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Originally published July 3, 2011 at 8:18 PM | Page modified July 3, 2011 at 10:23 PM

Unpaid taxes total $400B, but little political will to pursue it

At a time when tax increases or deep spending cuts seem to be the only options available to close the federal deficit, going after more than $400 billion a year in uncollected taxes should be a no-brainer.

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WASHINGTON — At a time when tax increases or deep spending cuts seem to be the only options available to close the federal deficit, going after more than $400 billion a year in uncollected taxes should be a no-brainer.

Yet, the so-called "tax gap" hardly rates a mention.

In its most recent analysis, from 2001, the Internal Revenue Service estimated about 84 percent of federal taxes were voluntarily paid on time that year, leaving a gross tax gap of $345 billion, or roughly 16 percent, uncollected.

Late payments and IRS collection efforts cut the net tax gap to $290 billion in 2001. But similar estimates point to a gross tax gap of $410 billion to $500 billion in 2010, said Benjamin Harris, a research economist at the center-left Brookings Institution.

"You could go a long way toward solving our budget mess by closing the tax gap, but the problem is, it's not easily closed," Harris said.

The IRS plans a new analysis this year or early next year, but the trends are clear.

The economy has grown more complex in the past 20 years, blurring lines between personal and business income and creating more opportunities for tax scofflaws. Congress limits the IRS budget, and sophisticated tax cheats realize odds of detection are relatively low. Others say most who misreport earnings do so inadvertently because of the tax code's complexity.

Better, more targeted IRS enforcement probably could cut the tax gap by 10 percent without fundamental changes to the IRS, Harris estimates. But the political will just isn't there.

The Obama administration wants to increase the IRS budget from $12.1 billion to $13.3 billion in fiscal 2012 and add 5,000 IRS agents. About $240 million would go for "new, revenue-generating tax-enforcement initiatives aimed at closing the tax gap," according to a Treasury Department budget request. The measures would reap an estimated $1.3 billion in extra annual tax revenue by 2014.

But House Republicans voted to cut the IRS budget by $600 million in fiscal 2012. IRS Commissioner Doug Shulman told lawmakers that the proposed GOP cuts would cause tax collections to fall by $4 billion because they would require slashing the agency's enforcement budget.

Curtis Dubay, senior tax-policy analyst at the conservative Heritage Foundation said Shulman was "posturing" to preserve IRS funding.

"The tax gap is not the result of people illegally evading taxes," Dubay said. "It's the result of an overly complex tax code ... "

Whether by willful evasion or unintentional mistakes, businesses and individuals that fail to report, underreport or underpay taxes cause honest taxpayers to pay more — about $2,200 each — to make up the revenue shortfall. That basic unfairness erodes confidence in the tax system, which lowers taxpayer morale and, in turn, increases noncompliance.

The biggest losers are wage earners and salaried workers, who pay an estimated 99 percent of their fair tax burden because taxes are withheld from their pay and reported by employers.

But individuals with business income — mainly self-employed, sole proprietors paid in cash — misreport roughly 54 percent of their income by underreporting it or claiming deductions, credits and exemptions to which they aren't entitled.

"You kind of feel like a sucker as a wage earner." Harris said. "Here you are paying taxes because someone else is paying you, but if someone else is getting paid on their own, they pay taxes at half the rate."

These taxpayers escape an estimated $110 billion in taxes each year, according to 2001 IRS estimates. Experts agree the amount surely has grown since then.

One niche industry helps taxpayers avoid taxes altogether. Between 1 million and 1.5 million Americans are believed to have undeclared offshore accounts where income is hidden and accessed through credit and debit cards, said David Callahan, a senior fellow at Demos, a liberal research and advocacy group in New York.

Others hide money in phony offshore companies.

Callahan said the Taxpayer Bill of Rights made it easier to cheat by requiring the IRS to show evidence of intent.

"Sophisticated people know that if you cheat on your taxes and get caught, you're going to have to pay the money back. But if you say 'I lost my receipts,' 'I didn't understand how the deductions work,' you're off the hook," Callahan said, with "a slap on the wrist."

The IRS has stepped up efforts to catch these cheaters, but efforts to shore up lax reporting standards have faced strong opposition.

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