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