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The tap gap, part 1: What is the biggest contributor?

“Tax gap” is kind of a wonky term. But it reflects a tax compliance and enforcement context that has definite implications for taxpayers.

The term refers to the difference between the amount of taxes that a revenue agency actually collects and the amount of taxes that theoretically were due.

In this two-part post, we will take note of the IRS’s recent estimate of the federal tax gap. We will also discuss how the tax gap affects IRS enforcement initiatives and taxpayer compliance.

It takes several years for the IRS to crunch the numbers and calculate the tax gap. The most recent years available are 2008 through 2010.

For those tax years, the IRS has estimated that the total amount of the gross tax gap is well over $450 billion. To be a bit more precise, the estimate is $458 billion.

Obviously that is huge number. But it is interesting to note the three components that the IRS adds up to get the overall figure.

Nonfiling is of course one these components. The other two are underreporting income and underpayment of taxes.

Of the three components, nonfiling is the smallest contributor to the tax gap, at $32 billion. The amount of the gap attributable to underpayment is somewhat larger, at $39 billion.

It is underreporting, however, that accounts for the bulk of the tax gap. In the tax years the IRS looked at, underreporting was estimated at $387 billion. That represents nearly 85 percent of the entire tax gap.

To be sure, there is a difference between the gross tax gap and the net tax gap. The net gap is a smaller number because some of the unpaid taxes included in the gross figure will eventually be collected.

In part two of this post, we will discuss the implications of these estimates for voluntary taxpayer compliance with tax laws.

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