Suggestions to close 'tax gap' have vocal opponents

USA TODAY
Suggestions to close 'tax gap' have vocal opponents
By Richard Wolf, USA TODAY

WASHINGTON — Buried deep inside a package of tax cuts that Republicans want to send President Bush this month is an obscure Senate proposal to limit the deduction taxpayers can claim for donated clothing.

By assigning values for the first time to items such as shirts and shoes, the Internal Revenue Service could reduce exaggerated claims and raise an estimated $280 million over five years, according to the congressional Joint Tax Committee. That's tiny compared with the $12.5 trillion in taxes the government is projected to collect over those five years, but the provision has picked up strong opposition from charities that receive clothing donations.

The Association of Gospel Rescue Missions, which runs 300 shelters and about 150 thrift stores, depended on donations for the 20 million pieces of clothing it distributed last year. It doesn't want to limit taxpayers' deductions.

"We think that it will decrease donations," the association's Phil Rydman says. "What happens is, the charity becomes the bad guy."

The battle over the treatment of clothing donations illustrates how difficult it is to close the nation's "tax gap," a $345 billion chasm between taxes owed and taxes paid. Virtually every suggestion for closing the gap — more audits, harsher penalties, new income reporting and tax withholding requirements, or an overhaul of the tax code — has vocal opponents. (Related story: U.S. sees red over back taxes)

"Tax-shelter promoters and others ... are tough adversaries," says Sen. Chuck Grassley, R-Iowa, chairman of the Senate Finance Committee.

Most scrutiny focuses on corporations and wealthy individuals who use bogus tax shelters to hide income. Sen. Kent Conrad, D-N.D., cites the case of a five-story building in the Cayman Islands that's the official tax "home" to more than 12,500 companies.

The fastest-growing portion of the tax gap comes from individual tax filers with business income, including the self-employed. They account for more than half of the tax gap that comes from underreported income. Yet only 2% of self-employed taxpayers are audited, according to J. Russell George, the Treasury Department's inspector general for tax administration.

The actions of paid tax preparers also have helped fuel a rise in unpaid taxes, says Conrad, a former state tax commissioner. "The world has changed dramatically in the accounting profession" since the 1980s, he says. "They've adopted very aggressive techniques to avoid taxes."

Part of the tax gap — the IRS doesn't know how much — stems from taxpayer confusion rather than fraud. About 15,000 changes have been made since 1986 in a code that now comes with 52 related schedules and worksheets.

The code is so complicated that in 2004, the IRS itself answered more than one in four questions to its toll-free lines incorrectly. Even Comptroller General David Walker, a certified public accountant, has trouble doing his taxes by hand. "It is mind-numbingly complex," he says.

For all those reasons, tax experts say only a small part of the tax gap can be recovered.

"Some of it is just not gettable," says Eric Toder of the non-partisan Urban Institute, who headed the IRS research division during President Bush's first term. "You're playing a game where there are very smart and clever people on the other side."

The number of audits and auditors dropped during the late 1990s, when Congress — angered by stories of aggressive IRS enforcers — ordered the IRS to focus more on helping honest taxpayers.

Since 2001, however, the IRS has renewed its focus on enforcement. More than 1.2 million individual returns were audited last year, the most since 1998. More than 220,000 audits were conducted on individuals who earned more than $100,000, the highest number in a decade. One in five companies with assets of $10 million or more was audited.

This year, Bush is seeking $137 million more for enforcement. Congress is considering twice that much. Senate Budget Committee Chairman Judd Gregg, R-N.H., refers to it as "an investment in revenue."

The potential solutions go beyond money. The Joint Tax Committee last year listed 69 proposals for closing the tax gap. Among them was one that would require withholding taxes on payments to government contractors, which the Bush administration has suggested this year.

Bush also wants credit card companies to tell the IRS how much they pass on to businesses — to restaurants where customers charge their meals, for example — so the businesses can't underreport their receipts.

Those who want to close the tax gap must overcome opposition from conservatives and the small-business lobby, who worry that additional reporting and withholding would be overly burdensome.

"The only solution the IRS seems to have is to go after the legal guys with reporting requirements that can be expensive," says Martin Regalia, chief economist for the U.S. Chamber of Commerce. "The gap should not be closed on the backs of businesses."

Adds Dan Mitchell of the conservative Heritage Foundation: "If we want to reduce the tax gap, lower tax rates, period. That's the only way it works."

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