The “tax gap” is the difference between annual income tax due and the amount actually collected. Certain types of income sources are known to be underreported at rates averaging 50-60% and are “opaque” in the view of tax authorities.
“Compared to the U.S. as a whole, Connecticut has a greater share of ‘opaque income sources that accrue disproportionately to higher earners’ and that are underreported at a high rate, which is one of two key causes of the tax gap.” this report says.
The other reason for the tax gap is a shortage of Department of Revenue Service employees. Since 2000 DRS lost 25% of its staff while the number of tax returns grew by about the same percentage. Its current audit rate of around 1% compares unfavorably with other states which average 3%. Annual revenue loss is estimated at 2.6 billion.
This study found that “Audits are a widely used public-policy tool for reducing corruption, improving public service delivery…and improving tax compliance.” In a 2121 study of 53,000 tax returns researchers from Harvard and MIT found audits increased voluntary compliance over a five- to eight-year period. These audits produced net gains of 1.5 times the original underpayment. By doing too few audits, DRS is not only losing revenue due to missed underreporting cases but also missing future revenue that would accrue due to increased voluntary tax compliance.
Can DRS achieve it’s core service priority of “providing effective and efficient tax enforcement” with an audit rate one third of other states? Given its greater share of “opaque income sources” Connecticut DRS should have a higher audit rate than other states and enough seasoned professionals to uncover increasingly sophisticated tax dodging schemes.
More transparency is needed to show whether the DRS is providing efficient and effective tax enforcement. As recommended by Patrick O’Brien Ph.D., Research and Policy Director of CT Voices, this data should include ;
- the DRS annual audit rate by income level
- the estimated size of Connecticut’s annual tax gap overall and separately by major tax components (individual income tax, corporate income tax, etc.)
- the estimated distribution of the tax gap by income level
William Buhler lives in Cromwell