Figure Reflects Difference Between Taxes Owed and Taxes Paid : ‘Tax Gap’ Grows to $84.9 Billion, IRS Reports

Individuals and businesses voluntarily paid only 83.2% of the federal income taxes they owed last year, leaving the government with a tax gap of $84.9 billion, the Internal Revenue Service said Thursday.

More than half of the shortage was attributed to individuals who file tax returns but fail to report income from moonlighting, small businesses or other legal non-wage sources.

IRS Commissioner Lawrence B. Gibbs said closing the gap may require a basic change of attitude among taxpayers in much the same way, he said, that they came to consider drunk driving unacceptable.

“I think in this country we still have an attitude . . . (that) it’s socially acceptable to cut a corner here and there” on taxes, Gibbs told the House Ways and Means oversight subcommittee.

“We are going to destroy the system” unless a way is found to ensure that everyone pays a fair share, said Rep. J. J. Pickle (D-Tex.), chairman of the subcommittee.

Pickle said the IRS estimate is understated, even for legal income. He noted that the IRS made no effort to estimate the tax loss from narcotics, prostitution and other illegal sources of income.

As serious a problem as the $84.9-billion gap represents, Gibbs said, there was good news:

- The 1987 gap is $30 billion less than the IRS in 1983 predicted that it would be. Gibbs attributed the decline to new tax laws, improved data collection, lower estimates of cheating on tips and capital gains and a decision not to count $7 billion in taxes that were acknowledged but not paid.

- The rate of voluntary compliance, which had dropped to 81.1% in 1986, rose last year to 83.2%, virtually the same level as 1973. Gibbs said compliance by individuals and corporations is expected to continue rising through 1992 but will probably still remain below 85%.

Includes Eventual Collections

Because of a growing economy and inflation, the dollar amount of the tax gap will keep going up, Gibbs said. The gap, which totaled $28 billion in 1973, is expected to climb to $87 billion this year and almost $114 billion in 1992.

The tax gap includes money that eventually may be collected by IRS enforcement procedures. The agency collected about $475 billion in income taxes last year.

Inflated wages and economic growth will offset part of the tax-gap decline that could be expected because of tougher enforcement provisions enacted over the last several years, as well as the lower tax rates and smaller number of deductions that resulted from the big tax overhaul enacted in 1986.

“To the extent that, under new law, a subtraction from income is no longer allowed, a taxpayer cannot overstate it on the tax return,” the report says. “This reduces non-compliance. Moreover, because rates at which individual incomes are taxed were reduced, the tax gap associated with any given amount of unreported income fell.”

The biggest single cause of the tax gap is the under-reporting of income by individuals who file returns. That cost more than $48 billion last year, or almost 57% of the gap. Almost $17 billion of that income was from non-farm businesses conducted as sole proprietorships. Another $7.7 billion was attributed to such “informal suppliers” as moonlighting carpenters and roadside vendors.

Overstatement of individual deductions accounted for 4.1% of the 1987 tax gap, or $3.5 billion; claiming too many personal exemptions cost $2 billion.

Another $7 billion of the gap was blamed on people with taxable earnings who failed to file a return. Another $1 billion was lost to taxpayers who make mathematical errors on their returns.

Moonlighters Culprits

Individuals accounted for more than $63 billion of the gap; corporations more than $21 billion. Companies with assets of $10 million or more were responsible for three-fourths of the corporate gap.

Because of withholding and similar accounting, the IRS said, individuals who file returns voluntarily report 99.5% of their wages and salaries, 98.4% of pension income and almost 95% of interest and dividends. For capital gains the figure is 88%.

On the other hand, roadside merchants and moonlighting craftsmen report only 13.1% of their earnings.

Because the 1986 tax overhaul shifted $125 billion in taxes from individuals to corporations over five years, the IRS projects the corporate tax gap to rise from nearly $15.6 billion in 1986 to $31 billion in 1992.