Order Code RL33882
Tax Gap and Tax Enforcement
February 16, 2007
James M. Bickley
Specialist in Public Finance
Government and Finance Division

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Tax Gap and Tax Enforcement
Summary
Recent and projected large federal budget deficits have generated congressional
interest in the feasibility of raising revenue by reducing the tax gap. The Internal
Revenue Service (IRS) defines the gross tax gap as “the difference between the
aggregate tax liability imposed by law for a given tax year and the amount of tax that
taxpayers pay voluntarily and timely for that year.” “The net gap is the amount of the
gross tax gap that remains unpaid after all enforced and other late payments are made
for the tax year.” For tax (calendar) year 2001, the IRS estimates a gross tax gap of
$345 billion, equal to a noncompliance rate of 16.3%. For the same tax year, IRS
enforcement activities, coupled with other late payments, recovered about $55 billion
of the gross tax gap, resulting in a net tax gap of $290 billion.
The estimated gross tax gap of $345 billion consists of underreporting of tax
liability ($285 billion), nonfiling of tax returns ($27 billion), and underpayment of
taxes ($33 billion). (Taxes on illegal activities are excluded from these estimates.)
The $285 billion of underreporting of tax liability has the following components:
$197 billion of individual income tax, $54 billion in employment tax, $30 billion in
corporate income tax, and $4 billion in estate taxes.
The IRS has replaced the Taxpayer Compliance Measurement Program — a
systematic approach for estimating the tax gap — with the National Research
Program (NRP). One of the guiding principles for the NRP is to minimize the
compliance burden on those taxpayers selected in the NRP sample. The new
methodology of the NRP was applied to the underreporting gap for the individual
income tax for tax year 2001.
The estimates of the gross tax gap have been heavily publicized; perhaps as a
result, some public officials have emphasized better enforcement of tax laws in order
to raise revenue. Three factors limit the dollar amount that can be collected by
increased enforcement. First, much of the gross tax gap for individual income tax
filers is due to types of unreported income that are difficult to detect. Second, some
of the detected tax liability cannot be easily collected, particularly from those
taxpayers who are currently unable to pay. Third, many detected tax liabilities are
so small relative to enforcement costs that it is not cost-effective to pursue collection.
From fiscal years 2001 to 2006, greater tax enforcement efforts by the IRS
increased enforcement revenue from $33.8 billion to $48.7 billion. The IRS is
attempting to reduce the gross tax gap by pursuing a strategy, which has seven
components: reduce opportunities for evasion, make a multi-year commitment to
research, continue improvements in information technology, improve compliance
activities, enhance taxpayer service, reform and simplify the tax law, and coordinate
with partners and stakeholders.
This report will be updated as issues develop or new legislation is introduced.

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Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Tax Gap Concepts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Methodology to Estimate the Tax Gap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Taxpayer Compliance Measurement Program . . . . . . . . . . . . . . . . . . . . . . . . 2
National Research Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Tax Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Limitations to Increased Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Tax Enforcement Efforts 2001-2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Comprehensive Strategy for Reducing the Tax Gap . . . . . . . . . . . . . . . . . . . . . . . 5
Appendix A: Gross Tax Gap Data for 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
List of Tables
Table A1. Estimated Gross Tax Gap by Type of Tax . . . . . . . . . . . . . . . . . . . . . . 8
Table A2. Estimated Gross Tax Gap by Type of Error . . . . . . . . . . . . . . . . . . . . . 9

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Tax Gap and Tax Enforcement
Introduction
Recent and projected large federal budget deficits have generated congressional
and executive branch interest in raising revenue by reducing the tax gap.1 Other
motivations for reducing the tax gap include adverse effects on (1) public trust in the
fairness of the tax system, which may adversely affect voluntary compliance with tax
laws, and (2) economic efficiency by providing an incentive for inputs of labor and
capital to shift to those sectors of the economy with lower taxes. This report defines
tax gap concepts, explains the methodology used to calculate the tax gap, examines
the relationship between the tax gap and enforcement, and briefly discusses the
Internal Revenue Service’s (IRS’s) strategy to reduce the gross tax gap.2
Tax Gap Concepts
The IRS defines the gross tax gap as “the difference between the aggregate tax
liability imposed by law for a given tax year and the amount of tax that taxpayers pay
voluntarily and timely for that year.”3 And it defines the net tax gap as “the amount
of the gross tax gap that remains unpaid after all enforced and other late payments are
made for the tax year.”4 Currently, these tax gap concepts exclude illegal activities
because the IRS lacks adequate data on these activities.5
1 Kurt Ritterpusch, “Post-Election Action on Closing Tax Gap Deemed Common Ground
Issue for Congress,” Daily Tax Report, no. 208, Oct. 27, 2006, p. G1, and Drew Douglas,
“Treasury 2008 Budget Plan to Include Renewed Focus on Compliance, Tax Gap,” Daily
Tax Report, no. 13, Jan. 22, 2007, pp. G1-G3.
2 For a comprehensive review of the literature on tax compliance, see James Adreoni, Brian
Erard, and Jonathan Feinstein, “Tax Compliance,” Journal of Economic Literature, vol. 36,
no. 2, June 1998, pp. 818-860.
3 Alan Plumley, “Preliminary Update of the Tax Year 2001 Individual Income Tax
Underreporting Gap Estimates,” Internal Revenue Service, SOI Tax Stats-Papers-2005 IRS
Research Conference, Washington, June 7-8, 2005, p. 15. Available at
[http://www.irs.gov/taxstats/productsandpubs/article/0,,id=130103,00.html].
4 Ibid.
5 The IRS made tax gap studies for tax years 1979, 1983, and 1987. Each study used a
different definition of the tax gap. For a discussion of the changes in the concept of the tax
gap, see U.S. General Accounting Office, Tax Administration: IRS’ Tax Gap Studies,
Washington, March 1988, 23 p.

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CRS-2
For tax year 2001, the IRS estimates a gross tax gap of $345 billion, equal to a
noncompliance rate of 16.3%.6 For the same year, IRS enforcement activities,
coupled with other late payments, recovered about $55 billion of the gross tax gap,
resulting in a net tax gap of $290 billion.7
The estimated gross tax gap of $345 billion consists of underreporting of tax
liability ($285 billion), nonfiling of tax returns ($27 billion), and underpayment of
taxes ($33 billion).8 For 2001, the $285 billion of underreporting of tax liability has
the following components: $197 billion of individual income tax, $54 billion in
employment tax, $30 billion in corporate income tax, and $4 billion in estate taxes.9
There are no estimates of the underreporting of excise taxes.10 For 2001, the gross
tax gap by type of tax was individual income tax ($245 billion), corporate income tax
($32 billion), employment taxes ($59 billion), and estate taxes ($6 billion).11 IRS
enforcement to reduce the gross tax gap has focused on the individual and corporate
income components.
Methodology to Estimate the Tax Gap
The IRS has replaced the Taxpayer Compliance Measurement Program (TCMP)
with the National Research Program (NRP) to estimate the gross income tax gap.
Taxpayer Compliance Measurement Program
Prior to tax year 1989, the IRS relied on data from the TCMP to estimate the
gross tax gap for individual income taxpayers and small corporations (less than $10
million in assets). The IRS formulated upper- and lower-bound estimates of the
gross income tax gap. The IRS completed “line-by-line examinations of several
different types of tax returns.”12 The upper-bound estimates of the gross tax gap
were calculated from the TCMP and regular audits of large corporations. For larger
corporations ($10 million or more in assets), the IRS relied on regular operational
6 Internal Revenue Service, “IRS Updates Tax Gap Estimates,” IR-2006-28, Feb. 14, 2006,
p. 1. Available at [http://www.irs.gov/newsroom/article/0,,id=154496,00.html].
7 Ibid.
8 Ibid.
9 Ibid.
10 Internal Research Service, “Preliminary Update of the Tax Year 2001 Individual Income
Tax Underreporting Gap Estimates,” Nov. 17, 2005, p. 2.
11 The most current estimates for components of the gross tax gap for tax year 2001 are
listed in Appendix A.
12 Internal Revenue Service, Income Tax Compliance Research: Net Tax Gap and
Remittance Gap Estimates, Washington, April 1990, p. 2.

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CRS-3
audit of tax returns. If an audit showed an underpayment of taxes, the IRS examiner
determined the tax deficiency.13
The lower-bound estimate of the gross tax gap was based on the amounts
eventually assessed after the appeals and litigation process. Some of the tax
deficiency found from audits was negated by taxpayers’ appeals and court decisions
leading to a lower estimate of taxes owed but unpaid.14 “The eventual assessment
may be considered to be the true ‘legal’ liability in the sense that IRS cannot attempt
to assess more later, except in unusual cases.”15 The net tax gap differed depending
on whether the upper- or lower-bound estimate of the gross tax gap was used.
National Research Program
The last TCMP was for tax year 1988. Several times in the 1990s, IRS officials
attempted to conduct a new TCMP, but some Members of Congress objected because
of the high cost to the IRS and the compliance burden placed on taxpayers who were
selected in the TCMP sample. Consequently, IRS developed the National Research
Program (NRP). According to the IRS,
The goal of National Research Program (NRP) is to design and implement a
successful strategy to collect data that will be used to measure payment, filing
and reporting compliance and to deliver the data to the IRS Business Operation
Division to meet a wide range of needs including support for the development of
strategic plans and improvements in workload identification.16
A guiding principle for the NRP was to minimize compliance burden on taxpayers
selected in the NRP sample.17
The NPR methodology was applied to the underreporting gap for the individual
income tax for tax year 2001 and consisted of three major processes:
(1) casebuilding — creating information files on returns selected for the NRP
sample;
(2) classification — using that information to classify the returns according to
what, if any, items on the returns cannot be verified without additional
information from the taxpayers; and
(3) taxpayer audits limited to those items that cannot be independently verified.18
13 Ibid., p. 13.
14 Ibid., pp. 13-14.
15 Ibid., p. 14.
16 Internal Revenue Service, “National Research Program (NRP), May 24, 2005, p. 1.
Available at [http://www.irs.gov/privacy/article/0,,id=139179,00.html].
17 Ibid.
18 United States General Accounting Office, Tax Administration: IRS Is Implementing the
National Research Program as Planned, GAO-03-614, June 2003, p. 4.

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The IRS applied the NRP approach to about 46,000 randomly selected returns. It
deliberately oversampled high income returns in order to draw conclusions about
important sub-categories of taxpayers.19
Currently, the IRS is examining subchapter S corporations as part of the NRP.
The IRS estimates that a large portion of the tax gap is attributable to small
businesses including subchapter S corporations. The random sample consists of
approximately 5,000 returns covering two tax years, 2003 and 2004. The case
building and classification phases of the study are completed. The examination phase
of the study began in October 2005 and is expected to be completed in approximately
36 months. The results are scheduled to be available in December 2008.20
Tax Enforcement
The estimates of the gross tax gap have been heavily publicized. Perhaps as a
result, some public officials have emphasized better enforcement of tax laws to raise
revenue. According to some, enforcement alone is likely to have a limited impact on
the gross tax gap. Acting on this view, the IRS is implementing a comprehensive
approach to reduce the gross tax gap.
Limitations to Increased Enforcement
Three factors are seen limiting the net revenue potential from increased
enforcement. First, much of the gross tax gap for individual income tax filers is due
to types of unreported income that are difficult to detect. Usually the income is not
covered by third-party information returns (e.g., income earned by informal business
proprietors who operate on a cash basis). Second, even when the unreported income
is detected, some of the resulting tax liability cannot be easily collected, particularly
from those taxpayers who are currently unable to pay. Third, many detected tax
liabilities are so small relative to enforcement costs that it is not cost effective to
pursue collection.
Tax Enforcement Efforts 2001-2006
Empirical data suggest that additional tax enforcement actions alone will have
a limited effect on the gross tax gap. Between fiscal years 2001 and 2006, the IRS
increased its enforcement efforts, and the enforcement revenue collected rose from
$33.8 billion to $48.7 billion.21 And, while $14.9 billion represents a 44% increase,
it is only 4.3% of the estimated $345 billion gross tax gap in 2001. During the period
FY2001-FY2006, staffing for key enforcement occupations rose from 20,203 to
19 Internal Revenue Service, “Understanding the Tax Gap,” FS-2005-14, March 2005, p. 1.
Available at [http://www.irs.gov/newsroom/article/0,,id=137246,00.html].
20 Internal Revenue Service, “Federal Tax Gap: New Estimates, New Approaches,” 2006,
p. 8.
21 Internal Revenue Service, Fiscal Year 2006 Enforcement and Service Results, Nov. 20,
2006, p. 2.

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CRS-5
21,185 (4.8%); examinations of individual tax returns increased from 731,756 (or
0.58% of returns) to 1,293,681 (or 0.98% of returns); examinations of business
returns rose from 7,384,600 (or 0.55% of returns) to 8,722,410 (or 0.60% of returns);
and examinations of tax-exempt-organization returns increased from 5,342 to 7,079
(preliminary estimate).22 Rather than focusing only on enforcement, the Treasury
Department and the Government Accountability Office (GAO)23 argued that a
comprehensive strategy is needed to reduce the tax gap.
In FY2003-FY2005, some of the most abusive domestic tax shelters were
eliminated by the passage of legislation and expanded IRS enforcement.24 Tax
shelters are structured transactions with little or no clear business purpose. Further
examination of tax shelters may occur in the 110th Congress.25 Ms. Deborah Nolan,
IRS Commissioner of the Large and Mid-Size Business Division, stated that in 2007
the IRS will focus particular attention on large taxpayers’ international activities.26
Comprehensive Strategy for Reducing the Tax Gap
The Office of Tax Policy at the Treasury has developed what it considers a
comprehensive strategy for reducing the tax gap, guided by the following four key
principles:27
! Unintentional taxpayer errors and intentional taxpayer evasion
should both be addressed.
! Sources of noncompliance should be targeted with specificity.
22 Ibid., pp. 2-7.
23 U.S. Government Accountability Office, Tax Compliance: Multiple Approaches Are
Needed to Reduce the Tax Gap, Statement of Michael Brostek, Director, Tax Issues
Strategic Issues Team, before the Senate Committee on the Budget, Jan. 23, 2007, 21 p.
24 For an examination of tax shelters, see CRS Report RL32193, Anti-Tax-Shelter and Other
Revenue-Raising Tax Proposals Considered in the 108th Congress, by Jane G. Gravelle; and
Joseph Bankman, “The Tax Shelter Battle,” in The Crisis in Tax Administration, Henry J.
Aaron and Joel Slemrod, editors, (Washington: Brookings Institution Press, 2004), pp. 9-28.
25 The Joint Tax Committee published two reports concerning tax compliance. Some of the
options examined in their first report were enacted into law. In the 110th Congress, some
options in these reports may be proposed in legislation. See U.S. Congress, Joint Committee
on Taxation, “Options to Improve Tax Compliance and Reform Tax Expenditures,” Report
no. JCS-02-05, 109th Congress, 1st sess., (Washington, Jan. 27, 2005), 430 p.; and U.S.
Congress, Joint Committee on Taxation, “Additional Options to Improve Tax Compliance,”
109th Congress, 2nd sess., (Washington, Aug. 3, 2006), 43 p.
26 Stephen Joyce, “IRS to Continue Tax Compliance Push; Effect on Audits, Planning
Uncertain,” Daily Tax Report, Report Supplement: Tax Administration, no. 9, Jan. 16, 2007,
p. 7.
27 This section of the report consists of excerpts from U.S. Department of the Treasury,
Office of Tax Policy, A Comprehensive Strategy for Reducing the Tax Gap, Sept. 26, 2006,
12 p.

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! Enforcement activities should be combined with a commitment to
taxpayer service.
! Policy positions and compliance proposals should be sensitive to
taxpayer rights and maintain an appropriate balance between
enforcement activity and imposition of taxpayer burden.28
The resulting strategy developed by the Treasury (a strategy they term
“comprehensive, integrated and multi-year”) includes the following seven
components:
! Reduce Opportunities for Evasion. The Administration’s FY2007
budget included five legislative proposals to reduce evasion
opportunities and improve the efficiency of the IRS. The Treasury
Department’s Office of Tax Policy is working with the IRS to
develop additional legislative proposals for consideration as part of
the FY2008 budget process.
! Make a Multi-Year Commitment to Research. Research is essential
to identify sources of noncompliance so that IRS resources can be
properly targeted. Regularly updating compliance research ensures
that the IRS is aware of vulnerabilities as they emerge.
! Continue Improvements in Information Technology. Continued
improvements to technology would provide the IRS with better tools
to improve compliance through early detection, better case selection,
and better case management.
! Improve Compliance Activities. By improving document matching,
examination, and collection activities, the IRS would be better able
to prevent, detect, and remedy noncompliance.
! Enhance Taxpayer Service. Service is especially important to help
taxpayers avoid unintentional errors. Given the increasing
complexity of the tax code, providing taxpayers with assistance and
clear and accurate information before they file their tax returns
reduces unnecessary contacts afterwards, allowing the IRS to focus
enforcement resources on taxpayers who intentionally evade their
tax obligations.
! Reform and Simplify the Tax Law. Simplifying the tax law would
reduce unintentional errors caused by a lack of understanding.
Simplification would also reduce the opportunities for intentional
evasion and make it easier for the IRS to administer the tax laws.
! Coordinate with Partners and Stakeholders. Closer coordination is
needed between the IRS and state and foreign governments to share
information and compliance strategies. Closer coordination is also
28 Ibid., pp. 1-2.

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needed with practitioner organizations, including bar and accounting
associations, to maintain and improve mechanisms to ensure that
advisors provide appropriate tax advice.29
29 Ibid., pp. 2-3.

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Appendix A: Gross Tax Gap Data for 2001
Table A1. Estimated Gross Tax Gap by Type of Tax
Gross Tax Gap
Type of Tax
Share of Gross Tax Gap
($ Billions)
Individual Income
245
71%
Corporate Income
32
9%
Employment
59
17%
Estate
6
2%
Excise
Not Available
Totala
345
100%
Note: Totals may not add up to 100% due to rounding. Taxes on illegal activities are excluded from
these estimates.

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Table A2. Estimated Gross Tax Gap by Type of Error
Gross Tax
Share of Gross
Type of Error
Component of Error
Gap
Tax Gap
($Billions)
Underreportinga
Individual Income Tax
Non-Business Income
56
16%
Business Income
109
32%
Overstated, Adjustments,
32
9%
Deductions, Exemptions,
and Credits
Total
197
57%
Corporation Income Tax
30
9%
Employment Tax
FICA
15
4%
Self-Employment Income
39
11%
Tax
Total
54
16%
Estate Tax
4
1%
Total Underreporting
285
83%
Underpaymentsb
Individual Income Tax
23
7%
Employment Tax
5
1.5%
Other
5
1.5%
Total Underpayments
33
10%
Nonfilingc
Individual Income Tax
25
7%
Estate
2
1%
Total Nonfiling
27
8%
Grand Total
345
100%
Source: Adapted by CRS from Internal Revenue Service, “IRS Updates Tax Gap Estimates,” IR-
2006-28, Feb.14, 2006, p. 1, (Tax gap figures link), available at [http://www.irs.gov/newsroom/article/
0,,id=154496,00.html], and U.S. Department of the Treasury, Office of Tax Policy, A Comprehensive
Strategy for Reducing the Tax Gap, Sept. 26, 2006, pp. 3-4.
Notes:
a. Information regarding underreporting of excise taxes is not available. Taxes on illegal activities are
excluded from these estimates.
b. Underpayments include employer failures to deposit withheld income and employment taxes.
c. Information regarding the nonfiling gap associated with corporate income taxes, employment taxes,
or excise taxes is not available.

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