Unpaid federal taxes possible pot of gold

? Think of the uses of $300 billion, the annual gap between what taxpayers owe and what they pay.

It would more than cover the federal deficit for a year or the extra money President Bush wants in 2007 and 2008 for Iraq and Afghanistan.

It would pay for the $125 billion that Congress has agreed to spend on Hurricane Katrina relief, with enough left for three years worth of federal education programs.

Such are the dreams of lawmakers pressing the Internal Revenue Service to get more aggressive about reducing what is known throughout Washington as “the tax gap.”

Skeptics, however, scoff at the notion there is a pot of gold waiting to be claimed. They say it is an illusion as long as nothing is done about the hopelessly complicated tax system.

$2,860 per household

An IRS study last year concluded that the tax gap in 2001 was $345 billion. Of that, $197 billion came from underreporting on individual income tax returns and $88 billion from underreporting by corporations and the self-employed. The rest came from those not filing or not paying the proper amount.

That gap narrowed to $290 billion after enforcement efforts and late payments were factored in. Still, that left the government collecting only 86 percent of the more than $2 trillion it was owed in 2001.

That translated into a “surtax” of about $2,680 per household in 2001, the national taxpayer advocate said at a recent hearing of the House Budget Committee. “That is an extraordinary burden to ask our nation’s compliant taxpayers to bear every year,” Nina E. Olson said.

“It’s not just a budgetary problem,” the committee chairman, Rep. John Spratt, D-S.C., said at the hearing. “It raises fundamental issues of moral fairness.”

The new Democratic majority sees these uncollected billions as a major source of revenue that could be used to pay for education, health and other priorities without busting the budget.

The IRS does claim some progress in cracking down on cheaters. The agency’s commissioner, Mark Everson, said enforcement revenue has climbed from $34 billion in the 2002 budget year to $49 billion in 2006. The audit rate for individual returns has gone from a little over one in 200 in 2001, to about one in 100 in 2006, with the returns of millionaires getting closer looks, Everson said.

Tax gap action

The Bush administration, in its budget proposal for next year, provided $410 million for programs to reduce the tax gap and outlined 16 legislative changes it said would raise about $29 billion over 10 years.

The Senate Finance Committee chairman said he was “very, very disappointed” by the proposals. “We’re not asking for the moon. We’re asking for more than one cent on the dollar,” said Sen. Max Baucus, D-Mont.

But Chris Edwards, director of tax policy studies at the libertarian Cato Institute, said the taxpayer compliance rate is one of the highest in the West, well above some European countries with thriving underground economies. The U.S. rate has held steady in the mid-80 percent level the past three decades.

He compared it to seat belt use, about 81 percent despite years of efforts to educate drivers.

Edwards, in an interview, predicted there would not be any real inroads in shrinking the gap until the tax laws were simpler; that is not expected to happen soon.

“Every new loophole adds additional incentives and ability for people to cheat,” he said.

Everson agreed. “We will never be able to audit our way out of the tax gap,” he said. Simplification would help, he said, but reducing the gap dramatically “will take some draconian steps” that “risk imposing unacceptable burdens on compliant taxpayers.”

Nonetheless, small steps are under way. The IRS hopes to garner $2 billion over 10 years from a program begun in 2006 whereby private collection agencies help pursue delinquent taxpayers.

The tax agency for the past decade has fostered voluntary tip reporting programs in the food and beverage industries, persistent sources of underreporting.

The Treasury Department’s inspector general for tax administration has estimated the IRS could pick up an additional $342 million over five years by seeking out tip agreements in the cosmetology and taxi-limousine industries.

In Congress, a bipartisan group of lawmakers is pushing one of the administration’s proposals: requiring brokers and mutual fund companies to track and report to taxpayers and the IRS investment information related to capital gains taxes. That would make it easier for taxpayers fill out their returns and help close an annual gap in capital gains taxes estimated at $17 billion.

Olson, the taxpayer advocate, said the IRS must expand third-party information reporting. There is little cheating when a person’s company reports wages to the IRS, but compliance is less than 50 percent for income not subject to third-party reporting.

One example might be more reporting on gross proceeds from Internet auction and sales sites, she said, noting that 700,000 people regard eBay sales as their primary or secondary source of income.

Cracking down on tax avoiders also will keep honest taxpayers honest, she said.

“If compliant taxpayers believe that everyone else is paying his or her fair share, they are likely to remain compliant,” she said. “But no one wants to feel like a ‘tax chump.”‘