time to bring on a
whole new program dealing with software, conveying data, data
security, and what I have seen is that the IRS, when it puts
its mind to things in a laser-like fashion, can accomplish some
amazing things. So it seems to me that if the IRS were to be
given the authority to do these things and the directive that
it has to focus on it as it focused on the private collection
agency, it should be able to accomplish that and is probably
cheaper than the cost of the private collection agency.
Mr. Brostek. We have a separate team that looks at the
business system modernization effort from the team that I am
in. We have frequently found problems with the management of
that modernization, and it certainly is behind the schedule it
was intended to follow, and it has not had as much delivered as
it was supposed to have delivered.
On the other hand, they do have greater capacity now than
they certainly did back in the period you were talking about
earlier to do this kind of matching. It would undoubtedly take
them additional effort to implement any new requirements. They
would have to do software development, and they may need
additional----
Chairman Spratt. There would be a lag time of several years
in all probability between the enactment of legislation and
appropriations and the effective implementation of this; is
that right?
Mr. Brostek. That is certainly true, and it would depend a
lot on the specific initiative that was implemented and how
complex, for instance, the rule-making would be to determine
exactly how the information reporting would be done.
Chairman Spratt. Mr. Edwards, any observation?
Mr. Edwards. I am happy to make an observation on your
prior question.
You asked about what compliance might be now in 2007. It
does strike me--looking at the GAO, it shows the overall number
being fairly stable and compliant over the decades, but there
are many conflicting forces, of course, going into that that
are probably balanced out. Tax or marginal tax rates are much
lower than they were in the 1960s and 1970s and even to an
extent in the 1980s. So that is good for compliance. The
capital gains rate was cut from 20 to 15 percent in recent
years, thus reducing the incentive to evade capital gains taxes
by 25 percent.
On the other hand, you have got this huge increase in tax
expenditures. Even in the last few years, more tax credits for
energy and education and all kinds of other things consume the
IRS' time. They make tax paying very confusing. The globalized
economy is probably making tax compliance worse. So all of
these things, it seems, sort of balanced out over time.
Chairman Spratt. Mr. Cooper.
Mr. Cooper. Thank you, Mr. Chairman.
First, I would like to thank the tax advocate for the new
IRS split refund regulations which enable taxpayers to not
spend all of their refund at one time and hopefully save a
portion of it. So thank you for that on behalf of the
Congressional Savings and Ownership Caucus. That was one of our
priorities.
I would like to focus on tax expenditures again, and as Mr.
Edwards just noted, Congress has legislated through the Tax
Code to an amazing degree. If you add up all of the tax
expenditures, as I mentioned in an earlier question, it is some
$847 billion a year. That approaches the size of all Federal
discretionary spending, including all defense spending and all
domestic discretionary spending, so that is how much we have
sacrificed in revenue just to serve a remarkably undefined
constituency here, because as I quoted the other Ms. Olson
earlier, ``unmeasured and immeasurable, unverified and
unverifiable.''
So it seems to me, if you analyze it, what we have created
here is a system in which the 17,000 Ways and Means and Finance
Committees' lobbyists can get a tax break virtually for free
for their clients, and as Commissioner Everson testified
earlier, he admitted it takes the IRS some 20 years to catch up
with law changes and who benefits and who does not and tax gap
or tax cheating and things like that. That is a pretty scary
prospect.
So I wanted to experiment with you the idea that perhaps we
should make the tax expenditures more measurable and
verifiable. For example, if you ask for and receive a tax
break, wouldn't it be nice if, in succeeding years, you had to
report who benefited from it and to what degree? That would
improve accountability, I would think. Whereas, today, we do
not really know where the money goes, and that is an
astonishing amount of Federal money to lose.
Another approach would be, as Mr. Brostek reported, from
GAO that there is a definite noncompliance rate associated with
each tax expenditure. The more breaks you give, the more
confusion you have in the Code and the more people do not pay
their taxes. So these breaks create their own tax gap, and from
Mr. Brostek's numbers, it looks like we lose $32 billion a year
just in increased noncompliance as a result of these tax
expenditures. That is about 4 percent of the total tax
expenditures. So, if the government were really interested in
collecting that money from the tax gap related to tax breaks,
we would go ahead and have an upfront fee of about 4 percent,
anticipating that there would be about 4 percent noncompliance,
and I am already unpopular with the 17,000 lobbyists for the
Ways and Means Committee.
But if the government, just as a theoretical question, were
interested in simplifying the Code, improving verifiability and
measurability, wouldn't it consider undertaking those steps of
identifying who the beneficiaries are of these breaks and to
what extent and also going ahead and anticipating a certain
degree of noncompliance resulting therefrom? Those steps would
come closer toward improving accountability of government.
Comments?
Mr. Brostek. We did a report on tax expenditures a couple
of years ago, and we have been updating the figures since. That
is how we have the figure that is in my testimony today. We
have felt that these provisions should have the same type of
scrutiny as an outlay program. Now, there is a wide variety of
tax expenditures. There are a lot of different purposes for the
tax expenditures, but many of them are akin to a social program
that is in the Internal Revenue Code. Yet, from our viewpoint,
there is really not the same ownership that you would have if
you had it in a line agency that is responsible for overseeing
outlays of Federal funds.
So we did, in fact, press for more visibility for these in
the budget process, more research and more data collection so
that we could determine whether or not the provisions are
worthwhile, whether they are returning to the taxpayers a
reasonable ROI for our revenue loss.
Mr. Cooper. If I could just interrupt you for a second,
when you say ``data collection,'' that makes me think that you
are wanting to put the monkey on the government's back. These
people are getting a special break. There is no constitutional
right to a break. Shouldn't the monkey be on their back to
report?
Mr. Brostek. That certainly is a reasonable proposition to
me. I think that would generally be the case. There would be
the need to collect data that we do not collect already, and
one of the things that would be an issue here is we have talked
some about the IRS having inadequate computer systems, in many
cases, for administering the complex Tax Code. If they were
also to collect the use information for these tax expenditures,
there would be a lot more data that would come into the IRS,
and so that would increase their need for computer systems, and
someone would need to analyze that data if it were going to be
worth collecting.
Mr. Cooper. I see that my time has expired.
Thank you, Mr. Chairman.
Chairman Spratt. You could come back--hold on if you have
got further questions, but let us recognize Mr. Boyd, and then
you can come back for additional questions.
Mr. Boyd. Thank you, Mr. Chairman, and thank you, panel
members.
Earlier, a number of people on the committee and the
Commissioner expressed the notion that the complexity of the
current code does two things. It complicates it for those who
want to abide by the rules who eventually throw up their hands,
and the complexity allows those who want to cheat that ability.
Do any of you disagree with that? Do any of you on the panel
disagree? I am not asking for an editorial here, but do any of
you disagree with that theory?
Ms. Olson. No.
Mr. Boyd. Okay. Thank you.
Mr. Edwards, I read a little bit about you, and I know you
are listed as an expert on Federal tax and budget policy. I
listened to your statement, and you said that everything seems
to be going pretty well, that there is nothing wrong with our
code. If you compare it to other nations, we have got an 86
percent compliance rate.
Mr. Edwards. There is nothing wrong with our compliance
rate, I think, compared to other countries. There is a lot
wrong with our code.
Mr. Boyd. Okay. There is nothing wrong with our compliance
rate, but there is something wrong with the Code, but nothing
that a lowering of the rates and a simplification would not
fix.
Given that and your expertise in tax and budget policy,
what do we do about the largest deficits in the history of the
Nation in the last 3 years?
Mr. Edwards. Well, I mean I am very concerned about what
has been going on on the spending side of the budget. I looked
at the numbers the other day under President Bush from 2001 to
2007. If you take out interest, which has been pretty stable
over recent years, Federal outlays have gone up 54 percent just
over those 6 years. So I think the problem is on the spending
side of the budget.
Mr. Boyd. With the bulk of that coming on the national
defense side and with the entitlement program?
Mr. Edwards. Yes, absolutely, and I think I have a big
concern with both the defense and nondefense and entitlement
sides of the budget. I mean all of that spending sucks money
out of the private sector. Spending on defense is not good for
the economy just like excess spending in the entitlement
incentive program.
Mr. Boyd. But you would concede, until you attack the
defense and entitlement sides, you really do not solve that
problem?
Mr. Edwards. Absolutely. I agree with that entirely.
Mr. Boyd. Okay. Thank you.
Ms. Olson, earlier there was discussion about the Private
Collection Initiative, and I understand that you have some
issues with that.
Would you care to comment what those are and what you see
those problems as?
Ms. Olson. Well, I have been involved with the Private
Collection Initiative since its inception for the last 5 years,
before it even was legislation, when Treasury asked me to
ensure that taxpayer rights were protected in this initiative,
and my goal was to make sure that taxpayers were being treated
in the same manner and under the same rules and under
essentially the same procedures as they would be treated by the
IRS employees, and I have had employees detailed to this
initiative full time to watch it and report back to me, and
this year----
Mr. Boyd. Could I ask you about that?
Ms. Olson. Yes.
Mr. Boyd. You have 65 Federal employees monitoring 75
private sector employees? That is the number I have. Is that
correct?
Ms. Olson. That is the IRS' employees. It does not include
the--I would say we have 3 employees looking at this pretty
much full time.
Mr. Boyd. Okay. The IRS has 65 monitoring 75 private
employees, and you have 3 monitoring the IRS guys?
Ms. Olson. Right, and all of the information in our report,
that we have reported on, has come from the IRS, so we are
reliant on the IRS giving us that information. So I do not know
whether there are more IRS employees, really. I do not know who
is in that 65 number, except I know mine are not, and it was
some of those numbers as we looked at the program as it went
out, as it really started rolling out, and looking at the cases
that were going on there that led me this year in my December
31st report to recommend that Congress repeal the authority to
use the private collection agencies because I believe that the
business case was not there. It was just costing taxpayers too
much and that the IRS could do it much cheaper. I believe that
there is a workforce that could be trained to do that inside
the IRS that would be much more stable, would protect taxpayers
better, and some of the very premises that the program was
based on, such as that there were easy cases that we just were
not getting to that we could just ship out to the private
collection agencies and they could just do like that do not
exist. In fact, the IRS is now having to go to higher dollar
accounts and small business accounts and accounts where
taxpayers have not filed other tax returns in order to make up
the number of cases that they are shipping out.
I guess the third concern that I had about it was that if
you go online to the IRS Web site and you look up our Internal
Revenue Manual, which is essentially our instructions to staff
about how they are to treat taxpayers, you can find specific
instructions to the collection employees about what they are
supposed to do, and because we are contracting out to these
employees, to these private parties as a matter of Federal
procurement law we cannot disclose the instructions that they
give to their employees. We cannot tell taxpayers how private
collection agency employees are being told to treat taxpayers.
That is a matter for the private collection agencies to agree
because it is considered proprietary information, and I found
that very disturbing.
Mr. Boyd. I do, too.
Chairman Spratt. Would the gentleman yield?
Do the private contractors have the same authority, for
example, the extraordinary authority, to administer, I guess, a
search warrant, an administrative search warrant, to sequester
the funds in a bank account, for example, without notifying the
taxpayer?
Ms. Olson. No, sir. They are limited under the
Constitution. You know, it is the Federal Government that has
the authority to assess and collect taxes, and so the way
this----
Chairman Spratt. And it is nondelegable?
Ms. Olson. It is nondelegable, and so these individuals can
only ask the taxpayer things that do not involve the exercise
of discretion or judgment, so they can ask them ``Do you owe
the tax in full or can you pay this in 36 months?'' one of the
problems is if the taxpayer says, ``Well, I need 60 months'' or
``I do not think that I should have to pay this penalty. I was
in a coma during all of these years. I could not pay it while I
was in a coma,'' then that case has to go back to the IRS to be
worked. So then we have two people working a case at any given
time.
Mr. George. Mr. Chairman, if I could just briefly address
this issue, my office is very closely monitoring the
implementation of this program given the sensitive nature of
it, and we believe it is just much too early to make an
assessment as to its success or failure, but we will be
reporting on this within the year.
Chairman Spratt. What about a lien?
Ms. Olson. No, they cannot----
Chairman Spratt. You have got the most powerful lien known
to the law if they want to levy a lien against the taxpayer who
is delinquent.
Ms. Olson. It has to go back to the IRS, and the IRS does
it.
Chairman Spratt. Okay.
Excuse me, Mr. Boyd. Thank you for yielding.
Mr. Cooper.
Mr. Cooper. Thank you.
Ms. Olson, you mentioned in your testimony that due to the
special accounts receivable function of the IRS that they
should have greater budget leeway than some other agencies.
What should their current budget be? What would be the
right amount of money for the IRS?
Ms. Olson. Well, I would want to see--I am not subject to
the same restraints as the Commissioner. You know, I get to
speak freely in that respect, and my views do not represent the
views of the administration nor the Commissioner nor the
Secretary of the Treasury or pretty much anybody else, but I
believe that the current budget is a good start, and I would
want to see more funding for taxpayer service. We are ramping
down some of the walk-in sites and some of the level of service
on answering the phones, and I think I would take a good look
at what more we need in the IT Department, and then on a going-
forward basis, I think that we just need to think that the IRS
needs for a period of years--and I am not quite sure what that
period would be but for at least 10--increases, roughly, in the
2-percent to 3-percent range overall, both enforcement and
taxpayer service and IT, to get caught up and stay abreast with
some of the demands that we have.
I also think that we have to look at the way the IRS
calculates return on investment, and one of the things that we
suggested was that the IRS report annually to Congress about
its return on investment calculations, both on the service side
and the enforcement side, and what you are getting for your
investments.
Mr. Cooper. A couple of other questions.
There are a number of small but nuisance areas; for
example, household employee paperwork. It is a nightmare, a
blizzard of ink and paper.
Is it your responsibility or whose is it to come up with
simpler approaches for that that we can take that
recommendation and perhaps pass it into law?
Ms. Olson. Well, we have looked at that in the past, and we
will continue to look at that. I agree with you that it is
very, very complex. We have also looked at just the whole
Federal employment tax arena because that is where so many
small businesses get into problems. It is just the complexity
of the rules, and we have tried to come up with some proposals.
Mr. Cooper. Well, since you are the Taxpayer Advocate, I
look forward to hearing from you on those things.
Ms. Olson. Thank you.
Mr. Cooper. Another set of questions.
So many people just run and hide when they hear the ``T''
word. They do not want to understand the complexity of the
Code. Is there a simple breakdown? I thought I remembered from
law school or someplace that a quarter or a half of the Tax
Code is consumed with the capital gains distinction and income
of some amazing portion. It would help if we kind of had some
idea. I know that these retirement accounts are wonderful, but
just with the complexity between the IRAs and Roth IRAs and all
of the other varieties, that is a gigantic section of
paperwork, and perhaps it is for a good purpose, but sometimes
we do not realize the extent to which complexity is engendered
by what seem like relatively simple ideas.
Mr. Edwards. Lots of tax experts will say that the capital
gains is the single most complex part of the Tax Code, and it
is not just individual capital gains; corporate capital gains
is very, very complex, and often when you read about the tax
shelters in the newspaper about some corporation doing some
sort of machination, it revolves around the treatment of
corporate capital gains.
Mr. Cooper. Well, has some tax wizard made a map of the
Code and just said, ``Hey, half is here and half is there''?
Because I think that might help us understand sometimes the
complexity.
A final point. Mr. Brostek mentioned that many of these tax
expenditures are in fact social programs, and I cannot help but
note the irony that for discretionary spending here in Congress
we have some 20 committees, including our friends on the
Appropriations Committee, to oversee that $800 billion or $900
billion worth of spending, but on the tax expenditure side we
barely have any committees looking at how that is understood.
So perhaps we should double the Appropriations Committee.
Perhaps we should have another set of committees here in
Congress to look at how that money is, in fact, being spent
because today we are largely clueless. It is almost a shadow
government in place, and there is little or no accountability.
Mr. Edwards. Can I make a comment on the tax expenditure?
There are two aspects of it. One is the complexity, which we
have discussed. The other is the fairness issue. It seems to
me, with this explosion in tax expenditures, you create greater
horizontal inequities in the Code. People earning the same
amount of money can pay substantially different amounts of tax,
and even if you look at education tax expenditures they have
increased from 7 to 16 just in the last 10 years.
So what we are doing is we are subsidizing, say, you know,
young lawyers who are going to law school on the one hand, but
we are burdening truck drivers and garbage men on the other
hand because they do not get that sort of tax break. So there
is a fairness thing here as well.
Mr. Cooper. Without data, though, we almost do not know how
unfair or--you know, it is an amazing netherworld that we have
entered into due to the multiplication of the size of these tax
breaks.
Mr. Brostek. It is, if I can jump in.
There is a variety of levels of data that we have
available. You know, for instance, on the earned income credit
we have a pretty good understanding of who is receiving it and
how much and where they live in the country and all kinds of
things like that, but on some of the other provisions we have
virtually nothing at all. If we have a special accelerated
depreciation provision, that gets reported to the IRS with all
other depreciation on one line on the tax form, and we do not
know who is even using that benefit that is in the Tax Code.
Mr. Cooper. On the EITC, though, the major abuse there is
claiming dependents that you are not entitled to claim or
claiming too many dependents, isn't it? So I cannot understand
why there is not a matching process there. Commissioner Everson
mentioned earlier that suddenly 5 million dependents in America
disappeared once there was better reporting. Surely, there is a
nonintrusive way of getting at EITC fraud.
Ms. Olson. I think that there is a lot actually that the
IRS is doing on EITC, and we do have a very active matching
program, and that does stop a fair number of refunds going out.
I think any time you have something that is in the realm of
$4,000 on top of--that could be without any withholding and you
could get a check back of $4,000, that is a great enticement
for people to find ways to claim it, and with the human mind
being what it is there are always new ways. Once we find the
way that they are doing it, they invent a new one. It just
requires ongoing watching, I think.
There is a large amount, though, when we were working on
trying to quantify this, of taxpayers who are eligible for the
EITC who are not claiming it. We think that might be with the
childless worker where it is not involving the children, but it
is there. I have worked with United Kingdom and studied their
credit and made some recommendations about how to restructure
all of our family provisions--the child credit, the dependency
exemption, the head of household status, and the earned income
credit--to sort of lessen some of the complexity. It is a very
complex area of law, not just the EITC.
Chairman Spratt. Gentlemen, we have got to be on the floor,
especially on the floor, at around 1:00 o'clock.
Let me thank each one of you for excellent presentations,
very forthright and forthcoming testimony. We appreciate your
assistance in helping us better understand the tax gap and what
we might hope to realize from it.
Thank you very much for coming.
Mr. Boyd. Mr. Chairman.
Chairman Spratt. Mr. Boyd.
Mr. Boyd. May I ask one--I have one quick request of Mr.
George on the Private Collection Initiative.
Chairman Spratt. Sure.
Mr. Boyd. You said it is too early. How much time do you
think you will need for your group to make an assessment, an
evaluation, of whether it working or not?
Mr. George. We expect to issue a report in April,
Congressman Boyd.
Mr. Boyd. Can you make sure that we get a copy of that
report? I would be grateful.
Mr. George. Yes. Certainly, sir.
Mr. Boyd. Thank you very much.
Chairman Spratt. I would, before adjourning, ask unanimous
consent that members who did not have the opportunity to ask
questions of the witnesses be given 7 days to submit questions
for the record. Without objection, so ordered.
Thank you very much.
[Whereupon, at 12:57 p.m., the committee was adjourned.]