A new report by Joel Slemrod of the University of Michigan and Andrew Johns of the IRS finds that more income is hidden from the IRS by higher-income people. The report uses data from the National Research Program (NRP) Individual Income Tax Reporting Compliance Study for the 2001 tax year. This is the same data that was used to produce the famous conclusion that the tax gap (the difference between taxes owed and taxes paid) for that year was $290 billion. The authors supplement this data with estimates of additional unreported income by the IRS.
They find that people whose real adjusted gross income (AGI) is between half a million and a million dollars fail to report 21 percent of their income on average. By contrast, those with real AGI between $40,000 and $50,000 fail to report just 7 percent of their income.
This is not surprising. Most of the income received by low- and middle-income people takes the form of wages, for which there is third party reporting. (Your employer reports how much you were paid to the IRS, which can easily verify that what you report is no different.) High-income people tend to have more income in the form of self-employment earnings, capital gains, rent income, partnership income or other types of income that are more difficult for the IRS to detect. The authors say this partially, but not entirely, explains why the rich misreport more. But given the abundance of tax shelters being peddled specifically to high-income taxpayers, we would be amazed if misreporting of income to the IRS was not more pronounced among the wealthy.