A recent report by the nonpartisan Government Accountability Office (GAO) estimates that the federal government loses between $116 billion and $304 billion annually to tax fraud. This staggering loss amounts to roughly two to six percent of total federal taxes owed, a figure that actually exceeds the entire annual budget of the Supplemental Nutrition Assistance Program (SNAP), which stands as one of the nation’s leading anti-poverty initiatives.
The findings add substantial weight to ongoing arguments favoring a much simpler federal tax code alongside better-coordinated fraud enforcement mechanisms within the Internal Revenue Service (IRS). As lawmakers and fiscal analysts grapple with ballooning deficits, the new study underscores how administrative challenges and structural loopholes continue to drain billions of dollars from public coffers each year.
What Is Tax Fraud?
Tax fraud represents a critical component of the broader tax gap, which measures the aggregate difference between estimated federal taxes legally owed and the actual federal taxes paid on time by citizens and corporations each year. What makes the GAO study particularly novel is its direct attempt to formally measure tax fraud specifically within the wider tax gap. Historically, the IRS does not offer a separate, dedicated official estimate tracking tax revenue lost strictly due to fraudulent activity.
Much of the revenue lost to tax fraud occurs within what economists refer to as the "shadow economy." According to economic literature reviewed and cited by the GAO, this hidden or informal market could account for anywhere from two to nine percent of the nation’s Gross Domestic Product. The shadow economy typically includes cash-based businesses, unreported transactions, informal labor arrangements, and other economic activities that deliberately evade detection, regulatory oversight, and tax collection.
Tax Fraud, Tax Gap, and Improper Payments: What’s the Difference?
While tax fraud captures intentional deception, the broader tax gap measures overall taxpayer noncompliance, encompassing both intentional fraud and unintentional mathematical or reporting errors. As of tax year 2022, the gross tax gap stood at approximately $696 billion. This enormous figure amounts to roughly 15 percent of all taxes legally owed, indicating that fraudulent evasion accounts for an estimated 17 to 44 percent of the total tax gap—a remarkably substantial share.
After factoring in enforcement efforts, including late payments collected by the government and revenue recovered through audits—which totaled about $90 billion—the remaining net tax gap sat at $606 billion. A closer breakdown reveals that the vast majority of the tax gap, roughly 77 percent, stems from underreporting income. The remainder is split between nonfiling and the underpayment of assessed taxes.
Furthermore, roughly 71 percent of total underreporting occurs within the individual income tax system, heavily concentrated in sole proprietorship income. This specific category alone accounts for $117 billion, or 17 percent, of the entire tax gap. The IRS has consistently found that sole proprietorship income and other income streams characterized by little to no third-party information reporting or mandatory tax withholding tend to suffer from exceptionally high rates of taxpayer noncompliance.
A closely related issue involves improper payments associated with major refundable tax credits, such as the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC). Improper payments refer to overpayments or underpayments that the government should not have disbursed or could not properly verify as going to the correct recipient in the correct amount. According to the latest estimates released by the Treasury Department and the IRS, improper payments for four major refundable tax credits totaled $28.1 billion in fiscal year 2025.
Much like the broader tax gap, not all improper payments tied to refundable credits are the result of deliberate fraud. The intricate rules and confusing statutory structure governing credits like the EITC, CTC, and Premium Tax Credit frequently lead to genuine, unintentional errors by taxpayers. These honest mistakes ultimately generate administrative overpayments or underpayments, all of which are officially categorized as improper payments in federal government data.
Can Congress and the IRS Reduce the Tax Gap?
Federal fiscal analysts and the GAO readily acknowledge that it is practically impossible to completely eliminate fraud or entirely close the tax gap. Nevertheless, significant structural and administrative improvements could be implemented to materially reduce both fraud and overall noncompliance.
In its comprehensive report, the GAO issued specific recommendations aimed at tackling tax fraud directly. Beyond those targeted measures, experts analyzing the broader non-fraudulent share of the tax gap point to the compounding problems caused by extreme tax complexity in the United States and peer nations.
Tax complexity is a profound economic and administrative problem. It routinely leads to widespread taxpayer confusion, unintentional reporting errors, and heavy compliance burdens. This year alone, compliance costs are projected to reach roughly $544 billion—an amount nearly matching the size of the net tax gap itself. A disproportionate share of this complexity and its associated compliance costs falls heavily upon American businesses.
The intrinsic complexity of business taxation reflects the inherent challenge of accurately defining and tracking business income. This is compounded by tax rules that vary widely depending on the legal form of the enterprise—whether C corporations, S corporations, partnerships, or sole proprietorships—alongside a sprawling web of information reporting requirements, such as Form 1099 mandates, which generally serve to bolster compliance across the broader federal system. Because of these interconnected rules, streamlining the code in a way that unequivocally boosts compliance remains a formidable policy challenge.
One prominent reform option involves fundamental tax restructuring that replaces complicated corporate and business income taxes with a straightforward tax on distributed profits, paired with a simplified individual income tax levied at the same rate. This exact approach has been successfully implemented in countries like Estonia, yielding remarkably low compliance costs, a very small corporate tax gap, and a highly competitive tax framework capable of generating revenues on par with other developed nations. A more incremental approach would focus on systematically stripping away unnecessarily complicated deductions, specialized credits, corporate minimum taxes, and other niche provisions from the tax code.
Congress could similarly reduce improper payments linked to refundable credits by simplifying statutory definitions and streamlining program rules. For instance, eligibility requirements for the EITC currently vary widely depending on a taxpayer’s filing status and the number of children they have, forcing parents and guardians through a complicated maze of determinations. Compounding the confusion, the qualifying child rules differ between the EITC and the CTC, fueling widespread taxpayer errors.
Policy experts suggest these programs could be greatly simplified by consolidating child-related benefits into a single, unified child credit, while restructuring the EITC into a straightforward per-worker incentive delivered regardless of family size or structure. This kind of reform has previously been championed by lawmakers such as former Senator Mitt Romney.
Another viable avenue for curbing improper payments involves expanding the Treasury Department’s Do Not Pay system. As fiscal policy analysts have noted, the Treasury has recently bolstered the system and achieved notable success in proactively preventing improper payments to deceased individuals. However, the agency currently lacks the explicit statutory authority required to expand the system’s capabilities so it can effectively cross-check improper payments related to employment status, shifting income, and identity verification.
The federal government continues to hemorrhage hundreds of billions of dollars every year to direct tax fraud, alongside hundreds of billions more driven by unintentional noncompliance and administrative errors. While eradicating tax fraud entirely or fully closing the tax gap remains an unattainable goal, lawmakers and tax administrators possess actionable pathways to reform. By addressing the root causes of a Byzantine tax code and modernizing tax administration, the federal government can meaningfully narrow the gap between taxes owed and taxes paid while shrinking the avenues available to fraudsters.
