Modernization at IRS Could Help Reduce Tax Gap and Shrink Deficit
The estimated $345 billion in revenue that goes uncollected every year is a tempting target for deficit crusaders. However, closing the so-called tax gap is not a cure-all, and attempting to address the problem could create other tax compliance issues. Despite such potential complications, a new report by the Government Accountability Office (GAO) has found that recent modernizations to the Internal Revenue Service's (IRS) computer systems show promise in helping to close the tax gap while avoiding some of the problems that may arise from aggressive tax collection.
Reducing the tax gap, which is the difference between what individuals and businesses owe the government and what they actually pay on a timely basis, is important to improving the integrity of the tax system, ensuring fairness, and fulfilling the funding demands of the government. The last estimate of the average gross tax gap was $345 billion. IRS released the updated estimate in 2007, which was based on data compiled in 2001, the last time the agency tried to determine the amount of revenue the government loses each year through noncompliance with tax laws.
In a 2007 paper for the Tax Policy Center, Eric Toder noted that stepped-up IRS enforcement imposes not just increased costs on the IRS, but on filers as well:
Measures to improve compliance also impose compliance costs on taxpayers (in addition to the tax and penalties they must pay) in the form of additional time spent gathering records, meeting with and corresponding with IRS agents, and possibly seeking assistance from outside counsel or tax preparers…
But additional enforcement and reporting requirements also impose time and sometimes money burdens on compliant taxpayers who must undergo an audit, respond to IRS correspondence, or supply additional data with their tax returns and on third parties such as brokers or credit card companies who must prepare additional reports for the IRS and taxpayers.
According to the GAO report, improvements to IRS’s business nonfiler program, which aids the agency in tracking down businesses that do not pay their taxes, could play a significant role in shrinking the tax gap. The system has the added benefit of not placing a higher compliance burden on businesses.
Most businesses within the United States, including corporations, partnerships, and any business that has employees, are required to register with IRS. Once a business registers, the agency uses the account to track whether the business has filed the necessary tax returns for any given year. If a business does not file a return by the due date, the agency considers the organization to be a potential nonfiler.
There are, of course, many legitimate reasons why a business might not file a tax return, including not owing any tax that year, or, if the business is a subsidiary, a parent company filing the return. Additionally, a business may have closed, merged with another business, no longer have employees, or restructured and registered a new account with IRS.
For more than two decades, government watchdogs, including GAO and the Treasury Department's inspector general for tax administration (TIGTA), have documented IRS's shortcomings at attempting to correctly identify and pursue businesses that illegitimately fail to file a tax return. GAO noted:
Each year IRS identifies a large number of potential business nonfiler cases, more than IRS has the capacity to work. Many cases go unresolved, and many that IRS does pursue are closed with a determination that the business does not owe IRS a return – a generally unproductive use of IRS's enforcement resources.
To address these issues, IRS instituted the Business Master File Case Creation Nonfiler Identification Process (BMF CCNIP) in 2009. The long-winded acronym is simply a program that uses third-party information and IRS account data "to select potential business nonfiler cases for pursuit based on the likelihood of securing returns and revenue." Despite lacking formal data on its performance – because the program is so new – BMF CCNIP, according to IRS officials, is showing a positive impact on prioritizing nonfiling cases.
The success of BMF CCNIP is not only important to IRS's accurate identification and pursuit of business nonfilers, which reduces the tax gap through recovered revenue, but it is also important to IRS's efforts to better understand the tax gap. Unlike the tax gap estimate for individuals, there currently is no comprehensive tax gap estimate for business nonfiling. Accurate identification of more illegitimate nonfilings by business would provide IRS with at least a partial estimate of business nonfilers, thereby increasing the accuracy of the tax gap estimate.
It is important for IRS to accurately identify and pursue businesses that owe taxes to the government because each instance of nonpayment reduces the confidence of those individuals and businesses that actually pay their taxes on time and in full. Moreover, $345 billion is more than a sliver of the $1.3 trillion projected deficit, and while it will be impossible to close the tax gap completely, BMF CCNIP could significantly improve the fairness of tax administration without imposing new burdens on business, alleviate the burden that individuals have to shoulder because of noncompliance, and chip away at the federal budget deficit.