Closing the Tax Gap: A New Priority

Congress sees dollar signs in measures to narrow the tax gap.

By Joan Pryde, Senior Tax Editor, the Kiplinger letters

July 25, 2008

There’s a new push to close the tax gap. Democratic leaders in Congress are intent on enacting proposals to increase tax compliance. They’re calling it tax fairness, but the need for a lot more revenue is a primary motive.

The Treasury would reap a windfall from measures to close the tax gap -- the difference between what the Internal Revenue Service is owed in taxes from individuals and businesses and what it actually takes in. Back in 2001, the IRS estimated the tax gap at around $300 billion, but seven years later it’s widely assumed that the number is much larger.

Congress could use this revenue windfall to offset the cost of big tax cuts, including extending expiring tax breaks, reforming the alternative minimum tax, easing the estate tax and the like. In fact, a new estimate shows that boosting compliance with tax laws by just 1% would bring $3 billion a year more to the Treasury -- a big gift to lawmakers hunting for revenue raisers to offset spending or tax cuts.

Some tax gap proposals stand a good chance of passing this year or next. A big one is requiring brokers to report a customer’s basis in securities they sell. This would help curb underreporting of capital gains. Whatever Congress passes will apply to many types of securities: stocks, bonds, mutual funds, options, etc. Brokers will have time to get their systems ready: The reporting rule will apply only to securities bought 18 months after enactment.

A number of other measures to close the tax gap are also likely to pass:

• Extending the three-year statute of limitations on the IRS’ ability to assess tax.

• Making credit card companies file 1099s on payments made to merchants.

• Requiring return preparers who aren’t CPAs, lawyers or enrolled agents to register, pass a test and renew their eligibility periodically.

• Ordering the IRS to create a self-audit program for taxpayers, patterned after those now used by some states. The IRS would contact taxpayers about deductions that other filers have habitually overstated, such as auto expenses, meals and entertainment, explain the rules and give them a chance to fix the mistake, in which case, any penalty they owed would be reduced or waived.

You’ll hear talk about other ideas, but quick action on them is a long shot: Having states share more data with the IRS is stalled because of IRS computer security problems. Mandating electronic filing for individuals is an idea that lawmakers will resist because they know they’d take a lot of heat from their constituents. And a big boost in funding for the IRS won’t fly because of the Service’s recent track record of computer glitches and rebate processing problems: Congress will be leery of forking over big bucks until the IRS shows it can wisely spend what it already has.

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