Updated Tax Gap Estimate Shows Big Jump From Prior Years
DATED OCT. 12, 2023
IRS updates tax gap projections for 2020, 2021; projected annual gap rises to $688 billion
October 12, 2023
WASHINGTON — The Internal Revenue Service today released new tax gap projections for tax years 2020 and 2021 showing the projected gross tax gap increased to $688 billion in tax year 2021, a significant jump from previous estimates.
The new estimate reflects a rise of more than $192 billion from the prior estimates for tax years 2014-2016 and a rise of $138 billion from the revised projections for tax years 2017-2019. This marks the first year tax gap projections have been provided for single tax years and also marks the beginning of tax gap updates on an annual basis.
“This increase in the tax gap underscores the importance of increased IRS compliance efforts on key areas,” said IRS Commissioner Danny Werfel. “With the help of Inflation Reduction Act funding, we are adding focus and resources to areas of compliance concern, including high-income and high-wealth individuals, partnerships and corporations. “These steps are urgent in many ways, including adding more fairness to the tax system, protecting those who pay their taxes and working to combat the tax gap.”
Tax gap details: late payments and IRS enforcement generated $63 billion in 2021
The $688 gross tax gap is the difference between estimated 'true' tax liability for a given period and the amount of tax that is paid on time. The gross tax gap covers three key areas — nonfiling of taxes, underreporting of taxes and underpayment of taxes.
The IRS notes that the tax gap estimates and projections cannot fully account for all types of noncompliance. In addition, the projections released today are based largely upon the compliance behavior estimated from the most recent set of completed audits (from tax years 2014-2016). That estimated compliance behavior is projected forward to taxpayers in tax years 2020 and 2021.
Late payments and IRS enforcement efforts are projected to generate an additional $63 billion on tax year 2021 returns, resulting in a projected net tax gap of $625 billion. Between tax years 2014-2016 and tax year 2021, the estimated tax liability increased by about 38 percent, roughly the same increase as the gross and net tax gaps. Much of these increases in tax liability and the tax gap can be attributed to economic growth.
Voluntary compliance rate remains relatively steady
The tax year 2020 and 2021 tax gap projections translate to about 85% of taxes paid voluntarily and on time, which is in line with recent levels. After IRS compliance efforts are factored in, the projected share of taxes eventually paid is 86.3% for tax year 2021, down slightly from the 87.0% for tax years 2014-2016. This drop in compliance does not factor in any changes in compliance behavior; instead, it is due to changes in the types of income and how that income is reported to the IRS.
The gross tax gap comprises three components:
Nonfiling, which means tax not paid on time by those who do not file on time:
$77 billion in tax year 2021, up from $41 billion in tax years 2017-2019.
Underreporting, which reflects tax understated on timely filed returns.
$542 billion in tax year 2021, up from $445 billion in tax years 2017-2019.
Underpayment, or tax that was reported on time, but not paid on time).
$68 billion in tax year 2021, up from $64 billion in tax years 2017-2019.
With the help of Inflation Reduction Act resources, the IRS will be taking a variety of steps to help improve voluntary compliance by improving taxpayer services and offering new technology tools to work in concert with additional compliance work. In 2022, the latest year for which data is available, the IRS collected more than $4.9 trillion in taxes, penalties, interest and user fees.
Tax gap studies through the years have consistently demonstrated that third-party reporting of income significantly raises voluntary compliance with the tax laws. And voluntary compliance rises even higher when income payments are also subject to withholding. The IRS also has an array of other taxpayer service programs aimed at supporting accurate tax filing and helping address the tax gap. These range from working with businesses and partner groups to a variety of education and outreach efforts.
The voluntary compliance rate of the U.S. tax system is vitally important for the nation. A one-percentage-point increase in voluntary compliance would bring in about $46 billion in additional tax receipts.
The tax gap estimates provide insight into the historical scale of tax compliance and to the persisting sources of low compliance.
Projecting the tax gap; offshore, digital assets, pandemic credits not fully represented
Given the complexity of the tax system and available data, no single approach can be used for estimating each component of the tax gap. Each approach is subject to measurement or nonsampling error; the component estimates that are based on samples are also subject to sampling error. For the individual income tax underreporting tax gap, Detection Controlled Estimation is used to adjust for measurement errors that result when some existing noncompliance is not detected during an audit. Other statistical techniques are used to control for bias in estimates based on operational audit data. Because multiple methods are used to estimate different subcomponents of the tax gap and then are projected into future tax years, no standard errors are reported. Those reviewing these projections should be mindful of these limitations.
Given available data, these projections of the tax gap components presented do not represent the full extent of potential non-compliance. There are several factors to keep in mind:
The projections cannot fully represent noncompliance in some components of the tax system including offshore activities, issues involving digital assets and cryptocurrency as well as corporate income tax, income from flow-through entities and illegal activities because data are lacking.
Projections rely upon estimates of compliance behavior. No such estimates are available for pandemic credits, so there is no reliable method of representing noncompliance for pandemic credits.
The tax gap associated with illegal activities has been outside the scope of tax gap estimation because the objective of government is to eliminate those activities, which would eliminate any associated tax.
For noncompliance associated with digital assets and other emerging issues, it takes time to develop the expertise to uncover associated noncompliance and for examinations to be completed that can be used to measure the extent of that noncompliance.
The IRS continues to actively work on new methods for estimating and projecting the tax gap to better reflect changes in taxpayer behavior as they emerge.