May 12, 2021
Senate Finance subpanel holds tax gap hearing
The May 11 Senate Finance Subcommittee on Taxation & IRS Oversight hearing on "Closing the Tax Gap: Lost Revenue from Noncompliance and the Role of Offshore Tax Evasion," focused on the tax gap issue that has taken on a higher profile following a $1 trillion annual tax gap estimate by IRS Commissioner Rettig. That estimate has led some policymakers to call for narrowing the gap as part of the initiative to provide revenue for other priorities, including a proposal in President Biden's human infrastructure American Families Plan for financial institutions to report information about aggregate account outflows and inflows. Republicans are beginning to express some reluctance to support the Democratic approach to the tax gap, with full Committee Ranking Member Mike Crapo (R-ID) telling Commissioner Rettig in a May 11 letter that "discussions of increased IRS monitoring, auditing and targeting of certain taxpayer classes and enforcement must be balanced against privacy concerns and taxpayer rights."
In an opening statement, Chairman Sheldon Whitehouse (D-RI), who co-sponsors international tax legislation aimed at targeting profits that purportedly are being sheltered in tax havens, said Treasury loses billions per year from offshore tax evasion, lamented the reduction over the years in IRS funding including for enforcement, and expressed support for the Biden administration's approach, including more reporting.
Ranking member John Thune (R-SD) said both the $80 billion the Administration has proposed for initiatives to narrow the tax gap and estimate that reforms will generate an additional $700 billion in tax revenue over the course of a decade are too high, and there should be more accuracy about the return on investment from IRS funding increases when figures are portrayed as offsets for spending. He said Republicans are open to discussions about IRS resources, but they must also include further attention to customer service and other issues. Senator Thune also noted that the Administration proposes requiring banks to give the IRS more information about businesses such as partnerships and sole proprietorships as well as individuals with business income, and there are concerns that banks could be viewed as an extension of tax enforcement on behalf of the IRS. He also noted that there are "two degrees of separation between the tax gap estimate and revenue that can be scored from enforcement proposals," because CBO rules prohibit scoring uncertain revenue from enforcement, suggesting using the proposal as a revenue offset could be complicated.
- Barry Johnson, Acting Chief, Research and Analytics Officer, IRS
- Doug O'Donnell, Deputy Commissioner, Services & Enforcement, IRS
- J. Russell George, Treasury Inspector General for Tax Administration,
- Nina Olson, Executive Director, Center for Taxpayer Rights,
- Charles Rossotti, Former Commissioner (1997—2002), IRS
Testimony in brief:
- Johnson said components of the last official tax gap estimate of $441 billion are a non-filing gross tax gap of $39 billion, underreporting gap of $352 billion, and underpayment gap of $50 billion.
- O'Donnell called on Congress to provide IRS the resources it needs to stop sophisticated tax evasion.
- George said studies show audits have the largest impact on tax compliance and IRS lost 15,000 enforcement employees between 2010—2018, which resulted in a 40% reduction in examinations.
- Olson said investments in the IRS are required to avoid increasing the tax gap and took issue with equating the gap with evasion, when there are very different types of noncompliance attributable to very different causes.
- Rossotti discussed his plan to move more income from low visibility to higher visibility by filling the gaps on income that is not reported by third parties to the IRS, upgrade IRS technology to make full use of all the information available, and rebuild IRS's skilled workforce and provide them technology to resolve taxpayer cases more rapidly and efficiently.
In addition, there is also a 2019 paper by former Treasury Secretary Larry Summers and now-Treasury official Natasha Sarin. A Treasury fact sheet on its proposal is available here.
Below is a paraphrasing of select member questions and witness responses.
Whitehouse: Outside research has suggested that US citizens hold as much as $1 trillion in offshore tax havens.
Johnson: Based on 2017 FATCA reporting, that number would be $2 trillion.
Whitehouse: Rossotti described gaps in reporting, how do you fill them?
Rossotti: An additional 1099 report on money in and money out of financial accounts, limited to upper income taxpayers and flow-through businesses, would go a long way toward closing the gap.
Thune: There is a distinction between tax gap and tax evasion.
Olson: Noncompliance can be attributed to tax law complexity, procedural complexity (people not understanding what IRS requires), pure evasion, or a protest against how money is used.
Thune: IRS Commissioner Rettig stated that the tax gap could approach $1 trillion. Could you clarify the estimate?
You said $245 billion is on the individual side, and most of that is underreporting. Do you have the components of that number?
Johnson: The official IRS estimate is $441 billion for 2011—2013.
Business income is $110 billion, nonbusiness income is $57 billion, etc.
What you do think of the higher 'guesstimate' and its methodology?
Olson: I am disturbed about 'guesstimates' because it sends the wrong message to IRS employees regarding tax cheating. There is a need to do responsible work, but we should wait to hear what the rigorous methods are.
Sherrod Brown (D-OH): The TCJA gave a windfall to pass-through businesses, which are largely not small businesses but businesses in high-dollar industries. How would the Rossotti proposal improve compliance from pass-throughs?
Rossotti: Over the last 40 years, the fraction of business income earned in pass-throughs has become a large sector and IRS compliance programs have not kept up. We propose an additional information report, technology to make use of information — for instance, IRS has no technological ability to check K-1s — and use of that information to follow up (with enforcement) when deficiencies are identified.
Private debt collection
Chuck Grassley (R-IA): I am concerned about a recent report on high-income taxpayers, whose accounts were not assigned to the private debt collection program. Do you have any suggestions to improve the process used to identify accounts to the program?
George: The longer you wait to report delinquent accounts, the less likely you are to receive anything from them. Private debt collectors are still collecting more money than the cost to the government and giving them accounts to address more quickly could help.
Tom Carper (D-DE): Five former commissioners expressed support for President Biden's plans in a Washington Post opinion piece May 4. What components are most important?
Rossotti: Information reporting, funding for technology, and rebuilding the IRS workforce. It is important to have a sustained effort, not a onetime appropriation.
Elizabeth Warren (D-MA): I am introducing a funding bill to boost IRS enforcement, but IRS needs more. (She asked about third-party reporting, or lack thereof, on various types of transactions.) The kinds of income the IRS has the least visibility are overwhelmingly concentrated among richest taxpayers, whereas average workers' compensation is automatically reported by their employers. Is the honor system working?
Strengthening third party reporting would make it harder for wealthy taxpayers to hide their income. My legislation requires banks and financial institutions to provide the IRS with information on account-holders' balances. Strengthening reporting and increasing enforcement funding would ensure that enforcement is focused on the "biggest fish," making the tax system fair and raising revenue to expand opportunities in America.
Rossotti: The system is working to a certain extent, because there is a great deal of income that is not reported third-party but that is still reported by taxpayers. But the reporting level on income not third-party reported is 50% on various types of income.
Debbie Stabenow (D-MI): As opposed to wage-earners whose taxes are withheld, for wealthy taxpayers with capital gains income and pass-through income, there is less oversight by the IRS. We could use the additional money to extend the Child Tax Credit and pay for roads and bridges, and the wealthy should pay their fair share. Why are taxpayers at the top less likely to pay their taxes?
Johnson: When we have information reporting and withholding or information reporting alone, there is over 90% accuracy. When we have no information reporting, the accuracy level drops to less than 50%. For those taxpayers whose income isn't subjected to withholding and reporting, there is a higher level of nonreporting.
Steve Daines (R-MT): Former Commissioner Koskinen said that IRS may not be able to use the $80 billion requested.
Olson: It would be hard for IRS to ramp up that quickly, and Rossotti has suggested a set-aside over a sustained period of years for technology and skilled employees, plus congressional oversight to make sure dollars are applied well.
Full Committee Chairman Wyden (D-OR): For high-income individuals who have multiple years without filing taxes, has the IRS made recent criminal referrals on failure to file or pay estimated tax?
I don't understand how one can assert all tools are being used when we are talking about high-income filers and multiple years no filing returns. No DOJ referrals sends a message that there is no deterrent.
O'Donnell: Unsure, but we are using all tools available to bring those taxpayers into compliance.
Rob Portman (R-OH): It is confusing seeing so many different predictions of how much revenue could be recovered from the tax gap. There are various enforcement numbers out here, including the Summers-Sarin estimate that a $100 billion investment would yield $1 trillion/10 years.
Is there a way to improve information reporting without compromising privacy or being overly burdensome?
Rossotti: It is the combination of new technology using information IRS has, supplemented by audits, that would make the big difference.
Statements and testimony are available here.
Senator Crapo's letter is available here.
For additional information concerning this Alert, please contact:
|Washington Council Ernst & Young|
| • Any member of the group at (202) 293-7474.|