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Alan Fram the Associated Press
Published: 07 January 2012

WASHINGTON (AP) -- People and businesses underpaid their taxes by an estimated 17 percent in the most recent year studied, failing to send the government a massive $450 billion that it was owed, according to an Internal Revenue Service report released Friday.

The study covered 2006, the most recent data the IRS said was available. The amount of underpaid taxes far exceeded the size of the entire federal budget deficit at the time.

After IRS audits and other enforcement efforts, non-compliance in 2006 shrank to 14 percent. That left the final amount of unpaid taxes at $385 billion, the agency said.

Friday's report immediately became fodder for lawmakers arguing that any effort to overhaul the tax code - which seems a long-shot in an election year - must include closing the gap between what is owed and actually paid.

"The best way to increase compliance is to reform the tax code to make it simpler," said Michelle Dimarob, spokeswoman for House Ways and Means Committee Chairman Dave Camp, R-Mich. She said that would cause fewer errors and "greater certainty, which is key to job creation."

"In an era when we're squeezing the federal budget for every dollar of savings, we have to make every effort to recover these lost funds," said Senate Finance Committee Chairman Max Baucus, D-Mont.

By either measure, the total of unpaid taxes in 2006 was larger than that fiscal year's budget deficit of $248 billion. Federal fiscal years begin in October of the previous year.

Federal deficits have since mushroomed out of control, hitting a record $1.4 trillion in 2009 and barely receding to $1.3 trillion last year. President Barack Obama and Republicans in Congress have agreed to some spending cuts but have remained deadlocked over how to curb the gigantic budget shortfalls that are projected indefinitely.

Altogether, the IRS estimates it was owed nearly $2.7 trillion in taxes in 2006.

The agency said that out of the $450 billion taxpayers underpaid that year, the largest share - an estimated $376 billion - came from underreporting of income.

The IRS pointedly noted that compliance increases when third parties like employers report income information to the government and when they withhold taxes that are owed.

The report said that with wage and salary information reported to the IRS on W-2 forms, only 1 percent of that income was misreported. But an estimated 56 percent of income was underreported when the government requires little or no information, such as income earned by some small businesses, renters and businesses selling property.

The IRS has made efforts to improve compliance, such as increasing oversight of professional tax return preparers and increasing the information that must be reported to the agency by stock brokers, mutual fund companies and for some business transactions.

Even so, tax analysts said there was no reason to believe that today's compliance rate has changed significantly from the 2006 figures.

That is chiefly because significant portions of the underpaid taxes are believed to come from businesses and individuals who report information about their income that is difficult for the IRS to verify.

"It's hard to get to that," said Clint Stretch, a tax policy expert for Deloitte Tax LLP. "Nobody wants a bunch of IRS police hammering on small business people."

John Buckley, a Georgetown University law professor and former Democratic congressional tax aide, said that if IRS budget cuts continue, "It's quite probable we'll see a decline in compliance rates."

The IRS's roughly $12 billion budget was reduced by about $300 million this year.

The overall 2006 compliance rates were roughly similar to 2001, the last year the IRS had examined.

In that year, 16 percent of taxes were unpaid initially, while enforcement efforts lowered the non-compliance rate to 13 percent.

That meant that in 2001, $345 billion in taxes were uncollected initially and $290 billion remained unpaid even after IRS audits and other enforcement efforts.

"Despite increasing complexity and an ever-changing tax code, compliance has remained steady," said IRS spokesman Frank Keith.

The dollar amounts of unpaid taxes were larger in 2006 chiefly because the size of the economy and the amount of taxes owed had grown, agency officials said.

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