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Updated January 4, 2023
Federal Tax Gap: Size, Contributing Factors, and the Debate
over Reducing It
Federal Tax Gap
Size of the Tax Gap
The federal tax gap is a measure of taxpayer
The most recent tax gap study by the IRS covers the years
noncompliance. The Internal Revenue Service (IRS)
2014 to 2016. According to the study, the average annual
provides two estimates of the gap: a gross measure and a
gross gap totaled $496 billion in that period, or about 15%
net measure. The former is the difference between the total
of total average annual federal taxes owed. Late payments
amount of federal individual and corporate income,
and IRS enforcement actions produced a net gap of $428
employment, and estate and gift taxes owed in a year and
billion. This estimate does not consider the effect of IRS
the total amount of those taxes paid voluntarily on time.
enforcement on taxpayer noncompliance.
The net tax gap is the difference between all taxes owed
and taxes paid after accounting for late taxpayer payments
As Table 1 shows, between 2001 and 2016, the net federal
and taxes collected through IRS enforcement actions. In
tax gap (2021 dollars) reached its lowest level in 2001
effect, it represents the amount of federal taxes that never
($444 billion) and its highest level in 2006 ($516 billion),
will be paid or collected.
and then trended downward to 2016. Similarly, the net
taxpayer noncompliance rate rose 2.6 percentage points
The federal tax gap may concern policymakers for several
from 2001 to 2008-2010 and then fell 3.3 percentage points
reasons. First, the gap represents uncollected revenue that
by 2014-2016.
the federal government could use for many purposes, such
as reducing the budget deficit or paying for new programs.
Table 1. Net Federal Tax Gap Estimates from 2001 to
Second, the gap imposes costs on compliant taxpayers that
2016
are not borne to the same extent by noncompliant taxpayers
($ bil ions)
(e.g., higher taxes in the future, cutbacks in beneficial
government programs, and interest payments on federal
Net Taxpayer
debt to finance budget deficits). Third, sustained growth in
Current
2021
Noncompliance
the tax gap may undermine public confidence in the
Year(s)
Dollars
Dollars
Ratea (%)
fairness and integrity of the federal tax system.
2001
$290
$444
13.7%
Estimating the Federal Tax Gap
2006
$385
$516
14.5%
The IRS has been estimating the size and composition of
2008-
the tax gap since 1979. Pre-1989 estimates were based on
$406
$508
16.3%
2010
compliance data obtained through the Taxpayer
Compliance Measurement Program (TCMP). The data were
2011-
based on comprehensive in-person audits done by IRS
$380
$450
14.2%
2013
examination officers. Audited taxpayers had to provide
documents supporting every tax return item. Many found
2014-
$428
$488
13.0%
these audits burdensome.
2016
Source: Internal Revenue Service, Tax Gap Estimates; and Bureau of
Congressional opposition to the TCMP’s audits led the IRS
Labor Statistics, Annual Average Consumer Price Indexes.
to adopt, in 2000, a different method of collecting
compliance data known as the National Research Program
a. The percentage of federal taxes owed in a year that were not
(NRP). To estimate compliance with the individual income
paid on time, after IRS enforcement actions and late taxpayer
tax, the NRP uses a random sample of audits of about
payments.
13,000 taxpayers deemed representative of the entire filing
population. Random sampling has the advantage of
Sources of the Federal Tax Gap
providing information on both compliant taxpayers and
The federal tax gap has three main sources: (1)
noncompliant taxpayers who otherwise might be difficult to
understatement of tax liability through unreported income
identify using the IRS’s income detection tools. To estimate
or overstated deductions, credits, and other income
other components of the tax gap (e.g., corporate income and
adjustments; (2) failure to pay taxes owed on time; and (3)
employment taxes), the IRS relies on a variety of data
failure to file a return on time, or nonfiling.
sources and empirical methods.
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link to page 2 Federal Tax Gap: Size, Contributing Factors, and the Debate over Reducing It
Table 2. Components of the Gross Federal Tax Gap
Income Visibility
($ bil ions)
Another factor is the ability of the IRS to track taxable
income. Income is most visible to the IRS when it is subject
2011-2013
2014-2016
to information reporting by third parties. Compliance is
even greater when income is subject to employer
Nonfiling
$37
$39
withholding, as happens with most wage income.
Underreported
$349
$398
According to IRS estimates, the amount of understated tax
Income
liability in 2014 to 2016 was an average $126 billion for
income subject to little or no reporting (e.g., farm income,
Underpayment of
$52
$59
sole proprietor income, rents, and royalties), but only $7
tax
billion for income subject to substantial information
Gross Tax Gap
$438
$496
reporting and withholding (e.g., wages and salaries).
Source: Internal Revenue Service; Research, Applied Analytics, and
Tax Code Complexity
Statistics; Tax Gap Estimates 2014-2016 (And Projections for 2017-
The federal tax gap is also thought to be a product of tax
2019), Publication 5364; August 2022.
code complexity. Complicated tax provisions that change
often may make it difficult for many individuals to pay their
As Table 2 shows, unreported income is by far the largest
taxes owed without committing errors that add to the
source of the federal tax gap. In 2011-2013, it accounted for
federal tax gap. Tax code complexity also creates
nearly 79.6% of the gross tax gap; income underreporting
opportunities for taxpayers who use the services of tax
made up 80.2% of the gap in 2014-2016.
professionals to reduce their tax liability through
questionable interpretations of tax law and regulations.
Noncompliance with the individual income tax underlies
Policy Issues
each component. In 2014-2016, this noncompliance
accounted for 72% of the gross tax gap, with unreported
The 117th Congress passed legislation that is intended, in
individual income making up 56% of the gap. Of all the
part, to reduce the federal tax gap. Under the law commonly
sources of unreported income, according to the IRS, the
known as the Inflation Reduction Act (IRA; P.L. 117-169),
largest amount was $130 billion in unreported business
the IRS is receiving nearly $79 billion in mandatory
income, which accounted for 26% of the gross tax gap. This
funding for its main activities through the end of FY2031.
income is subject to no withholding and little or no
The act specified that $3.2 billion of that amount will be
information reporting, making it harder for the IRS to track
used for taxpayer services, $45.6 billion for enforcement,
than wage, interest, and dividend income. There is reason to
$25.3 billion for operations support, and $4.75 billion for
think that much of the unreported business income is
the IRS business systems improvement program. This
attributable to sole proprietorships and partnerships, and
represents the first time Congress has approved multiyear
thus subject to the individual income tax.
funding for the IRS, which is supposed to disclose a plan
Contributing Factors
for using this money in February 2023.
Several forces are thought to play key roles in the size and
The IRA funding raises several issues. One is the return on
composition of the federal tax gap.
investment (ROI) from new enforcement actions. Although
such actions might raise more revenue than their cost,
IRS Resources
enforcement activities vary in their cost-effectiveness.
The size of the IRS budget and its staff, especially for
Some say that the IRS should improve its understanding of
enforcement activities and taxpayer services, affect the tax
the reasons for this variation so it can maximize the ROI on
gap through their impact on taxpayer compliance.
new enforcement initiatives.
Decreases in those resources since FY2010 have fueled a
concern that an underfunded IRS is setting the stage for
Some point out that permanently reducing the tax gap
further growth in the federal tax gap.
involves more than boosting IRS resources, and that the
federal tax code should also be simplified. In their view, tax
Between FY2010 and FY2019, the IRS budget (measured
simplification would enable more taxpayers to meet their
in 2021 dollars) declined 20.4%. The IRS’s inflation-
obligations with fewer errors and without tax-preparer
adjusted enforcement budget and staff declined more than
assistance. Clarifying ambiguous tax provisions may make
the IRS budget and workforce did. These cutbacks included
it harder for corporations and high-income individuals to
a 40.5% reduction in the number of revenue agents, who
prevail in disputes with the IRS over tax law interpretation.
handle the most complex enforcement cases, and a 45.5%
reduction in the number of field collection officers. These
Another policy issue is the impact of enforcement actions
declines resulted in decreases in audit rates during that
on taxpayer rights. Reducing the tax gap may require new
period for all taxpayers. This included a 61% drop in the
investments in the IRS’s information technology and
audit rate from FY2010 to FY2018 for individuals with
employee training, more spending on taxpayer services, and
incomes above $1 million.
a redesign of IRS information systems. Some maintain that
if the IRS makes these changes, it should avoid increasing
The IRS’s prefiling assistance and education programs help
taxpayer filing burdens, prioritize the protection of taxpayer
individuals avoid the unintended errors that can contribute
rights, and heed the wishes of compliant taxpayers.
to the federal tax gap. From FY2010 to FY2019, the IRS’s
staffing for this purpose decreased 31.5%.
Gary Guenther, Analyst in Public Finance
IF11887
https://crsreports.congress.gov
Federal Tax Gap: Size, Contributing Factors, and the Debate over Reducing It
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https://crsreports.congress.gov | IF11887 · VERSION 3 · UPDATED