The Slow Approach to Closing the Tax Gap

The federal tax gap is about $345 billion per year! Reasons for this gap has been studied by the IRS, GAO and others for decades. Many proposals have been made, yet few have been enacted. President Bush's 2009 budget proposal included 16 tax compliance proposals. Some of these have been inserted into tax bills as revenue generators. For example, the proposal to require brokers to include stock basis information on 1099s has been included in a few bills, but not yet enacted.

I call this the "slow approach" to reducing the tax gap: Study it continuously, generate lots of ideas for reducing the gap, but avoid comprehensive legislation with a plan for reducing it. Political and budget reasons seem to be the cause for the slow approach. PAYGO has many benefits, but one of them doesn't seem to be to enact legislation that only raises revenue (no new tax breaks). So, we see tax gap proposals come to the table only when revenue is needed to pay for new or extended tax breaks.

The recently enacted housing bill is an example. It includes a requirement, effective for 2011, for credit and debit card payment processors, as well as online processors, such as PayPal, to issue 1099s noting the gross amount processed for merchants. This proposal has been in President Bush's budget proposal for the past few years, although calling for IRS regulations rather than a statutory change. The Joint Committee on Taxation estimates that this new reporting requirement will generate over $9 billion over 10 years. That seems like a lot given that unlike cash transactions, there is an audit trail for credit and debit card transactions. I'm guessing that a lot of the revenue estimate stems from online sellers who are not reporting sales despite transaction and activity levels that indicate they are operating a business.

One concern I have is with the long lead time until this new reporting provision is effective (2011). While this lead time is likely due to the need to allow reporters to get their systems capable of filing the 1099s, it also means the many people who don't like this provision have plenty of time to encourage Congress to repeal it.

For more information on the new reporting requirement and the tax gap, please see my short article in the AICPA Tax Insider for 8/14/08. It has more links to information mentioned above.