By contrast, 35 percent of the tax gap came from unreported business earnings by non-farm sole proprietors, and another 13 percent resulted from unreported partnership income. This suggests that the best way to evade taxes, should one choose to go that route, would be to start your own business. It’s just too easy to hide income and overstate business expenses in ways that are almost impossible to detect. And since most small businesses don’t make much money even if they accurately report all their income and expenses, it isn’t worth the IRS’s time to go after them.
In practice, the IRS has to concentrate its resources on areas where there is the greatest potential revenue yield, which may not be where the greatest amount of evasion exists. For example, a high percentage of alimony income goes unreported, but the total amount of alimony paid is so small that the aggregate dollar amount of evasion is tiny. The same is true of unreported state tax refunds and unemployment compensation. Indeed, the relatively high level of unreporting from these income sources may be due largely to taxpayer ignorance that such income is in fact taxable.
The point is that closing the tax gap in ways that will yield significant revenue to the government is much harder than generally believed. Most people think the IRS just needs to audit more people. But unless it has good reason in advance to believe that fairly substantial revenues will result from an audit, it could easily be counterproductive. The increased deterrent effect could be more than offset by taxpayer complaints that will result in efforts by Congress to tie the IRS’s hands and cut its budget.
In the end, there is really no pot of money that Congress can use to pay for more spending. To get more than a small part of the tax gap will require draconian enforcement efforts that will lead to a taxpayer backlash and a quick retreat by Congress and the IRS. It may be that we simply have to accept a certain amount of tax cheating as part of the price we pay for a free society.
Bruce Bartlett is a former senior fellow with the National Center for Policy Analysis of Dallas, Texas. Bartlett is a prolific author, having published over 900 articles in national publications, and prominent magazines and published four books, including Reaganomics: Supply-Side Economics in Action.
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