The Honorable Dave Camp
Chairman
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.

Question 1

Evasion at the individual taxpayer level:  What are the statistics regarding tax evasion by individuals?

Response 1

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.[1]

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.[2]

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.[3]  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.[4] 

I have proposed both administrative and legislative recommendations to improve tax compliance in the cash economy.[5]    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;[6]
• Eliminate the corporate exception from information reporting for small corporations;[7]
• Accelerate the taxpayer identification number validation process;
• Provide for withholding on payments to noncompliant contractors;[8] and 
• Require financial institutions to report all accounts to the IRS by eliminating the $10 minimum on interest reporting.

Question 2

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?

Response 2

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.”[9]

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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.

Sincerely,

                                                                        Nina E. Olson

                                                                        National Taxpayer Advocate