ACCT 401 Week 1 Group Discussion Board Forum 1 Example

Group Discussion Board Forum 1: Voluntary Compliance and the Tax Gap

ACCT 401 Individual Taxation, Group Discussion Board Forum 1

Thread by [Student Name]

The taxpayer example and the classmates are composites; the textbook, Scripture and the research cited are real.

Consider two taxpayers who each earn $62,000. Dana is a nurse whose hospital reports her wages on Form W-2 and withholds federal income tax from every paycheck. Luis runs a landscaping business and is paid by homeowners in cash and by check, and no one reports his receipts to the IRS. Both are legally required to report all of their income, and both face the same tax rates. Yet Dana could not underreport her income without the IRS noticing, because the agency's matching program compares her return with her employer's report, while an understatement by Luis would be discovered only if his return were audited. My answer to this week's prompt is that the federal income tax works largely because most income is reported by someone other than the taxpayer, and that voluntary compliance is weakest exactly where that reporting is missing.

Spilker et al. (2018) describe the U.S. system as one of self-assessment: taxpayers compute their own tax and file returns, and the IRS verifies a small fraction through correspondence, office and field examinations. The difference between what is owed and what is voluntarily paid on time is the tax gap. The IRS projected a gross tax gap of $696 billion for tax year 2022 and a voluntary compliance rate of 85.0%, with underreported income on filed returns its largest component (Internal Revenue Service, 2024). The chapters also present the criteria a good tax should satisfy, including sufficiency, equity, certainty, convenience and economy, and the tax gap undermines more than one of them: revenue falls short, and honest taxpayers bear a larger share than those who do not comply.

The research agrees on where the gap comes from. Slemrod (2007) reviewed IRS compliance studies and showed that noncompliance is concentrated in income that no third party reports or withholds on. The IRS's latest analysis puts numbers on that pattern: wages, which are subject to both information reporting and withholding, are misreported at about 1%, while nonfarm sole proprietor income, with little or no information reporting, is misreported at 55% (Internal Revenue Service, 2024). A large field experiment in Denmark reached the same conclusion. Kleven et al. (2011) randomly audited tens of thousands of taxpayers and found that evasion of third-party-reported income was close to zero, while evasion of self-reported income was substantial; letters warning of a higher audit probability raised the income people reported themselves. People are not more honest about wages than about cash receipts; they simply have less opportunity to be dishonest.

That evidence raises a moral point. In Romans 13:7, Paul instructs believers to give everyone what they are owed, taxes and revenue included (English Standard Version Bible, 2001/2016). The command does not depend on the chance of being caught. For a Christian accountant, Luis's situation is the important one, because it is where the law relies on conscience. Helping a self-employed client keep complete records, report all receipts and claim every deduction the law allows is both good tax practice and faithful obedience. The best tax planning, as Spilker et al. (2018) frame it, reduces taxes through legal choices, never by omitting income.

Reply to Hannah

Hannah, you argued that the best way to close the tax gap is to fund more IRS audits, and I agree that audits matter. Your point that enforcement funding has fallen over the past decade is also well taken, since fewer examiners means each audit has to count. The Danish experiment in my thread found that taxpayers who were warned of a higher audit probability increased the income they reported, so the threat of enforcement changes behavior (Kleven et al., 2011). Still, I think the evidence points to a cheaper tool working alongside audits. Audits are expensive, they reach only a small fraction of returns each year and they often happen years after the return was filed, so their deterrent effect depends on taxpayers believing they are likely. Information reporting works on every return automatically. Congress has used this approach before, for example by requiring payment settlement entities to report card and third-party network payments to merchants on Form 1099-K. Extending reporting to more business receipts would raise compliance among the taxpayers Slemrod (2007) identified as most likely to underreport without increasing audits of wage earners, who already comply at very high rates. Audits would then be focused where they do the most good, on returns that reporting cannot verify. That approach also respects the many taxpayers who already comply, since they would see fewer unnecessary examinations. I would also add a fairness point: when enforcement is concentrated on returns that are easy to examine, such as those claiming refundable credits, it can fall hardest on lower-income taxpayers while leaving larger gaps in business income untouched.

Reply to Marcus

Marcus, you suggested that a flat tax would close much of the tax gap because a simpler system leaves less room for mistakes and gaming. A simpler rate schedule would reduce some errors, and Spilker et al. (2018) list simplicity among the qualities of a good tax. I am not convinced, though, that the rate structure is where most noncompliance comes from. Rates affect how much a taxpayer gains by hiding a dollar of income, but they do not change whether that dollar is visible to the IRS. The underreporting Slemrod (2007) documented is mainly a failure to report income at all, especially business receipts that no third party reports. A taxpayer who omits $20,000 of cash receipts escapes tax whether the rate is graduated or flat, so changing the schedule would leave that behavior unchanged. The IRS's own estimates show underreporting on filed returns as the largest part of the gap (Internal Revenue Service, 2024), and that part depends on whether income is visible, not on how many brackets apply to it. Where I think your point is strongest is on the deduction and credit side. Itemized deductions, education credits and the earned income credit all require taxpayers to apply detailed rules, and the IRS's own studies attribute part of the gap to overclaimed credits and deductions. Complex credits produce errors, some honest and some not, and simplifying them could reduce mistakes and the cost of compliance. Perhaps the most effective reform would combine your idea of simplicity with broader information reporting, so that the tax is easier to compute and income is harder to hide. Either way, the obligation in Romans 13:7 stays the same for each taxpayer, whatever the rate schedule looks like.

References

English Standard Version Bible. (2016). Crossway. (Original work published 2001)

Internal Revenue Service. (2024). Tax gap projections for tax year 2022 (Publication 5869). U.S. Department of the Treasury. https://www.irs.gov/pub/irs-pdf/p5869.pdf

Kleven, H. J., Knudsen, M. B., Kreiner, C. T., Pedersen, S., & Saez, E. (2011). Unwilling or unable to cheat? Evidence from a tax audit experiment in Denmark. Econometrica, 79(3), 651-692. https://doi.org/10.3982/ECTA9113

Slemrod, J. (2007). Cheating ourselves: The economics of tax evasion. Journal of Economic Perspectives, 21(1), 25-48. https://doi.org/10.1257/jep.21.1.25

Spilker, B. C., Ayers, B. C., Barrick, J. A., Lewis, T. K., Robinson, J. R., Weaver, C. D., Worsham, R. G., & Outslay, E. (2018). Taxation of individuals and business entities (Custom ed.). McGraw-Hill Education.