The Internal Revenue Service has just released its latest estimate of the “tax gap” — the difference between what Americans pay in taxes and what they actually owe. For the years 2008 to 2010 (the IRS’s latest data), the annual gap averaged a huge $458 billion. It’s surely higher now. Gulp. If everyone religiously paid every penny owed, budget deficits would shrink dramatically. This isn’t about to happen, for reasons I’ll explain in a moment, but first let’s take a closer look at the tax gap. It represents slightly less than a fifth of the total tax liability. Americans pay the other four-fifths voluntarily, if not always enthusiastically. Put differently, the $458 billion is 18.3 percent of the estimated $2.496 trillion of taxes owed annually for the three-year period. The IRS expects to collect $52 billion annually of the unpaid amounts through late payments, audits and enforcement actions. This would reduce the final tax gap to $406 billion, or 16.3 percent of total tax liability. In general, the more income that is subject to mandatory reporting and withholding, the higher the compliance rate. Most wage and salary payments must be automatically reported to the government; the compliance rate is about 99 percent. By contrast, the compliance rate of taxpayers where there is no automatic reporting and withholding — for example, on farm and small-business income — is 63 percent. And, obviously, most income from criminal activity is not reported. Individuals — including the self-employed — account for most of the tax gap. For the years 2008-2010, they represented about 90 percent of the unpaid $458 billion. Most of this involved underreporting of income as opposed to underpayment of taxes due or not filing at all. All this suggests three takeaways. First, it’s possible to reduce the gap further by more enforcement. It makes no sense (as my colleague Catherine Rampell has repeatedly pointed out) for the Republican-led Congress to criticize the IRS for poor performance and, simultaneously, cut its budget. This limits the number of audits of tax evaders and tax cheats. It also reduces the size of tax compliance centers, where taxpayers can have questions answered by phone. We expect people to pay their taxes; the least we can do is help them understand what their taxes are. Second, even if this problem were solved — which seems unlikely — it’s impossible, as a practical matter, to close the entire tax gap. This would require draconian measures such as universal audits and much steeper penalties. They would be hugely unpopular and, almost certainly, would trigger a fierce public backlash. Moreover, much of this exercise would be uneconomic: The IRS would spend as much or more in compliance costs as it would recover in small underpayments. Finally, the tax gap is yet another reason for tax reform. The code’s complexity is a major cause of underpayment. Some of this is unintentional; taxpayers mistakenly deduct more than is allowed. But much is intentional; taxpayers dare the government to catch relatively modest income misstatements or excess deductions. A simpler system with fewer tax breaks and lower rates would limit these opportunities. But this isn’t likely — as I pointed out in a recent column — because too many Americans are wedded to existing tax breaks: say, the deductions for mortgage interest and charitable contributions. Little wonder the IRS is so unpopular. We expect it to do an efficient job of collecting tax revenue when the underlying system is hopelessly inefficient. It has been charged with a mission impossible. courtesy the washington post