America’s Tax Gap Projected to Hit Nearly $700 Billion: IRS

Federal tax forms at the IRS in Chicago, on Nov. 1, 2005. Scott Olson/Getty Images

The federal government is losing hundreds of billions of dollars annually in tax revenue, with the main culprit being underreporting by taxpayers, according to the IRS.

The tax gap “reflects the difference between projected ‘true’ tax liability and the amount of tax that is actually paid on time,” the IRS said.

For tax year 2022, the country’s projected gross tax gap is calculated to be $696 billion, the agency said in an Oct. 10 statement. In 2021, this figure was $688 billion. The 2022 figure is an increase of more than $200 billion from tax years 2014–2016. It is also up from 2017–2019 numbers. The IRS attributed the increase to economic growth.

“The increase for 2022 is similar to the 41 percent increase in the economy since the 2014–2016 time period as measured by the Gross Domestic Product,” the agency noted.

The voluntary compliance rate among taxpayers remained steady at 85 percent. The 2022 tax gap increase “ultimately reflects growth in the economy and changes in the sources of income—not a change in taxpayer behavior involving filing or paying their taxes,” the IRS stated.

Underreporting of taxes, which reflects tax understated on timely filed returns, was found to be the biggest reason for the tax gap, making up 77 percent of the deficit. Individual income tax made up the majority of the tax gap, contributing $514 billion to the gross tax gap and $447 billion to tax year 2022’s tax gap projection. This is followed by employment tax including self-employment and corporation income tax.

The latest projections are from a period before the IRS began increasing tax compliance work after the Inflation Reduction Act was passed in August 2022.

In February, the IRS launched an initiative to pursue high-income, high-wealth individuals who have not filed their taxes since 2017. These people were estimated to have received annual incomes in the range of $400,000 to $1 million or higher.

Since then, the agency “has stepped up compliance activity” and collected $1.3 billion from high-income taxpayers, the tax agency noted.

The agency needs to “focus both on compliance efforts to enforce existing laws as well as improving service to help taxpayers with their tax obligations to help address the tax gap,” IRS Commissioner Danny Werfel said in Thursday’s statement. “While the bottom line for the new tax gap numbers shows the increase basically reflects growth in the larger economy, the size of the gap also vividly illustrates the ongoing need for adequate funding for the IRS.”

IRS Tax Gap Flaws

IRS tax gap estimates have been criticized by the U.S. Government Accountability Office (GAO). In calculating estimates, the IRS applies a statistical technique to account for noncompliance that was undetected by audit examiners, GAO said in a May 6 report.

“Applying this technique nearly doubles the individual underreporting tax gap estimate, increasing the estimate from $145 billion to $278 billion,” it noted. “IRS has not conducted analysis to understand the causes of this estimate of undetected noncompliance.”

GAO also criticized the agency’s strategic operating plan (SOP), which outlines how the tax agency intends to spend the billions of additional funding received under the Inflation Reduction Act.

“The SOP is not clearly linked to tax gap data,” the office stated in the report. “For example, the plan does not address sole proprietor noncompliance, which is one of the largest areas of tax noncompliance.”

The Tax Foundation criticized the IRS for the tax gap in an October 2023 blog post, noting that the agency “absolves Congress and itself” for contributing to the issue.

The tax agency has been unable to stem the increase in improper payments paid to taxpayers via programs such as the Child Tax Credit and the Earned Income Tax Credit, the foundation said.

In 2022 alone, $26 billion of the $98 billion in tax credits paid out by the IRS were overpayments. These overpayments were partly due to IRS failures and other issues such as the complexity of the tax system, the foundation said.

The idea that plugging the tax gap would somehow solve the federal government’s budget issues is untrue, it stated. The foundation calculated that even if Americans were 100 percent tax compliant, it still would not balance out the budget.

“The tax gap is based on the IRS’s benchmark estimate of how much the government would collect if taxpayers were 100 percent compliant, what they call the ‘Estimated Total True Tax Liability,’” Tax Foundation President Emeritus Scott Hodge wrote. “This, of course, is an ideal that has never been achieved in any tax system in history. Markets and people are remarkably adept at altering their behavior to minimize their tax burden.”

Hodge added that the United States does not have a unique problem with tax evasion and is actually below average when compared to tax gaps across the West.

The Epoch Times reached out to the IRS for further comment but did not hear back by publication time.