In a newly released study, the Government Accountability Office (GAO) has examined the effect of the Code's complexity on taxpayer compliance, and the relationship between taxpayer compliance and the growing tax gap (i.e., the difference between the amount of taxes actually owed and what was actually paid for a year). (GAO-11-747T)
GAO observed that tax expenditures in particular, the number of which has more than doubled since’74, add to the Code's complexity. Taxpayers are required to learn about, determine their eligibility for, and choose among various expenditures that often have similar purposes—which complicates both current reporting as well as tax planning. Although many tax expenditures are policy-driven and aimed at helping taxpayers, such as providing incentives to finance retirement, these expenditures bear a compliance cost to taxpayers in terms of both time and money. They also provide more opportunities for taxpayers to make mistakes or to intentionally evade taxes.
GAO also noted that the use of tax preparation software may lessen the need for taxpayers to understand the complexities of the Code since the software companies are current on tax law changes. However, the same is not necessarily true of paid preparers. In a 2001 audit, IRS found that returns prepared by paid preparers were more likely to contain errors than those prepared by taxpayers themselves.
Another issue highlighted by GAO was complexities in income reporting. Although measuring income is relatively straightforward for much of the population, it is a complicated matter for those with many different types of income—such as capital gains, rents, and self-employment. Complex reporting requirements, especially those for sole proprietors and S corporation shareholders, also increase the probability of taxpayer mistakes.
In light of these issues, among others, GAO offered a number of possible ways to reduce the tax gap and enhance taxpayer compliance. These include:
... enhancing information reporting, to both reduce complexity for taxpayers and reduce the opportunity to evade taxes;
Observation: The latest attempt to expand the information reporting rules for businesses was retroactively repealed by Congress for being too burdensome.
... ensuring high-quality services to taxpayers, and helping taxpayers who wish to comply with their obligations do so;
... simplifying the Code, or engaging in fundamental tax reform;
... devoting additional resources to enforcement;
... expanding compliance checks before IRS issues refunds; and
... using consistent definitions across various tax provisions so that taxpayers can more easily understand and comply with their obligations.
Observation: The recommendations made by GAO in its report, as well as those in the proposal made by Commissioner Shulman in April, both contain significant “pre-check” measures that are somewhat similar to the “ReadyReturn” system used in California. Under this system, for qualifying taxpayers (those who, among other things, have income only from wages and claim the standard deduction), the Franchise Tax Board uses information from the last filed return and from the taxpayer's Form W-2 to pre-fill a California state tax return. Taxpayers then simply confirm the information shown and pay the amount due or wait for their refund.