Paul L. Caron
Dean




Wednesday, October 6, 2021

The Tax Gap, Shades Of Gray, And The Manchin Memo

Daniel J. Hemel (Chicago; Google Scholar), Janet Holtzblatt (Tax Policy Center) & Steve Rosenthal (Tax Policy Center), The Tax Gap's Many Shades of Gray:

The “tax gap”—the difference between the amount of “true tax” and the amount of tax actually paid—has garnered widespread attention in recent months. Much of the commentary on the subject equates the tax gap with “tax evasion,” a term broadly understood to connote intentional (and potentially criminal) underreporting. This paper cautions against conflating the tax gap with tax evasion. The tax gap includes substantial gray areas where the law is ambiguous and the IRS’s determination of “true tax” is debatable. On top of that, the IRS’s methodology for measuring the tax gap includes upward adjustments that are recommended by front-line examiners but reversed on administrative appeal or judicial review. Moreover, a substantial portion of the estimated tax gap is derived from a statistical technique called “detection controlled estimation” that potentially magnifies the impact of later-reversed recommendations on the ultimate tax gap measure. Weighing in the opposite direction, the IRS’s approach to measuring the tax gap excludes some amounts that clearly constitute tax evasion (most significantly, underreporting of tax on illegal-source income).

Understanding the tax gap’s shades of gray can inform discussions of tax law and policy. We explain how proposals to use the tax gap as a performance target may produce perverse incentives for the IRS. We further explain how additional IRS funding—though necessary to improve the agency’s ability to enforce the tax laws—may have counterintuitive effects on the estimates of the tax gap. We also illustrate—using examples from the taxation of passthrough entities—how legislative reforms can reduce the size and scope of legal gray areas that contribute to the tax gap. Our analysis highlights the importance of increased IRS funding levels and substantive tax law changes as complementary strategies for improving tax compliance.

Daniel J. Hemel (Chicago; Google Scholar), The Tax Gap and the Manchin Memo:

Hours before we posted our paper, Politico posted a one-page memorandum of understanding between Senator Joe Manchin and Senate Majority Leader Chuck Schumer dated July 28, 2021, in which Manchin laid out his conditions for a budget reconciliation bill. The memo is startling in several respects. Manchin’s demand that the “Federal Reserve ends quantitative easing” as a precondition for the Senate to move forward on budget reconciliation reflects a rather bold rejection of central bank independence. Moreover, Manchin’s $1.5 trillion topline spending number is way below what other Democrats have been contemplating for months. Of particular interest to me was one item at the very end of Manchin’s list of revenue-raising measures that would offset the new spending: “Tax Gap.”

Speaking only for myself and not for any coauthors: I had three reactions to Manchin’s inclusion of the “Tax Gap” (without elaboration) in his list of offsets. ...

Benjamin Guggenheim, Academics Question Tax Gap Measures, 2021 TNTF 190-4 (Oct. 4, 2021)

https://taxprof.typepad.com/taxprof_blog/2021/10/the-tax-gap-shades-of-gray-and-the-manchin-memo.html

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