What is the Tax Gap?

The tax gap, as defined by the IRS, is the difference between the amount of tax owed by taxpayers for a given year and the amount that is actually paid voluntarily and timely. The tax gap is intended to represent, in dollar terms, the annual amount of tax noncompliance with our tax laws. This might be from under-reporting of income (either intentionally or by an honest misunderstanding of the tax law), non-filing, intentional tax evasion, or hiding offshore income.

While there is no true measure of the tax gap, estimates range from $574 billion to $700 billion (estimated by the U.S. Treasury Department) annually. Stated another way, the government fails to collect about 15% of taxes owed each year, or roughly $600 billion last year. It is thought that the top 1% of taxpayers are responsible for 30% of this tax gap.

For tax years 2011 through 2013, the IRS estimated that about 83.6% of taxes were paid voluntarily and on time. The resulting tax gap was estimated at $441 billion annually ($381 billion after enforcement and collection efforts). The percentage of voluntary compliance has remained relatively constant over the last 20 years.

In testimony to the Senate Finance Committee back in April, Charles Rettig, Internal Revenue Service Commissioner, stated that “the actual tax gap could approach, and possibly exceed $1 trillion” annually.

To put this in context, in Fiscal Year 2019, the IRS collected $3.56 trillion in taxes and generated almost 96% of the funding that supports the Federal Government’s operations.

How does this affect you?

The Biden administration is pushing the $3.5 trillion Build Back Better Act. Draft legislation provides for higher income taxes rates for higher income individuals and businesses to pay for the spending bill, it is also looking to increase tax collections and enforcement by the IRS as a means to close the tax gap and increase revenues.

In their Fiscal Year 2022 Budget request, IRS is seeking $340 million continue enforcement strategies and allow the IRS eventually to double its compliance efforts on partnerships, high-wealth returns, and large corporations with balance sheet assets greater than $10 million.

Tax compliance has changed over the last several years to include more informational reporting requirements. But enforcement and audits have waned in recent years due to resource constraints. The Biden administration and IRS budget requests are looking to change that trend.

Data Sources

Internal Revenue Service (IRS). 2019. “Federal Tax Compliance Research: Tax Gap Estimates for Tax Years 2011–2013,” Publication 1415 (rev. 09-2019).

SASSY SAYS

SASSY: My favorite animal is the elephant since they are fascinating creatures, just like me. I wish I had an elephant trunk, they are used for many tasks. Did you know that elephants have around 150,000 muscle units in their trunk alone? Their trunks are very sensitive – Asian elephants can pick up a peanut, shell it, blow the shell out and eat the nut. Elephants use their trunks to suck up water to drink. Its trunk can contain up to 8 liters of water. They also use their trunks as a snorkel when swimming. Here are some cool facts about elephants https://www.wwf.org.uk/learn/fascinating-facts/elephants and an interesting article on elephant trunks in The New York Times, https://www.nytimes.com/2021/06/01/science/elephant-trunks-suction.html