NCPA - National Center for Policy Analysis


January 31, 2007

Closing the estimated $290 billion tax gap -- the difference between what the Internal Revenue Service (IRS) thinks taxpayers should be paying and what it collects -- is not the best way to reduce the deficit, despite what many in Congress think, says the Wall Street Journal.

One of the most popular proposals in Washington is to increase dramatically the information taxpayers must report to the IRS, says the Journal.  Some potential examples:

  • Brokers would have to report securities sales information to the IRS, the better to monitor capital gains.
  • Individuals who participate in online auctions such as eBay would have to file a tax form about their transactions.
  • Americans would be required to file expanded mortgage interest forms, while mortgage lenders would have to report loan information.

The problem, says the Journal, is that most of the financial and social costs end up being borne by those who already dutifully pay their taxes, in the name of catching the few who evade the law.  The tradeoff for higher tax collection is less liberty, as we learned only a decade ago when Congress held much-hyped hearings on abusive IRS tactics and audits.

There is a better way, says the Journal.  The more complicated a tax system, the more likely taxpayers won't understand, or will try to dodge, the rules.  Simple tax regimes, such as a single flat rate, encourage compliance and efficiency, not to mention economic growth.  This has been the experience of many Eastern European countries after they imposed a flat tax, and the United States had similar jumps in reported tax income from "the rich" following the 1986 tax reform that cut rates and closed loopholes.

Source: Editorial, "The 'Tax Gap' Myth," Wall Street Journal, January 30, 2007.

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