NCPA - National Center for Policy Analysis

"Tax Gap" Rises And Falls With Tax Rates

March 6, 2000

The last data from an Internal Revenue Service program aimed at measuring tax compliance were published in 1996, indicating that the "tax gap" for 1992 was about $94 billion -- almost all from nonreporting or underreporting of income.

Although the IRS no longer publishes tax gap estimates, one can still get a good idea of the magnitude of tax evasion by comparing the Commerce Department's measure of income to the IRS's. The IRS compiles its data from tax returns, while Commerce gets its data directly from the sources of income.

The Commerce Department has recently published new data on the tax gap using this methodology.

  • It shows that in 1997 taxpayers should have reported $5.6 trillion of income on their tax returns.
  • However, IRS data show that just under $5 trillion actually was declared, leaving an income gap of $630 billion.
  • If the IRS had taxed this unreported income at the same rate reported income was taxed, the federal government would have taken in about $93 billion more income taxes in 1997 than it did.

Until the late 1970s, the tax gap was about 10 percent. However, by 1984, the gap had risen 40 percent to 14 percent of total income.

As the Reagan tax cuts became fully phased-in and tax rates were further reduced by the Tax Reform Act of 1986, the income gap dropped sharply, falling to 9.7 percent in 1988. The 1990-91 recession and higher tax rates enacted by Bill Clinton and a Democratic Congress in 1993 boosted the income gap once again to historically high levels. In 1997, the gap was estimated at 11.2 percent, but was as high as 12.9 percent in 1994 in the wake of the 1993 tax increase.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, March 6, 2000.


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