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The Tax Gap: What is the tax gap?

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The tax gap is the difference between taxes owed and taxes paid. The Internal Revenue Service estimates that over the past thirty years the tax gap has ranged from 16 to 20 percent of total tax liability. For 2001 the IRS estimates the gross tax gap at $345 billion, or slightly over 16 percent of tax liability, of which $55 billion will eventually be recovered through voluntary late payments and enforcement activities, leaving a net tax gap of about $290 billion. Some view the tax gap as a major revenue source that can be used to close the federal budget deficit or to pay for reform of the alternative minimum tax, without raising taxes. In fact, the potential revenue gains from proposals to improve enforcement are quite limited.

  • Nonfiling and underpayment of reported taxes account for less than 20 percent of the gross tax gap; underreporting on timely filed tax returns makes up the bulk of the gap. Underreporting on individual income tax returns alone accounted for about 68 percent of the gross tax gap in 2001.
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  • Over 60 percent of underreported individual tax is for business and self-employment income, which the IRS has no easy way to verify independently.
  • Only 10.5 percent of the underreporting gap is attributable to corporate income tax, and only 1.4 percent to the estate tax and excise taxes.
  • Individual income taxpayers fail to report about 54 percent of income from sources for which there is no information reporting, such as sole proprietorships. In contrast, less than 5 percent of income from easily verified sources-interest, dividends, and pensions-goes unreported. When income is subject to both information returns and tax withholding, as is the case with wages, just over 1 percent goes unreported.
 
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