27 July 2006

Who Doesn't Pay Their Federal Taxes?

The latest information (from 2001) on the amount of taxes that are not paided in sufficient amounts, on time, called the tax gap, are out. They are federal figures, but since Colorado's individual and corporate income taxes track the federal income tax, the numbers should also reflect Colorado's tax gap.

About 44% of it ($148 billion a year) comes from income and self-employment taxes owed by closely held businesses. About 16% comes from understated non-business income (disproportionately from investment income not subject to information return requirements such as capital gains and rental income), and about 9% comes from overstated deductions, exemptions and credits. About 33% comes from other sources (mostly underreporting of corporate income taxes and employment taxes).

Non-compliance rates vary greatly by type of income. About 1.2% of potential wage and salary tax revenue are not collected. About 4.5% of potential dividend, interest, pension and taxable Social Security income tax revenue are not collected. About 8.6% of potential tax revenue alimony, partnerships, S-corporations, capital gains, and overstated deductions and exemptions are not collected. And, about 53.9% of potential tax revenues from farms, rents and royalties, and sole proprietorships are not collected. The biggest factor in tax law compliance is the degree to which income appears on information returns. Taxpayers whose income isn't reported by third parties are much more likely to cheat.

More than a third of returns with capital gains incorrectly report that amount of the gain. Indepenent contrators omit on average 17% of income not subject to information returns, but just 3% of income subject to information returns.

The I.R.S. is not funded at at level that maximizes compliance. It estimates that for every additional dollar spent on enforcement, it could collect about $14 of additional tax revenues.

While there are some issues for actually collecting taxes owed, 90% of tax revenue loss comes from returns that incorrectly state how much is due, rather than from non-payment of taxes that taxpayers admit that they owe.

A leading cause of audit for lower income taxpayers is the earned income tax credit. The earned income tax credit is so complex that "the likelihood that the IRS had obtained the right result the first time [it conducts an audit] is not much better than a coin toss [43%]."

In short, your average tax cheat looks a lot like your stereotypical Republican voter.

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