Recently, I talked to an IRS insider who shared insights about the $539 billion tax gap (2021 data). The tax gap represents the half-a-trillion-dollar difference between what the IRS is owed and what it actually collects. Here are the three largest components:
(1) Underreporting ($348b): An example is when someone claims $500 worth of donated clothes that are actually worth $100, or when a business owner expenses personal costs. The IRS estimates that underreporting is a mix of intentional and unintentional actions, roughly split 50/50. Compliance rates jump by 90% when the IRS audits for underreporting, as most people pay up quickly after receiving a letter. However, the IRS lacks the resources and data capabilities to audit systematically at scale.
(2) Unintentional inaccuracies ($69b): Many people intend to file their taxes correctly but fail due to the complexity and confusion of the tax code. Improving processes and the "customer experience" at the IRS can help these well-intending taxpayers pay the correct amount.
(3) Intentional noncompliance ($52b): This category involves people who knowingly do not file, misreport, or cheat on their taxes. An example is a business owner not reporting tax on cash revenue. While some people simply dislike paying taxes, many are 1099 workers who are unaware they need to file or lack the resources to do so. Enhancing customer experience, such as the European model where taxpayers receive a bill, could help address this issue.
I would tag & thank my good friend for these insights, but she understandably wanted to remain anonymous.
