The Honorable Dave Camp
Committee on Ways and Means
United States House of Representatives
Washington, D.C. 20515
Dear Chairman Camp:
I am writing in response to your letter dated February 8, 2011, which requested that I answer two questions for the record submitted by Rep. Diane Black in connection with the Committee’s January 20, 2011, hearing on Fundamental Tax Reform. The questions, and my responses, follow.
Evasion at the individual taxpayer level: What are the statistics regarding tax evasion by individuals?
The term “tax evasion” is generally used to describe solely willful and intentional noncompliance with the tax law. In practice, the reasons for noncompliance with the tax law form a continuum from confusion about the law’s requirements, to errors attributable to the complexity of the law, to noncompliance that is facilitated by preparers, to willful and intentional noncompliance. I believe that the IRS needs to gain a better understanding of the reasons for various types of noncompliance, because the solutions vary based on the cause. For example, traditional enforcement measures may work best when dealing with taxpayers who are willfully and intentionally violating the law, while improved outreach (and, ultimately, tax simplification) may be most effective in addressing noncompliance that results from confusion about the law’s requirements. In the National Taxpayer Advocate’s 2010 Annual Report to Congress, we published an overview of studies that my office plans to conduct in the next few years to try to get a better handle on the causes of noncompliance.
At present, the IRS does not know the extent to which tax noncompliance is intentional. However, the IRS has conducted periodic research studies to estimate the size of the so-called “tax gap.” The tax gap is the amount of tax that is not voluntarily and timely reported and paid. According to the IRS’s most recent estimates, which are based on audits of tax returns filed for 2001, the tax gap stands at about $345 billion per year.
As shown on the “tax gap map” (attached as Appendix A), the components of the tax gap include:
- Nonfiling – $27 billion (7.8 percent);
- Underreporting – $285 billion (82.6 percent); and
- Underpayment – $33 billion (9.6 percent).
A closer look at the data shows that withholding and third-party information reporting are the key drivers of tax compliance. Reporting compliance rates are about 99 percent on wages subject to withholding and third-party information reporting, about 96 percent on income subject to full third-party information reporting (e.g., interest and dividends) – yet less than 50 percent on income not subject to third-party information reporting. Unreported income earned by individuals in the “cash economy” – taxable income from legal activities that is not subject to information reporting or withholding – is the single largest component of the tax gap. As shown on the tax gap map, self-employed taxpayers who file returns but underreport their income (and related self-employment taxes) account for about $148 billion in lost revenue per year, or 42.9 percent of the tax gap.
I have proposed both administrative and legislative recommendations to improve tax compliance in the cash economy. For example, I have proposed legislative recommendations to:
- Increase the use of the IRS’s electronic payment system for estimated tax payments;
- Authorize voluntary withholding agreements;
- Eliminate the corporate exception from information reporting for small corporations;
- Accelerate the taxpayer identification number validation process;
- Provide for withholding on payments to noncompliant contractors; and
- Require financial institutions to report all accounts to the IRS by eliminating the $10 minimum on interest reporting.
Corporate tax: We know the high U.S. corporate tax rate is not the only factor that U.S. companies consider when deciding where to locate future investments and that companies also consider such things as the workforce, ease of access to raw materials, quality of the infrastructure, stability of the legal and political environment, the location of customers and the cost of shipping finished goods to them, etc. Can you help explain how companies weigh these factors and how large – or small – a factor the U.S. statutory tax rate is?
I agree with the thrust of the question that corporations consider more than merely tax rates when deciding where to invest and locate their operations. Depending on the circumstances, costs such as those for labor or raw materials could outweigh tax effects. By statute, my office focuses on tax administration, and we do not have the expertise to identify or quantify factors that are considered in corporate decision-making.
For your convenience, I note that the Congress has at its disposal a staff of non-partisan economic experts who may address these issues in publications for Members. In particular, the Congressional Research Service (CRS) has observed that business relocation may be “the result of a variety of factors, ranging from technological progress, to exogenous shocks, to changes in institutional policies.”
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I hope you find these responses useful. If you have further questions, please feel free to contact my office at (202) 622-6100.
Nina E. Olson
National Taxpayer Advocate
Tax Year 2001 ($ Billions)
Internal Revenue Service, Feb. 2007
 See National Taxpayer Advocate 2010 Annual Report to Congress, vol. 2, at 89-99 (Researching the Causes of Noncompliance: An Overview of Upcoming Studies).
 IRS, Tax Gap Map for Year 2001 (Feb. 2007), available at http://www.irs.gov/pub/irs-utl/tax_gap_update_070212.pdf. These figures do not include unpaid tax on income from illegal activities. Because the IRS projects it will ultimately recover about $55 billion through late payments and enforcement action, it estimates the annual “net tax gap” to be about $290 billion. Id.
 IRS, Tax Gap Map for Year 2001 (Feb. 2007), available at http://www.irs.gov/pub/irs-utl/tax_gap_update_070212.pdf.
 Id. The $148 billion figure includes $109 billion attributable to unreported business income on individual tax returns and $39 billion attributable to unpaid self-employment taxes. Id.
 See National Taxpayer Advocate 2007 Annual Report to Congress 490 (Key Legislative Recommendation: Measures to Address Noncompliance in the Cash Economy); National Taxpayer Advocate 2007 Annual Report to Congress 35 (Most Serious Problem: The Cash Economy); National Taxpayer Advocate 2007 Annual Report to Congress, vol. 2, at 1 (A Comprehensive Strategy for Addressing the Cash Economy). See also National Taxpayer Advocate 2003 Annual Report to Congress 257 (Key Legislative Recommendation: Tax Withholding on Nonwage Workers); National Taxpayer Advocate 2004 Annual Report to Congress 478 (Key Legislative Recommendation: Tax Gap Provisions); National Taxpayer Advocate 2005 Annual Report to Congress 381 (Key Legislative Recommendation: Measures to Reduce Noncompliance in The Cash Economy); Statement of Nina E. Olson, National Taxpayer Advocate, Before the Senate Committee on Finance, The Tax Gap and Tax Shelters (July 21, 2004), available at http://www.irs.gov/pub/irs-utl/nta_sfc_testimony_tax_gap062104.pdf; Statement of Nina E. Olson, National Taxpayer Advocate, Before the Committee on the Budget, United States Senate, The Causes of and Solutions to the Federal Tax Gap (Feb. 15, 2006), available at http://www.irs.gov/pub/irs-utl/nta_senbudget_taxgap_021506.pdf; Statement of Nina E. Olson, National Taxpayer Advocate, Before the Subcommittee on Federal Financial Management, Government Information, and International Security of the Committee on Homeland Security and Governmental Affairs, United States Senate, The Tax Gap (Sept. 26, 2006), available at http://www.irs.gov/pub/irs-utl/nta_testimony_senate_hsgac_092606.pdf.
 For similar proposals, see the TAX GAP Act of 2010, S. 3795, 111th Cong. (2010) and Treasury Department, General Explanations of the Administration’s Fiscal Year 2012 Revenue Proposals 99 (Feb. 2011).
 Businesses making payments totaling $600 or more in a calendar year to any non-employee service provider (i.e., a contractor) that is not a corporation are generally required to send an information return to the IRS setting forth the amount as well as the name, address, and Taxpayer Identification Number (or TIN) of the contractor. IRC §§ 6041(a) & 6109(a)(3). Effective for payments made after December 31, 2011, the Patient Protection and Affordable Care Act, Pub. L. No. 111-148 (2010), expanded this information reporting requirement to include payments to a corporation (except a tax-exempt corporation) and payments for property. The National Taxpayer Advocate recommended that Congress repeal this requirement with respect to payments for property while retaining the requirement with respect to payments to corporations for services. National Taxpayer Advocate 2010 Annual Report to Congress 373-376. The Treasury Department recently made a similar proposal. See Treasury Department, General Explanations of the Administration’s Fiscal Year 2012 Revenue Proposals 97 (Feb. 2011).
 The Treasury Department recently made a recommendation to require businesses to withhold tax on payments to contractors who did not provide them with a valid TIN-name combination. Treasury Department, General Explanations of the Administration’s Fiscal Year 2012 Revenue Proposals 99 (Feb. 2011).
 David L. Brumbaugh, Taxes and International Competitiveness, RS22445 (May 19, 2006) 6; see Staff of the Joint Committee on Taxation, The Impact of International Tax Reform: Background and Selected Issues Relating to U.S. International Tax Rules and the Competitiveness of U.S. Businesses, JCX-22-06 (June 21, 2006) 57 (stating there “is no consensus on what method of taxing international investment income minimizes distortions in the allocation of capital when nations tax income at different effective rates, but the alternatives of capital export neutrality and capital import neutrality are the most cited guiding principles”), available at http://www.jct.gov/publications.html?func=startdown&id=1498; Simple, Fair, and Pro-Growth: Proposals to Fix America’s Tax System, Report of the President’s Advisory Panel on Federal Tax Reform (Nov. 2005) 104 (stating that the tax consequences of investment abroad depend “on the circumstances of the taxpayer”); Simplification, Compliance, and Corporate Taxation, Report on Tax Reform Options of the President’s Economic Recovery Advisory Board (Aug. 2010) 85-86 (discussing effects on the location of the economic activities of U.S. multinationals).