Democrats Seek Unpaid Taxes, Setting Up Clash

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WASHINGTON, Feb. 2 — Congressional Democrats, hoping to finance an ambitious agenda without raising taxes, are on a collision course with the Bush administration about pursuing the potentially vast amount of money that people hide from the Internal Revenue Service.

House and Senate Democrats say the government could collect as much as $100 billion more a year by whittling the tax gap — the unpaid taxes, mostly on unreported earnings, that the I.R.S. estimated was about $300 billion a year.

But the Treasury Department, which oversees the I.R.S., says it cannot realistically recover one-tenth as much as Democrats suggest.

On Monday, as part of President Bush’s budget proposal, the Treasury Department will unveil more than a dozen proposals to pursue tax cheats. But officials said those ideas would bring in less than $10 billion a year in extra revenue.

Mark W. Everson, the I.R.S. commissioner, has expressed far greater optimism. At a hearing of the Senate Budget Committee a year ago, he told lawmakers that the government could recover “between $50 billion and $100 billion without changing the dynamic between the I.R.S. and the people.”

Recouping unpaid taxes is a perennial concern in Washington. But the issue may have new urgency with the Democrats now in power and driving the considerable momentum behind it. Representative Charles B. Rangel, Democrat of New York and chairman of the Ways and Means Committee, has cited the tax gap as a top priority for increasing revenue, ahead of any discussion about rolling back President Bush’s tax cuts.

Democrats badly want the money because they have adopted strict “pay as you go” budgeting rules that require Congress to pay for any new programs or tax cuts with revenue from other areas.

“The tax gap is the logical place to go,” said Representative Rahm Emanuel, Democrat of Illinois and chairman of the House Democratic Caucus. “It’s also the fair thing to do. When you have a number as high as $300 billion in unreported and uncollected income taxes, that puts a burden on everybody.”

Administration officials contend that Democrats have exaggerated the amount of money they can recover.

“At this point we have to do more research to understand where this money is,” said Michele Davis, a Treasury Department spokeswoman. “We are very mindful of the compliance burden on taxpayers who do follow the law.”

The Democrats have offered only a few specific proposals, and lawmakers have conspicuously refused to comment about proposals that could raise money but also provoke a political reaction from legions of self-employed people and family businesses.

Based on an analysis of audited tax returns from 2001, the I.R.S. recently estimated that the government lost $290 billion that year as a result of underreporting and underpayment of taxes.

More than 80 percent of that loss stemmed from underreporting by individuals, not corporations.

And the biggest problems were with people in business for themselves, who earned income that was not reported to the I.R.S. on W-2 forms or on the Form 1099 that businesses file when they pay independent contractors.

The I.R.S. estimated that it lost $109 billion on unreported business income, almost all of that from sole proprietors, like painters, plumbers, dry cleaners, florists, limousine drivers and restaurant owners.

Small-business lobbying groups have begun to mobilize against proposals intended to reduce the tax gap.

Two of the biggest trade associations in Washington, the United States Chamber of Commerce and the National Federation of Independent Business, organized the Coalition for Fairness in Tax Compliance in December to address lawmakers about proposals that might burden law-abiding business owners.

“I’m focused on avoiding the wrong solutions,” said Macey Davis, tax counsel for the National Federation of Independent Business, which represents more than 600,000 small companies, half of which have fewer than five employees. “We’re not out to protect noncompliance. We’re out to protect those who are compliant and whose businesses could be hurt.”

Small-business groups have provided powerful support to President Bush and to Republican lawmakers. But they are poised to fight at least one proposal by the Treasury Department, which would authorize the I.R.S. to obtain information about a business’s revenues from credit card companies.

The proposal would allow the I.R.S. to compare the credit card payments made to a business with the revenues the business owner reports on his or her tax return. If the credit card payments were suspiciously high compared with what the business owner reported to the government, the I.R.S. could begin an audit.

Opponents of the proposal contend that it would catch very little wrong-doing because it would not examine payments made in cash or by check. They warn that it could have disruptive side effects on business operations. (A similar idea proposed by the Bush administration last year received virtually no attention from the Republican-led Congress.)

The Democrats’ biggest obstacle is that the tax gap is in some ways as amorphous as “waste, fraud and abuse” — everyone is against it, but no one is sure how to go about dealing with it. Many tax experts agree that increasing compliance would require an array of tactics, from increased auditing to tougher reporting requirements, to address scores of different practices.

Many such efforts would probably prompt political resistance, whether from small-business lobbying groups or from the credit card companies that might be ordered to provide the I.R.S. with transaction data at no charge. And some efforts may not yield much extra revenue. Another proposal that could lead to organized political opposition is a plan to crack down on investors who understate their profits when selling stocks.

The I.R.S. estimated that it lost about $11 billion in 2001 from people who understated their capital gains after selling stock. According to the agency’s review of tax returns that year, a year when the stock market was plunging and losses were more common than gains, about 38 percent of all people underreported their capital gains.

The problem, I.R.S. officials said, is that brokerage firms report only how much money a person receives from the sale of stock, not how much the person paid for it. Without an audit, the government has no way of verifying the profits that people report.

Nina Olson, the I.R.S.’s independent taxpayer advocate, has proposed that Congress require brokerage firms to report a person’s purchase cost as well as sales proceeds to the government. Mr. Emanuel has introduced a bill based on the idea.

The Bush administration is also planning to ask Congress to provide more money for enforcement efforts, including money for more auditors. But the I.R.S. currently audits fewer than one out of 435 tax returns. Doubling the number of auditors would mean that the I.R.S. would still audit less than 1 percent of all returns.

Democratic lawmakers contend that the Bush administration has been dragging its feet on efforts to track down underreporting.

“I know they can’t recover every dollar of the tax gap, but the I.R.S. needs to make an aggressive effort, and an honest one,” said Senator Max Baucus, Democrat of Montana and chairman of the Finance Committee. “Treasury shouldn’t lowball their estimate.”

But in an interview last week, Mr. Baucus declined to propose any of his own ideas for reducing cheating. “I’m leaving it up to them,” he said, referring to the Treasury Department.

Some Treasury officials, who spoke on condition of anonymity because President Bush had not announced his proposals, said that Democrats had exaggerated the amount of money they could recover. But in his testimony before the Senate budget committee last February, Mr. Everson said the government could recover much more than it has been collecting.

“What we’ve said is, between now and 2009, we want to get the compliance rate from 83.5 percent to 85 percent,” Mr. Everson said. “That gets you about $30 billion in improved compliance.”

Ms. Olson, the I.R.S. taxpayer advocate, said it was not implausible to recover something in the neighborhood of $100 billion a year.

“There’s no silver bullet,” Ms. Olson cautioned, noting that the government had to use an array of tactics to address scores of different compliance problems. But she added, “I think there’s a significant amount of money that’s left on the table and that’s not hard to recover.”