Lawmakers seek budget gold in elusive `tax gap'

February 05, 2007|By Joel Havemann | Joel Havemann,Los Angeles Times

WASHINGTON -- For members of Congress, thinking up bright ideas for spending tax dollars comes as naturally as breathing. But constrained by big deficits and a pledge not to make them any bigger, lawmakers find themselves in an uncomfortable bind.

That's why Washington has discovered a new buzzword - the "tax gap" - and the estimated $300 billion pot of untouched gold that it promises. That's how much the Internal Revenue Service says taxpayers owe the government annually but, for various reasons, never pay.

The chances of significantly narrowing that gap appear slim. But as Congress gets ready to receive President Bush's 2008 budget today, Democrats and Republicans are talking it up as a way to fund politically appealing initiatives - and bring down the deficit to boot.

"Closing the tax gap has got to be one of our top priorities," said the new Democratic chairman of the Senate Budget committee, Kent Conrad of North Dakota.

The IRS probably is low-balling its estimate of the tax gap, he said, and there should be more than a mere $300 billion available.

To boost efforts to harvest it, the chairman and the top Republican member of the Senate's tax-writing Finance Committee, Max Baucus of Montana and Chuck Grassley of Iowa, took the unusual step last week of visiting the IRS and asking some of its top bureaucrats about the tax gap - and, presumably, ways it might be closed.

While the existence of the tax gap is real enough, the likelihood that any substantial part of it can be collected is more hope than fact. The gap has been around as long as there have been taxes, and past efforts to close it have yielded meager results.

"If the tax gap was easy to close, the IRS would already have done it," said Mark Zandi, chief economist at Moody's

For one thing, the IRS would have to use tougher tactics to get more revenue - and that would make taxpayers squawk. The last time Congress addressed the subject of tax collection methods, in 1998, it reined in overzealous IRS agents.

Collecting more also would require spending more for audits and investigations. Last year, the IRS had a smaller enforcement staff, and it conducted fewer audits - fewer than one individual return in 100 - than a decade earlier.

"You can ask for more audits, income-tax withholding and reporting of income to the IRS," said Mel Schwarz, a partner in the Washington office of the accounting business Grant Thornton. "All of this would be invasive on a lot of taxpayers, many of whom already pay their taxes."

And as Robert Reischauer, president of the Urban Institute, pointed out, a lot of the money is owed by people who have gone bankrupt or moved overseas to escape the IRS's reach.

Also largely beyond the tax collectors' grasp is the huge underground cash economy, whose transactions go unreported to any financial authorities. It would take an American equivalent of the KGB to bring that into compliance with the U.S. tax code.

Underpayment of individual income taxes dominates the tax gap. The IRS estimated that individuals accounted for 71 percent of the 2001 tax gap, with the rest coming from underpayments of corporate income taxes, payroll taxes for Social Security and Medicare and estate taxes.

The IRS traced most of the gap to taxpayers who reported less taxable income than they should have, either by failing to report some of their income or by taking more deductions and credits than they were entitled to. Failure to file tax returns and failure to pay taxes owed accounted for much less.

Some of the tax gap is the result of honest mistakes on tax forms that grow more complex every year as Congress adds new wrinkles to the tax code. The IRS has no idea how big this category is.

But one thing is apparent from the IRS' research: The government has a much better chance of collecting all the money it is owed if a portion of it is withheld in advance and if the income is reported by two sources: the taxpayers and their employers.

Joel Havemann writes for the Los Angeles Times.

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