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Weekly UpdatesBACKGROUND
The National Research Program (NRP) is a comprehensive effort by the IRS to measure--at a strategic level--the voluntary filing, reporting, and payment compliance behaviors of U.S. taxpayers. As we pointed out in an earlier paper (Brown and Mazur, 2003), measuring taxpayer compliance for the Internal Revenue Service (IRS) is analogous to measuring the net profit for a private sector business. (1) Both are summary, bottom-line measures of the effectiveness of the organization. A company's management would have a very incomplete picture of the organization's operations without being able to compute net profits on a periodic basis. Similarly, the IRS could have a very distorted view of its operations if it did not develop up-to-date measures of taxpayer compliance.
Taxpayer compliance is a multi-faceted measure. One theoretically appealing way to define taxpayer compliance is to consider three distinct types of compliance: payment compliance; filing compliance; and reporting compliance. (2) These three mutually exclusive and exhaustive measures together provide a comprehensive look at overall taxpayer compliance, which would feed into estimates of the Tax Gap (the difference between taxes paid and taxes owed for all federal taxes and all taxpayers).
The chart in the Appendix, called the Tax Gap Map, provides a detailed look at the components of the tax gap, which for tax year 1998 was estimated at just over $280 billion, (3) along with an indication of the reliability of the estimates. There are three characteristics of the Tax Gap Map worth noting. First, definitive data exists only for a few component items, primarily the estimates of payment compliance and those for reporting compliance for the Earned Income Tax Credit and for Duplicate Dependents. (4) The other estimates all represent projections from earlier studies, primarily the Taxpayer Compliance Measurement Program (TCMP) studies done by the IRS in the 1980s and earlier. Second, these projections from dated compliance studies cannot possibly account for all the changes (tax and non-tax) that have taken place over the passing years. Therefore, the estimates should be viewed as rough guides to the magnitude of the tax gap components, despite the seeming precision of the estimates. Third, despite the imprecision of the estimates, it is likely that the largest components of the tax gap are noncompliance with the reporting requirements for the individual income tax and employment taxes. This should not be surprising given that these are the two largest components for federal tax revenue. (5)
There are very few instances of recent reporting compliance estimates, which are based on specific, targeted studies the IRS has conducted. One example is the Earned Income Tax Credit, where the IRS has conducted fairly reliable compliance studies for tax years 1997 and 1999. (6) In general, though, the most recent comprehensive studies on reporting compliance relate to tax years in the late 1980s. As the IRS conducts studies of payment, filing, and reporting compliance, the estimates of tax gap components will be updated and refined and confidence in the estimates will grow.
The IRS is charged with maintaining the integrity of the federal tax system. To meet this challenge, the IRS strategic planning and budgeting process provides a formal, structured environment for establishing strategic direction, determining resource levels to support the priorities and projects stemming from that direction, and evaluating performance results. It is both cyclical and iterative, and is dependent upon rigorous analysis. (7)
As part of the strategic planning process, the IRS requires regular estimates of taxpayer compliance with federal income tax laws, along with contributing factors, since patterns of noncompliance in the population can be expected to change over time. Developing these measures, and making them available on a regular basis will permit the IRS to rely on the compliance measures as strategic performance indicators.
The three measures provide different views of the compliance puzzle, and when placed next to one another provide a comprehensive picture of the overall level of compliance. The filing compliance measure tracks the percent of required returns that are timely filed. The reporting compliance measure tracks the percent of true tax liability that is correctly reported. The payment compliance measure tracks the percent of reported tax that is timely paid. The remainder of this paper provides a closer examination of the specific compliance measures followed by a discussion of how the strategic compliance measures relate to existing operational measures that target enforcement of the Tax Code.
FILING COMPLIANCE
The NRP filing compliance measures will ultimately provide information about the number of U.S. taxpayers who voluntarily file their tax returns in a timely manner, as well as an estimate of the uncollected tax revenue associated with taxpayers not meeting their filing responsibilities.
The IRS has developed two strategic filing compliance measures: the Filing Rate and the Nonfiling Tax Gap. The IRS has defined the Filing Rate as the percentage of the taxpayer population with a filing requirement that filed timely returns, while the Nonfiling Tax Gap is the dollar amount of unpaid taxes due from delinquent and non-filed returns. The two measures are somewhat complementary to one another in that the Filing Rate captures the frequency of voluntary filing compliance while the Nonfiling Tax Gap captures the dollar amount of taxes foregone attributed to filing noncompliance.
The Filing Rate calculation for individual taxpayers uses data from two sources: the Current Population Survey (CPS) from the Census Bureau and a database maintained by the IRS. The denominator (the number of those with a filing requirement) is estimated from the CPS. The numerator (the number of returns with a filing requirement that are filed timely) is estimated from IRS sources.
The Nonfiling Tax Gap is the difference between what non-filers owed in tax less what they may have already paid (for example, through withholding). For individuals it will be estimated using Census and IRS data. The CPS will again be used to estimate the amount of taxes owed by taxpayers with a filing liability. The IRS data will be used by Census to determine which taxpayers filed and how much they paid in tax if they did not file. Due to the concerns for data co-mingling, IRS will not perform this analysis and will receive only summary tables for the nonfiling estimates.
The issue of filing compliance is not trivial. As Figure 1 shows, the Filing Rate for individual taxpayers in tax year 2000 was estimated to be 90.7 percent. And while the Filing Rate appears to have climbed in the four most recent consecutive years (8) , we estimate that more than 11 million taxpayers are either filing their returns late or not at all.
[FIGURE 1 OMITTED]
The data that drives the strategic filing compliance measures have several limitations, with the most prominent of these being the scope of coverage. The Filing Rate and Nonfiling Tax Gap are available for individual taxpayers only, and it is unlikely that we could provide a breakdown of individual filers into smaller groupings, such as small business owners or wage-earners. Data sources for tax entities other than individuals simply do not exist, and reporting inconsistencies make it difficult to determine the grouping to which a nonfiler belongs. (9)
A second limitation to the Filing Rate estimates is their development time. The IRS will publish the Filing Rate on an annual basis (by tax year), but each release will occur about 18 months after the end of each tax year. For example, the IRS announced the Filing Rate for tax year 2000 in October 2002. (10)
Status
The IRS has completed development of the Filing Rate measure and reports it annually at the end of each fiscal year. The Filing Rate now exists from Tax Year 1992 through Tax Year 2000. Data for Tax ] Year 2001 will be available at the end of September 2003.
The IRS is awaiting summary-level tables from the Non-filing Tax Gap study for 2001 to create data for the measure. The IRS will have payment data for non-filers (such as withholding) to complement the Non-filing Tax Gap by the end of calendar 2003.
PAYMENT COMPLIANCE
The IRS has developed two strategic payment compliance measures: the Voluntary Payment Compliance Rate (VPCR) and the Cumulative Payment Compliance Rate (CPCR). The IRS has defined the VPCR as the percentage of the total tax paid timely on timely filed returns relative to the total tax reported on timely filed returns, while the CPCR is defined as the percentage of tax paid on timely filed returns to a given date relative to the total tax reported on timely filed returns. The IRS designed the cumulative measure (CPCR) to account for the revenue flow associated with timely filed returns over time. (11) The two measures complement one another in that the VPCR captures the initial payment compliance of timely filers while the CPCR captures subsequent payments associated with those timely filed returns.
Both the VPCR and the CPCR use the IRS master file databases as the source of the data for their calculations. Unlike the filing and reporting compliance measures, the IRS possesses complete payment compliance data for each taxpayer and can develop payment compliance measures relying solely on internal data.
As the following Table shows, the IRS estimates that the VPCR for all taxpayers in Tax Year 2000 was 98.7 percent, up slightly from the VPCR in the two previous years. While that percentage is reasonably high, it means that business and individual taxpayers did not forward to the IRS in a timely manner more than $31 billion identified on their tax returns as the tax liability.
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