The $600 Billion the IRS Can’t Collect

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Dennis Brack / Bloomberg News / Getty Images

Although you wouldn’t know it by the weather, April is fast approaching. And that means in the coming weeks, millions of Americans will be breaking out their W-2s and their favorite tax software to figure out exactly how much money they owe their government. Of course, in an economy as large and complex as America’s there are plenty of folks who don’t pay exactly what they owe. These people can range from those engaged in illicit activities like drug dealing to legitimate service industry workers, like babysitters, who are paid in cash. The difference between what is legally owed the federal government and what it actually collects in taxes each year is called the “tax gap,” which the IRS recently estimated reached $385 billion in 2006. Other studies have placed that figure higher — at upwards of $600 billion.

So who owes this money and why? The single biggest contributor to the tax gap — accounting for 84% of it — are people who simply under-report their income. This doesn’t usually happen to folks whose employers withholds taxes from their paychecks, as 99% of people in that position end up paying their income taxes in full and on time. The biggest headache for the IRS is collecting business income from the self employed, who must voluntarily report their earnings, and may — accidentally or on purpose – omit items such as income received through bartering, debt cancellation, or kickbacks. The IRS says only 44% of taxes owed on such business income end up getting collected by the agency.

(MORE: Don’t Let Identity Thieves Steal Your Tax Refund)

Actually recouping much of this money, however, may be tougher than it sounds. Often the resources needed to collect unpaid taxes outweigh the extra revenue that would be collected. But many believe that merely simplifying the tax code would enable the IRS to collect a greater percentage of taxes owed. This is the approach advocated by Susan Striz in a 2010 West Virginia Law Review article. She points to a 2002 study by the Government Accountability Office which showed that “fifty-six percent of [tax] returns prepared by a paid preparer had errors in comparison to only forty-seven percent prepared by the taxpayer.” And these errors didn’t only include returns that claimed too big a refund, but those that caused the filer to overpay the government. In other words, the tax code is so complicated that even paid professionals screw up more than half the time, and this is a major factor leading to a higher tax gap.

But the tax gap isn’t just a product of the complexity of the tax code. According to a 2011 study by economists Edgar Fiege and Richard Cebula, tax compliance in the U.S. tends to go up during periods of economic growth, and fall during recessions. It also tends to rise when taxes are lower and fall when tax rates are higher. And this hypothesis is supported by a look at tax compliance rates across developed countries. Despite the hundreds of billions in taxes the U.S. government fails to collect each year, it has one of the highest tax compliance rates of any developed country. This can partly be explained by America’s relatively low tax rates and effective tax collection regime. But another big factor determining compliance rates is culture: In some countries like the U.S., it’s simply standard behavior to pay your taxes, while in others, tax compliance is much less common.

(MORE: What You Need to Know As Tax Time Rolls Around)

Behavioral economists call the cultural tendency to pay duties, “tax morale.” As James Suroweicki of The New Yorker defines it:

“In most developed countries, tax-compliance rates are much higher than a calculation of risks would imply. We don’t pay our taxes just because we’re afraid of getting caught; we also feel a responsibility to contribute to the common good. But that sense of responsibility comes with conditions . . . we’ll chip in as long as we have faith that our fellow-citizens are doing the same, and that our government is basically legitimate. Countries where people feel that they have some say in how the state acts, and where there are high levels of trust, tend to have high rates of tax compliance. That may be why Americans, despite being virulently anti-tax in their rhetoric, are notably compliant taxpayers.”

So while Americans may pay, in total, far less in taxes than we collectively owe, we’re actually much more inclined to pay our dues than most other people in the world. That is probably a product of our relatively low-tax system, but also a product of culture. That being said, we could probably make our tax collection apparatus much more effective by simplifying the tax code — as evidenced by the fact that even well-paid tax professionals have trouble not making mistakes.

MORE: 7 Tax Breaks You Probably Overlooked

41 comments
joshuathirteen
joshuathirteen

The tax simplification talked about I the article doesn't remotely relate to the question of nude reported income headlining the article. Undue reporting of income has nothing to do with complex tax codes. The second theme of compliance is relevant, though much harder to do anything about. Yes cutting rate might increase compliance (unproven) but I really doubt we'd see a net gain from increaded compliance alone. Tax cheating is a human nature problem, not an issue with the tax system per se.

BillWright
BillWright

There is a very simple way to solve the problem: we should get rid of the income tax, and use a consumption based tax instead ... one that exempts basic food, clothing and health care so we do not disproportionately impact the poor.  We can phase out the Income Tax slowly over 10 year period, and phase in a VAT, tweaking the amount as we go to keep it revenue neutral.  But compliance would shoot up.  And it would be vastly more efficient than the Income Tax.  Plus we could get the government out of snooping in out bank accounts.

DanBruce
DanBruce

In this country, it is the rich who take more than their fair share. No one ever became wealthy by giving more that they take. At the top, we are a nation of takers.

DavidBurgess
DavidBurgess

Go ahead and don't take me seriously since I'm a Canadian, but it seems to me that if the USA closed half of their foreign bases they could eliminate the deficit overnight.

tweetjosht
tweetjosht

Don't we yet realize that the real problem isn't the tax code itself, but the fact that all of our congressmen rely on contributions from big businesses to get elected, and then when they are in the pockets of the big business, their hands are tied. They don't have any choice, the people getting them into office are the people they work for, not the people.


After that, they don't have a choice but to create laws that support the money, and once again, not the people.


We can't blame the tax law, because it's not the issue. We can't blame the businesses, they are just doing what is in their best interest. We can only look at the system itself and find ways to make government work more for the people, not the big corporations. There are plenty of people willing to take the risk and go into business, but government and big business, because of the system, have created an environment where it's near impossible for anyone to get skin in the game and compete effectively.

tweetjosht
tweetjosht

@GetRichSlowly That's 3.5% of national debt. If we all paid full taxes, and the government stopped overspending. We'd be out of debt in 28y.

BartHawkins
BartHawkins

This article is mendacious in the extreme.  "Relatively low tax rates," indeed!!!!  At the Federal level....maybe.  But we as a Nation pay MORE in taxes than ANY OTHER when we take into account the lack of services we enjoy for our money.

Juxtapose this with the very HIGH tax rates we pay to state, city, county, and other governments - as sales, property, excise, and other taxation, and we are HUGELY taxed - in aggegate, not even taking into account relatively poor service equivalents per dollar.

Obviously written by an insane liberal, this article needs to get its facts straight.

Taxes I pay:

I earn reasonably well - and therefore....

I Pay about 25% net net to the Feds; 8% to SS and Medicare (doubty taxed, of course, which raises both to 30% and 10%, respectively)

I pay 8% general sales

I pay about 6% of my income in property taxes (one home, two cars)

I pay higher prices for EVERYTHING I buy (in constant dollars) due to inflation, which is modulated by the Feds

Setting the last element aside, this amounts to more than 50% of my income spent on taxes.

This is about what the French pay.  For comprehensive services.

jkantor
jkantor

If you have a small business that barely provides a livable income, they want you to pay enough taxes so that you can't survive. But billion dollar International Corporations can just pick a tax haven and pay nothing.

melonheadx13
melonheadx13

simplify yes, give even bigger advantages to the romney rich who pay the romney rate of less than 14% no.  one simplification is obvious--the 25% minimum to those in the romney rich income class.

Greg306
Greg306

Tax morale is directly influenced by the values that are promoted by social and political leaders.  For 30+ years, the Republican party has promoted an anti-tax, anti-American ideology that has directly contributed to an erosion in tax compliance.  Studies from the US Treasury in the 1980's identified tax compliance by region, and those regions that had the greatest rate of tax cheaters were those in which the Republican party was strongest. The response, under the Reagan Administration, was to slash the budget for empirically rigorous analysis of tax cheaters. 

DeweySayenoff
DeweySayenoff

Tax fairness should be how things work.  And by fairness, I don't mean everyone paying the same tax RATE.  That's inherently UNFAIR, and it's also too simple-minded.  The idea is a scale - all income, regardless of source, is considered "income".  That simplifies things.  Social security?  That's income.  Disability?  That's income.  Capital gains?  That's income.  Interest on IRA's?  That's income. But it's only income when you take control of it.  If you make a withdraw from an IRA, that withdraw is income.  If you sell stocks, even if you reinvest it, the sale is income, so your reinvestment will be minus taxes.  On every transaction you or your agent does which brings in money for any length of time or any purpose, regardless of where it goes later, it's income.  

Insurance payments on paid accounts are considered payment for losses and are not considered "income". Food stamps, welfare and other hand-outs ARE considered income.

Losses in investment?  You eat it.  Investments are a risk.  You don't get compensated for that.

Then the taxes are scaled based on where you live using the local average cost of education.  The higher the cost of education on average, the more you pay in taxes.  It's simply a table that will be updated annually.  No figuring involved except addition and subtraction.

The amount you earn will be taxed at a rate consistent with your deductions (keep them, they're useful) and your local tax rate.  If you have multiple dwellings, your tax rate will be based on the area with the HIGHEST tax rate.  The tax rates will be structured according to livability for that region.  If you do not make a liveable income based on your deductions, you will not be taxed at the federal level.  If you do, your taxes will scale slowly.  The top tax rate will likely be above 70%, but that's for others to figure out.

This way, all income is reportable regardless of source or type.  Taxes are fair based on this because if you don't make a liveable wage, why are you paying federal taxes?  You already pay state taxes and sales taxes and both of those are hurting you.  If you are making a liveable wage, your tax rate will always make sure you are taxed so that you make a liveable wage.  The amount taken out in federal taxes won't make you suddenly be below a liveable wage for your area. Deductions would be where one would find any breaks - deductions for being a student living on their own, for example, or for having to BE on welfare.  (Which would put you under the liveable wage limit anyhow, unless your welfare payments put you above it due to other income.)  Nothing complicated and it's all per-calculated based on deductions.  So your tax form would have five lines.  Income from all sources, deductions, taxes due, taxes paid and the difference (if any), which is what's due the government or your refund.  Your refund would not be considered income.

THAT is what's fair.  Making sure those who can't afford it aren't taxed and making sure those who can, are.  By making all income taxable, it simplifies the whole thing.  What did you make - all sources?  Line A.  How many deductions?  Line B.  Look at regional chart (you get one at your post-office or can go online to enter your zip code for it) and find the range for line A under the column for B and viola', your taxes due are there.  The rest is figuring out whether you pay them or they pay you.  No muss, no fuss, no tricky crap.

88_88
88_88

Once currency is eliminated and payments are made electronically this issue will be eliminated.  Even the drug dealers would  not be able to skirt the issue.  Imagine everyone possessing a device similar to a phone (or a phone for that matter) and when we pay for something or get paid for something credits are added or subtracted.  This way all transactions could be monitored and taxed in real time.

Onepatriot
Onepatriot

I lived for awhile in a high dollar community where I witnessed a lot of people who formed LLC's for their investment properties and worked from their homes, and while I'm sure they weren't all for tax shelters, I think a lot of them were.  What a lifestyle.  The wealthy know how to skirt the tax laws while living the good life.

branchltd
branchltd

Don't pay cash to independents.  It's almost certain to go unreported.

mqurashi8
mqurashi8

The tax evasion is ripe in the construction industry. Workers who work under the contract labor definition not only avoid paying income taxes, but also not pay into social security fund or medicare. They also make it difficult for an employer to who wants to provide benefits to compete.

Onepatriot
Onepatriot

We can always find someone evading their tax obligations.  I bet we all know someone who brags about how they do it.  Ususally they're the ones that want everything they can bleed from the government while they rail against it being  too big.   I do wish we had a flat tax and better ways to tax those self employed who deal in cash etc. so they can get by at everyone else's expense.

It always puzzles  me how you can require people to pay income tax, yet make the code and the forms so difficult that most can't figure it out on their own without going to a tax preparer.

Denesius
Denesius

Mr Matthews: You missed one of the most important determinants of tax compliance: the perception of the degree of the compliance of the other taxpayers. If I feel others are taking advantage of tax cheats, I'm far less likely to fully report my income.  This is a fact of life in developed countries, and the main reason some financially strapped cultures, like Greece, have such horrible tax compliance rates.

TaxCollection
TaxCollection

The IRS had a program to go after some of the older back taxes, but they killed that program in 2009. Why? Because they were using private debt collectors and people had a problem with that, because collection agencies are all evil, right? But it turns out that the IRS may have used flawed data in reaching the decision to stop the program, according to a GAO report: http://www.insidearm.com/daily/govt-receivables/government-receivables/irs-wrong-to-end-private-debt-collection-program-gao-report/.

RicardoElsewhere
RicardoElsewhere

Really? You place the the tax-gap burden on working-class? How about the mega corporations that exploit loopholes and special tax breaks that they themselves had lobbied Congress for? How about going after the big guys for a change?

joshuathirteen
joshuathirteen

Gotta love autocorrecting software. The word nude in the first sentence above should be under. The word undue in the second should also be under.

BillWright
BillWright

@DanBruce Bull.  Steve Jobs and Apple computer got rich because they made great products, and people happily paid for it.  Warren Buffet got rich because he invested wisely.  Neither of them took more than they gave to others.  DanBruse's argument is nothing but typical Socialist BS.

ToddLyon
ToddLyon

@DavidBurgess  It would actually have a very small effect on the deficit, 80% of US spending goes towards entitlements.

TommyTuttle
TommyTuttle

@BartHawkins Sure, but the French pay for the French military, while you and I pay for the US military.  The US military budget in 2010 was well over $600 billion.  For a country of 300 million, that's $2000 per year for every man, woman and child.  More like $4000 for each actual taxpayer.  And that's before you've paved a single road, or hired a single park ranger or air traffic controller.  Corporations pay a chunk, but that too comes with a hidden cost.

And every time I hear anyone talking about budget cuts, I think about how the first $4k of my taxes isn't even up for discussion, we aren't even talking about reducing that.  So yeah, it's gonna be expensive.  That's the price of living here.  If you can find a better deal elsewhere, let me know, but I'm okay with just paying it and continuing to enjoy life here in America.

humtake
humtake

@Greg306 Actually, any person who can think critically knows that Republicans are defending the Constitution by trying to make sure the government treats everyone equally.  Your discrimination towards those who have more than you is unbecoming.  It's already been proven that most Americans pay the same tax rate, regardless of how much money they have.  That's called equality.  You Liberals LOVE to talk about being fair to everyone until it comes to someone who has more than you, then you want their blood.  If you can't take something from someone, you just blame Republicans.  Obama has been a shining example of this.  Why not practice what you preach and treat everyone fairly?  While the country fights to implement same-sex marriage because it discriminates against same-sex couples, you turn around and discriminate against another group of people.  Hypocrites, all of you.

melonheadx13
melonheadx13

@Greg306 i think they love the good old days of the feudal lords reigning over their ignorant and dirty serfs who are more than grateful for the crumbs off the lord's table.

FrankBlank
FrankBlank

@DeweySayenoff  Some good ideas, particularly re. income, but quixotic.  For example, wall street hoochie Maria Bartiromo has already pointed out, on TV no less, that capital gains is not income.

Since she's speaking for the people who own congress this lie has legs, this lie has power.  

Leftcoastrocky
Leftcoastrocky

@88_88 Imagine the Russian and Chinese hackers hacking into the electronic system.

aliahm08
aliahm08

@88_88 Very risky, it would become misunderstood by many, despite the generations coming being so technologically advanced. The beta would most definitely have an array of negatives, and despite the inefficiency, technology is very difficult to perfect. Who's to say an incomprehensible geek would create a virus for such a device, and bypass the security during a transaction? What if a device were lost prior to a very important transaction, or even a less important purchase. One mistake, or virus into the system, those billions of dollars digging into the worldwide deficit economies would very much be wasteful, as they would only have to re-dig to fix the problem. It's a remarkable idea, and I respect the thought, just saying it's not too probable to perfectly be placed into society in the next few years to come - we need a total technological savvy generation, very, very savvy. Before it works to its full function and efficiency, there are problems that need to be overcome, and rectified. 

mrpaul2u70
mrpaul2u70

I use LLC's to hold title to investment property. How is it in any way a tax shelter? The LLC files its own tax return annually and the income or loss passes on to the LLC members pursuant to their share of ownership. All that the LLC is good for is to limit personal liability of a member in the event of a lawsuit.  

tom.litton
tom.litton

@Onepatriot I for one would much rather pay the government the extra $150 rather than HR Block...

Greg306
Greg306

@Denesius This was one of the strongest predictors of tax cheating in the studies in the 1980's - those most likely to cheat either (a) believed that tax cheating was morally justified, or (b) that tax cheating was common.  While that might sound unremarkable, those two factors were far more likely predict who would cheat than (c) fear of getting caught.  Remarkably, there was no statistically significant correlation between how afraid you were that you would be caught and whether you would actually cheat on taxes.


NSMMP
NSMMP

@RicardoElsewhere If the loophole and tax break are lawful, why not exploit them.  Why are corporations and others obligated to pay more than the law requires in taxes.  The article was about cheating on taxes.

I personally believe that the income tax laws should be changed to make it easy to prepare an income tax return either as an individual (or as a corporation).  As I have grown older, frequent tax law changes and complexity has increased to where I rely on tax preparation software.  If I were to rely on my skill to prepare a tax return, I would definitely over pay.

I believe that congress creates complex tax law to cheat us.


doddeb
doddeb

LoL, cannot like your comment enough.  When I saw this article I thought it was going to be about loopholes for corporations and the wealthy, and money stashed in cooperative banks outside the US.  As usual, everything gets blamed on those of us who have so little anymore.

88_88
88_88

@aliahm08 - it seems to me we are already heading in the virtual currency direction.  Consider how many transactions you do on  a daily basis that are credit swaps.  You buys something with a credit card and you now have a balance you owe.  You pay the credit card online from your bank account.  Bank account is debited and credit card account is credited.  No currency actually changes hands.  There certainly will be some technological challenges and security will certainly be a primary concern.  Certainly you've seen the Chase commercials where a group of tech savvy adults are eating a meal at a restaurant and one person pays for the whole meal and everyone transfers money to the payer's account.  Same principle will apply to the drug dealer, day laborer working on your lawn, etc only in order to get paid an electronic credit/debit transaction will occur between the parties and the government gets paid on all transactions which qualify as income.  The device does not have to be so personal to those using it.  In addition to personal communication devices to transfer credits there could be transaction terminals positioned like ATMs.  The device could be very generic but the function it provides would be very specific  to the parties of the transaction so there would be devices everywhere in case you did lose your personal device. Perhaps you have an account (credit account just like a bank account) and it's tied to your SSN to track your money.  No SSN...no credits...no credits....no way to buy things...may solve a lot of illegal immigration issues to boot ;)

Greg306
Greg306

@NSMMP @RicardoElsewhere Some corporations use lobbyists to argue for illegitimate positions in the guise of addressing legitimate concerns - if they can out-think or slip something past the Congressional staffers (who are usually much more junior and much lower paid than the lobbyists), then it gets passed into law.  

tom.litton
tom.litton

@NSMMP @RicardoElsewhere What i would like to see is a completely automated system, where the amount taken out of your paycheck is adjusted automatically for things like donations, etc, so there is no need to even file taxes for a large percentage of people.

 Of course the tax system is way to complicated for that to happen now.