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Closing the tax gap

The top of a tax form.

TESS VIGELAND: Here's how my husband and I deal with tax time in our household: get it over and done with as soon as possible. We filed two weeks ago, and blessed be, we're gettin' a refund!

[Party blower!]

That means we should adjust our withholdings, of course. But for this year, no complaints.

Tax filing can be a test of honesty. Especially when it comes to reporting income like cash transactions and capital gains. The IRS says taxpayers aren't paying on everything they should, and that means Uncle Sam isn't getting all his money. It's called the tax gap. And Marketplace's John Dimsdale tells us the government is trying hard to close it.

JOHN DIMSDALE: The IRS figures Americans are about 85 percent honest when it comes to taxes. That leaves a 15 percent gap.

DON ALEXANDER: I think the gap is probably higher and we're lucky if we get 75 percent.

He oughta know. Don Alexander was IRS Commissioner from 1973 to '77. Back in his day, he says tax compliance was slightly higher. In part because 2.5 percent of all returns were audited. Today, that's down to one percent.

ALEXANDER: Non-compliance breeds non-compliance. Why should a person paying his or her full way be a chump when the neighbors on both sides of the street are not doing so.

In 2001, the IRS estimated taxes owed, but uncollected, totaled 345-billion dollars a year. Even in Washington, that's a lot of money. Money that could eliminate the deficit with enough left over to start fixing Social Security. That's why lawmakers are salivating at the prospect of bringing in extra cash without the political risk of raising taxes.

Does this pot of gold really exist? Senator Max Baucus, chairman of the Senate Finance Committee, thinks it does.

MAX BAUCUS: It's clearly real. There's close to $300 billion every year that's legally owed, not collected.

The Bush administration agrees. The President's budget recommends a hefty $300 million increase for IRS enforcement and collection efforts next year. To help the IRS, the White House would require credit card companies to report sales figures. That would keep businesses honest with their own records. Plus, the President would force stock brokers and mutual fund companies to tell the IRS how much shareholders paid for the stocks they sell, making it easier to calculate and tax capital gains.

At a congressional hearing on the tax gap this week, Senate Budget Committee Chairman Kent Conrad said taxpayers are more likely to come clean when they know somebody else is also reporting their taxable transactions.

KENT CONRAD: For example, according to the IRS, for income that's subject to substantial reporting and withholding requirements, such as wages and salaries, we see a 99 percent compliance rate. When reporting requirements are in place we see a 91 percent compliance rate. Where we have neither, we see the compliance rate dropping to below fifty percent.

But small businesses, credit card companies and some mutual funds complain more annual tax reporting would be a financial burden.

At this week's hearing, IRS Commissioner Mark Everson conceded that while a recent crackdown on uncollected taxes has closed the gap some, closing it more will be a lot tougher.

MARK EVERSON: To reduce the tax gap dramatically would take some draconian steps, ones that would fundamentally change the relationship between taxpayers and the IRS. Require an unacceptably high commitment of enforcement resources and would risk imposing unacceptable burdens on compliant taxpayers.

Some believe the government should be withholding taxes from cash contracts or online transactions on websites such as eBay. But Senator Max Baucus thinks the government can bring in more tax revenue without drastic measures.

BAUCUS: We're not talking about vigorous IRS agents coming down and knocking on people's doors. e're just talking about the IRS fairly but firmly doing its job to collect the income that's legally owed but not collected.

Senator Baucus and other Democrats are considering giving the IRS even more money than the White House has asked for to beef up enforcement. Lawmakers figure they'll get a good return on their investment.

In Washington, I'm John Dimsdale for Marketplace Money.

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