The IRS report suggests that the tax gap—which is the amount of federal taxes owed but not paid—is not a major problem.
The IRS has come out with a new estimate of the "tax gap," which is the amount of unpaid federal taxes. In a nutshell, this is the amount of federal tax fraud. There is good news in the IRS report. In spite of what politicians say, tax evasion is not a growing problem in relation to the size of the economy.
From 2014 to 2016, the IRS found that the annual gross tax gap was $496 billion. After people didn't pay their taxes on time and the government took action, the tax gap was $428 billion. Individual income taxes brought in $306 billion, corporate income taxes brought in $34 billion, payroll taxes brought in $87 billion, and estate taxes brought in $2 billion.
The gross tax gap was $345 billion in 2001, $472 billion in 2006, $394 billion from 2008 to 2010, and $438 billion from 2011 to 2013. These numbers are from the new report. The IRS also said that the gap would be $540 billion from 2017 to 2019. As shown in the chart, the tax gap has grown in terms of dollars, but not in terms of the country's gross domestic product (GDP). (I used the GDP of the middle year to make the estimates for more than one year.)
The flip side of the gross tax gap is the “voluntary compliance rate,” which is the tax paid on time divided by the estimated full amount owed. The IRS report shows that the voluntary compliance rate rose from 83.7 percent in 2011–2013 to 85.0 percent in 2014–2016. The IRS projects the rate to be 85.1 percent in 2017–2019.
To me, the IRS report suggests that the tax gap is not a major problem. The gap is stable relative to the size of the economy, and our tax gap is smaller than the average tax gap in Europe, as I discuss here.
Given our stable and relatively small tax gap, President Biden’s expensive effort to boost IRS enforcement is misguided. There are civil liberties trade‐offs to consider when trying to close the tax gap with enforcement, as I discuss here. The optimal tax gap is not zero because that would require a more powerful government and impose higher compliance costs on taxpayers. And even with more power, the IRS would not achieve fully accurate tax payments because the agency itself makes frequent errors.
That said, there is a win‐win approach to reducing the tax gap. Simplifying the tax code and cutting tax rates would reduce the ability and incentive for taxpayers to cheat. It would also cut compliance costs and increase civil liberties. Tax simplification should be on the agenda of the new Congress in 2023.
