Tax Tuesday
The Tax Gap Is Unlikely to be a Piggy Bank
There’s likely a lot of change in those cushions, but what’s the cost to get them out?
Our elected Federal officials want to spend more money. And with over $20 trillion on the government credit card, the new spending needs to be at least partially offset by new revenue to make it through Congress.
We’ve seen several solutions floating around to raise revenue with minimal voter pain (gotta win re-election, right?), but one of the more popular suggestions is to close the tax gap.
The tax gap is the difference between what taxpayers should pay and what they actually pay. The total, according to the IRS, is hundreds of billions of dollars. That’s quite a bit of change.
Home Repair Hijinks
I’ll come back to the tax gap in a minute, but first, let me tell you about some work I had done on my house a few years back.
We had some bathroom upgrades made. Through some friends, we found an installer that happened to have the piece we needed. Better, due to various reasons that I’m purposefully keeping vague, he could give it to us for an absolutely screaming deal:
$1,500 if we paid cash. $1,600 otherwise.
With no additional questions asked, we paid the $1,500.
Why were we given the discount if we paid in Benjamins? Well, I can’t say for certain (I am not this person’s accountant), but I’m guessing it’s part of the tax gap.
Mind The Gap
Let’s go back to the tax gap.
Based on a series of informed estimates, the IRS comes up with a report every few years taking a stab at how much people owe in taxes versus how much they pay. Here’s a nice graph summarizing this amount:
In other words, they estimate over the three year period in question that $381 billion in taxes weren’t collected, out of $2.683 trillion. Which puts the US at a 85.5% compliance rate with the tax code.
So how do we get the people in red to pay their fair share of taxes? The current proposals are leaning hard into one solution: enforcement.
Give the IRS more money so they can dig through returns and find errors (whether purposeful or no). Force banks to report accounts with over $600 in annual transactions, or maybe over $10,000.
Whatever you think about the specific proposals, it won’t be an easy fix. Noncompliance money is the hardest money to get. We’ll have to spend quite a bit more on revenue agents or complex systems hoping to sort through the data dump finding mistakes.
There’s no guarantee that they’ll find any.
Cash is Hard to Track
Let’s go back to my home repair. I paid cash. If the person doing the repairs wanted to keep the $1,500 off his taxes, he’d pay his people under the table and spending the money without it ever going through the bank account.
If it did go through a bank account, then tracking every transaction from that account MIGHT spot the miss. But how worried can they really be over $1,500? How much effort is even an advance AI going to be able to put into proving that this is actually taxable income that wasn’t reported on the tax return?
These Are Mostly Small Businesses
Going back to the IRS report, they have a whole breakout of estimated missed taxes. The biggest area is underreported business income on the individual tax returns, which makes up up 25% of the gap (think self-employed, freelancers, contractors, etc.), with the heavily related Self-Employment Tax tied for 3rd at 10%.
This means that about 35% of the gap is due to small business filers, probably mostly single person shops.
Having spent years doing and teaching taxes, my guess is that much if this is due to these small businesses not understanding how to file their returns. These calculations can get complicated.
But even assuming that every single one of them is malicious, that is a whole lot of people to track down and prove they filed their returns incorrectly.
This is IRS Advertising, Not Policy Guidance
Look, there’s clearly a tax gap, and there’s likely more that should be done to catch some of the missing taxes. But we will have to pay more money for that. And there’s no guarantee that the additional money paid to compliance will lead to the kind of money that Congress is hoping to get.
I mean, it’s an estimate. It might not even exist!
Reasonable people can argue if the IRS budget is at the right amount. Based on the number of hours I’ve spent on hold with them, I‘d say they’re underfunded. But counting on the raise to lead to billions more dollars of tax revenue, much less hundreds of billions, seems like wishful thinking.
We’d be pouring in millions trying to get the least likely to comply.
There’s likely revenue to be raised here. But overselling it is just going to lead to disappointment.
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