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Lawmakers see pot of gold in tax gap

They're talking up the $300 billion owed to the IRS and ways to harvest it for spending.

February 04, 2007|Joel Havemann | Times Staff Writer

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 suddenly discovered a new buzzword -- the "tax gap" -- and the roughly $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 Monday, Democrats and Republicans alike 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 Senate Budget Committee Chairman Kent Conrad (D-N.D.).

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

To boost efforts to harvest it, the chairman and the top Republican member of the Senate's tax-writing finance committee, Sens. 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.

Though 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 Economy.com.

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.

"The 1998 act tilted the table in tax disputes in favor of taxpayers suspected of noncompliance," wrote Max B. Sawicky, an economist at the Economic Policy Institute, in his book "Bridging the Tax Gap."

Collecting more would also require spending more for audits and investigations. In fact, the IRS last year 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 firm Grant Thornton. "All of this would be invasive on a lot of taxpayers, many of whom already pay their taxes."

And as Robert D. 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' 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.

Measuring the tax gap is as much art as science. To find out what taxpayers should have paid on their 2001 income, the IRS conducted reviews of a random sample of 46,000 individual returns.

The IRS estimates that taxpayers still owed $345 billion after most 2001 tax payments were due. A combination of voluntary late payments and IRS enforcement actions shaved that figure to $290 billion. That means taxpayers paid 86.6% of the $2.157 trillion they owed -- the vast majority of it voluntarily.

Like just about everything else with a dollar sign in front of it, the $290-billion tax gap has probably grown since 2001. Even if it stayed the same, it would be enough to balance this year's budget, with about $50 billion left over.

Underpayment of individual income taxes dominates the tax gap. The IRS estimated that individuals accounted for 71% 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 underreported their taxable income, either by failing to report some 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, which grow more complex every year as Congress adds new wrinkles to the tax code. The IRS can't say how big this category is.

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

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