Face-off: Closing the Tax Gap

Daniel J. Mitchell
Senior Fellow, Cato Institute

Revenues have been pouring into Washington at record rates thanks, in part, to the 2003 tax rate reductions. But politicians are hungry for even more money, and they are targeting the small business community. They deny that small businesses are in the cross-hairs, but that is the real meaning of the hysterical rhetoric about the so-called tax gap.

If IRS numbers can be believed (bureaucrats have an incentive to exaggerate the amount of tax money not collected since that probably means more power, more bureaucrats, and more money for the agency), taxpayers are dodging about $300 billion each year. And the lion's share of this tax gap supposedly is the result of dishonest small business owners.

There are two ways to reduce the tax gap. The first is to lower tax rates and simplify the tax code. This approach is so strongly supported by academic research that even the International Monetary Fund confirmed that "countries with relatively low tax rates, fewer laws and regulations, and a well-established rule of law tend to have smaller shadow economies."

Unfortunately, politicians in Washington do not want lower tax rates. Instead, they are agitating for the second option, which is to create a more oppressive tax collection process. This means more audits, more harassment, and higher burdens on all taxpayers.

To his credit, Treasury Secretary Hank Paulson has explained that this option is more likely to harm the innocent than it is to catch the guilty. But being right does not count for much in Washington-especially when greedy politicians are looking for excuses to expand the burden of government.