Reducing Information Gaps to Reduce the Tax Gap: When is Information Reporting Warranted?

Abstract

A core problem for enforcement of tax laws is asymmetric information. The taxpayer knows the facts regarding the relevant transactions it engages in during the year-or at least has ready access to that information. The government is forced to play catch-up, obtaining that information either from the taxpayer or from third parties.

Information reporting is routinely used to address this information gap. The government obtains information about the taxpayer's tax situation from a third party and-equally important-the taxpayer knows that the government has received that information. This fosters taxpayer honesty.

Information reporting is not a panacea, however. It imposes costs on the private parties who are required to report. Moreover, it will not be equally effective in all situations. Generally speaking, the effectiveness and efficiency of information reporting varies with who the reporters are, what they are reporting about, and how much information they are required to include. Accordingly, the Essay proposes six distinct factors as a framework for evaluating information reporting requirements. The Essay also applies these factors to three current information reporting proposals and three recently enacted reporting requirements that are scheduled to become effective in 2011.

The proposed framework suggests that some of the laws and proposals will likely be much more effective than others in improving tax compliance. For example, the recent amendment requiring reporting by brokers of basis in investments will likely prove very valuable, as would the proposed elimination of the reporting exemption for payments for services provided by certain small corporations. Other information reporting laws and proposals have less promise. For example, the new requirement for information reporting by online auction sites such as eBay regarding the gross receipts of their high-volume sellers will likely make only a minimal impact on the tax gap. Information reports in that context cannot include basis information that is known, if at all, only by the sellers. Least worthwhile are proposals that require decentralized information reporting, particularly in non-arm's length contexts, such as requiring reporting by recipients of gifts in excess of the annual gift-tax free limit.

Keywords: Tax gap, tax compliance, tax evasion, information reporting, asymmetric information, income tax, gift tax, small businesses, eBay

JEL Classification: H20, H24, H25, H26, K34, K42