Tax Policy Center | Comments: Measuring the Tax Gap Eric Toder Urban-Brookings Tax Policy Center June 21, 2012

Tax Policy Center | Topics Covered Measurement of the Tax Gap –Individual Income Tax Underreporting in the United States –Individual Income Tax Non-filing in the United States Scope and Uses of Tax Gap Estimates in the UK –VAT, Excises, CIT and PIT

Attributes of Tax Gap Estimates Timeliness and Frequency –How much is new in “updates”? Comprehensiveness –Which tax sources are covered? How they are used –Guide to resource allocation? –Measure of revenue agency performance? How sophisticated is the methodology? Tax Policy Center |

Methodological Issues “Top down” or “Bottom-up” Use of External Data Sources –National income accounts, household surveys, information returns etc. Use of Random Audits –Correction for selection bias in operational data Adjustment for non-detection by examiners –Major determinant of bottom-line IRS estimates Projection of prior-year data Tax Policy Center |

Estimating Tax Gaps is Hard Most economic statistics measure something that has happened Tax gap measures something that has not happened –Returns not filed that should be –Tax liability not reported that should be There are no direct measures of “true” tax liability; it has to be imputed Tax Policy Center |

Summary: Plumley, Paine and Erard Two measures of non-filing –Non-filing tax gap in dollars –Voluntary filing rate (VFR) Paper in 2011 addressed methodological issues in estimating the non-filing rate This paper discusses improvements in measuring the VFR Tax Policy Center |

Improvements in VFR Measure VFR is ratio of returns filed on time by required filers (N) to total required returns (D) –N is tabulated from IRS data –D has been imputed from CPS data Improvements in measurement of D –Imputation of missing income to CPS data increases D by 7-9% Improvements in Measurement of N –Correction in instructions on requirements for taxpayers with losses Tax Policy Center |

Questions on Paper How does one account for inadvertent taxpayers errors in the tax gap measure? –Is it different if the fault lies with imprecise IRS instructions instead of a complex tax law? Should they also adjust interest and dividends and impute capital gains to D? Could income adjustments have improved the old filing gap measures? Tax Policy Center |

Summary: Bloomquist, Emblom,Johns and Langetieg Paper summarizes changes in NRP sample and frequency of studies Discusses two methodological improvements in measuring underreporting of tax due –Improvements in DCE methodology –Application of tax calculator instead of average tax rate to underreported income Tax Policy Center |

Improvements in Methodology Detection Controlled Estimation: –Estimation on non-detected income at line item level –Separate equations for probability of non-detection and amount missed on items with non-detection Separate Imputations of Missing Income from Tips and Flow-Through Enterprises Application of Tax Calculator to Underreported Income Tax Policy Center |

Questions Are detection errors on separate line items uncorrelated with each other? Is it assumed that DCE fails to capture underreported income on S-corp and partnership returns? How would the 2001 estimates have changed if the new methodology were applied to 2001 data? Tax Policy Center |

Summary: Thackray HMRC publishes annual tax gap estimates Individuals are divided into segments based on compliance risk Tax gap used as performance measure Compliance Risk Analysis Model (CRAM) used to allocated resources Tax Policy Center |

Comparison with U.S. Approach Much More Detail in Published Results –Annual tax gap estimates for various tax sources –Categorization of reasons for non- compliance (IRS does not do this) Use in Performance Measurement Little Discussion of Estimating Methodology Tax Policy Center |

Questions How are tax gap findings translated into: –Resource allocation decisions –Performance evaluation of HMRC leadership and staff How do HMRC tax gap measures adjust for: –Detection control issues –Income reported by non-filers Tax Policy Center |