Narrowing Tax Gap Called 'Unrealistic'
Paulson's Comments Anger Democrats

By Lori Montgomery
Washington Post Staff Writer
Thursday, April 19, 2007

Treasury Secretary Henry M. Paulson said yesterday that the Internal Revenue Service would have a tough time wringing money out of the nation's tax cheats without imposing "draconian" new burdens on honest taxpayers.

Speaking to a Senate committee led by Democrats eager to raise cash without raising tax rates, Paulson said it was "unrealistic" for them to expect to collect hundreds of billions of dollars from the federal tax gap, the difference between taxes owed and taxes paid.

"The tax gap is simply not a pot of gold that we can dip into every time we want to pay for a new or expanded program," Paulson told the Senate Finance Committee. "Nor should it be viewed as an easy solution to existing challenges," such as replacing the alternative minimum tax.

Democrats bristled at Paulson's remarks and accused the administration of failing to take seriously its duty to enforce the nation's tax laws. Finance Committee Chairman Max Baucus (D-Mont.) demanded that Paulson return in July with a strategy for increasing the voluntary compliance rate to 90 percent by 2017 from 84 percent, a change he said would increase tax collections by $150 billion a year.

"I know there is no magic solution to the tax gap," Baucus said. "But that doesn't mean there is no solution to the tax gap."

The IRS estimates the tax gap at $345 billion annually, enough to wipe out the federal deficit. Most of the gap is attributed to unreported income, much of it collected by small businesses, farmers and landlords but not reported to the IRS. While the size of the gap in dollars has ballooned with the U.S. economy, the rate of compliance has remained relatively constant for four decades.

The gap has become a popular target in recent years as the deficit soared. The IRS, which significantly curtailed enforcement under pressure from a Republican Congress in the late 1990s, has lately increased the number of audits, criminal referrals and enforcement agents.

In addition to more enforcement, the White House proposed 16 gap-closing measures in February that are pending in Congress. Though they include such contentious ideas as requiring credit companies to annually tell the IRS how much money is flowing to individual businesses, they would raise $30 billion over a decade, or less than 1 percent of the gap.

Democrats derided the package as inadequate and demanded that Paulson do more. But Pauslon made no commitments and laughed uncomfortably when asked whether he planned to follow Baucus's directive to return to the Hill in July.

During testimony, Paulson said other tax-gap ideas floating around Washington "would be unnecessarily painful, expensive and time-consuming for taxpayers." Politicians haven't endorsed the more extreme notions, but Paulson cited some anyway -- steps such as eliminating most cash transactions or tripling the number of IRS audits.

"In theory, each of these measures could bring in some additional revenue," Paulson said. "But the cost of compliance for individuals and businesses -- most of whom already pay what they owe -- would far outweigh the gains."