IRS blames complexity, cheating for gap in tax revenue

Complexity in the tax code and cheating by the self-employed and independent contractors are two of the biggest factors contributing to the "tax gap," the more than a quarter trillion dollar difference between what is owed the government and what is collected, the Senate Finance Committee was told Thursday.

Internal Revenue Service Commissioner Mark Everson said the gross tax gap was between $312 billion and $353 billion in 2001, the most recent year for which figures were available. He said IRS enforcement and late payments close about $55 billion of the gap -- making the net annual tax gap between $257 billion and $298 billion.

"Complexity in the tax code compromises both the service and enforcement missions of the IRS," said Everson. "Those who try to follow the law but cannot understand their tax obligations may make inadvertent errors or ultimately throw up their hands and say 'Why bother?' Meanwhile, individuals who seek to pay less than what they owe often hide behind the tax code's complexity in order to escape detection by the IRS and pay less."

The IRS study showed that underreporting of income is responsible for more than 80 percent of the total tax gap, with non-filing and underpayment accounting for about 10 percent each. Two thirds of the total comes from individual income taxes and more than 80 percent of that comes from understated income, mostly by the self-employed.

Everson, GAO Comptroller General David Walker and several other witnesses suggested tax withholding from independent contractors or self-employed individuals could begin to address that segment of the problem.

Walker suggested several tactics to reduce the tax gap, including beefing up enforcement, simplifying the tax code and enhanced withholding "in segments of the population where compliance is lower," and the possibility of a consumption tax. But he and National Taxpayer Advocate Nina Olson, an employee of the IRS, cautioned that enhanced withholding and beefed-up enforcement need to be balanced against the right of privacy and the unwanted effect of turning off more taxpayers than it captures.

Meanwhile, Sen. Saxby Chambliss, R-Ga., and Rep. John Linder, R-Ga., again introduced their legislation to replace the income tax with a national sales tax. "We're going to have to do a revolutionary change in the way we fund our systems," Linder said at a news conference.

The legislation would repeal individual and corporate income taxes, payroll taxes and the alternative minimum tax and instead impose a 23 percent tax on consumer goods. That tax would be collected by the states, which would keep a small percentage and remit the rest to the federal government.

The tax is strongly opposed by retailers, who say it would have a disproportionate impact on low- and middle-income families.

Chambliss said the tax reform issue could breathe some life into the lagging Social Security debate.

"The president's going to find out that there is a large segment of Americans who are ready for tax reform, unlike Social Security, where there is a small segment of Americans pushing the issue," he said.

Linder said the White House-appointed tax reform panel will consider his national sales tax proposal at a May 11 hearing. Linder said he believed the panel would put forward two or three tax reform options -- one that will make minor adjustments to the current income tax structure, and one that will be "a pure consumption tax."