Taxpayer-friendly IRS can't track billions in missing taxes

WASHINGTON -- The government is losing billions of dollars in unpaid income taxes each year. It doesn't really know how much, and it can't figure a way to find out without riling Congress and the taxpayers.

Loathe to return to much-criticized random audits, the Internal Revenue Service hasn't had a reliable way to measure the "tax compliance gap" since the 1980s.

That's particularly troublesome for an agency whose new strategic plan declares that the tax system "depends on each person who is voluntarily meeting his or her obligations having confidence that his or her neighbor or competitor is also complying."

The last time the IRS ventured even a guess at the size of the tax gap was in 1998, when the agency told Congress that $195 billion in individual and corporate income taxes went uncollected in fiscal 1997. That's an average of $1,625 for each of the 120 million income tax returns filed that year.

David Mader, the IRS's assistant deputy commissioner, said that number is an update of estimates made in the early 1980s and assumes the rate of tax compliance has not changed in the past two decades.

Still, he said, "There is no other data. ... It is imperative that we come up with a set of compliance measures around reporting, filing and paying."

Those are the three sources of the tax compliance gap:

-- Tax due on income that's underreported on tax returns.

-- Tax liability on income earned by taxpayers who fail to file returns.

-- Taxes due on income reported on returns, but not paid.

The IRS used to estimate the tax gap every few years by using a system that combined random audits of income tax returns with an examination of the finances of a sample of nonfilers. Tax experts both inside and outside the IRS agree that's the most accurate way to measure the tax gap.

But that system, known as the Taxpayer Compliance Measurement Program, was last used in 1988. Opposition from Congress and taxpayers upset at the prospect of random audits led to cancellation of the program planned for 1995. The IRS has been searching ever since for a politically acceptable way to measure compliance.

"Too many people in Congress just demagogued this issue so much that everybody's afraid of it," said Robert McIntyre of Citizens for Tax Justice.