New York Times Company
February 15, 2006


By David Cay Johnston

Historically, when income tax rates fall, so does tax cheating. But that is not what happened after President Bush started cutting taxes five years ago.

A new report by the Commerce Department found that Americans failed to report more than a trillion dollars in income on their 2003 tax returns. That was a 37 percent increase in unreported income from 2000.

In a separate report, the Internal Revenue Service looked at both unreported income and improper deductions and concluded that Americans shortchanged the government by $345 billion in 2001 -- an amount almost equal to the projected federal budget deficit for 2007.

The report, released yesterday by the I.R.S. commissioner, Mark W. Everson, was the agency's first estimate in 15 years of the gap between what Americans owed in taxes and what they paid. The I.R.S. report concluded that proprietors of small businesses, investors and farmers cheated the most. Workers who had 99 percent of their wages reported to the government and taxes withheld from their paychecks were the least likely to cheat.

Mr. Everson acknowledged that the estimate is probably low because the I.R.S. looked only at individuals and small unincorporated businesses. It has not revised its estimates of tax cheating by corporations, large estates and by firms that do not hire their workers directly but instead contract with an employee leasing firm.

The ability of the I.R.S. to enforce the tax laws has steadily eroded in the last 17 years as its ranks of auditors have been trimmed by about a third, the tax code has become more complex and new laws have been enacted to protect taxpayer rights.

In his proposed budget for 2007, Mr. Bush laid out a five-point plan to reduce the underpayment of taxes by $350 million a year, an amount equal to a tenth of a penny per dollar of the unpaid taxes.

A more serious effort to reduce the tax gap appears unlikely, two senators said yesterday.

Senator Charles E. Grassley, the Iowa Republican who is chairman of the Senate Finance Committee -- which has held hearings on the issues of unpaid taxes, abusive tax shelters and criminal tax evasion -- said it would take more than what Mr. Bush had proposed to make a meaningful dent.

"It's easy for politicians to stand on the soap box and criticize the tax gap," Senator Grassley said, "but I find it's pretty lonely when I need people to join me and get their hands dirty and try to solve these problems."

Senator Max Baucus, Democrat of Montana, the committee's ranking minority member, dismissed the Bush proposal as weak.

"The administration's budget plans won't take any real bite out of this unacceptable tax gap -- it just nibbles at this crisis while the deficit grows," Senator Baucus said.

"It's time for a comprehensive plan to go after scofflaws and tax cheats big and small, who are contributing to the deficit by not contributing their fair share," he said.

The Senate Budget Committee will hold a hearing today on reducing the gap between taxes owed and taxes paid.

The I.R.S. estimate was based on a detailed study of 46,000 individual income tax returns.

Mr. Everson said that about 13.6 million people did not file returns, costing the government about $27 billion in revenue. Another 10 million had incomes so modest that they were not required to file. About 130 million returns were filed. Cheating on business income was "a problem 50 times larger" than cheating by wage earners, Mr. Everson said.

The biggest single revenue loss came from proprietors of unincorporated businesses, who typically file a Schedule C with their tax return, who shorted the government an estimated $68 billion in 2001. Cheating by partnerships, most of whose members are wealthy professionals or investors, was put at $22 billion, while cheating by landlords and those collecting royalties was estimated at $13 billion.

In percentage terms, farmers cheated the most, the I.R.S. said, failing to pay the government $6 billion, or 72 percent of the taxes they should have.