Baer – Winter 2025

More Carrots, Less Sticks – Increasing Tax Compliance Through Greater Taxpayer Discretion

Jessica Baer

As the calendar approaches April 15th, millions of Americans prepare to file income tax returns; and each year, Americans short the Internal Revenue Service (IRS) over half a trillion dollars.1 Most proposals aimed at increasing compliance seek to leverage punishments or instill fear through mechanisms like audits, ominous letters, and penalties. In order to begin to change the widespread vilifications of taxes, however, Americans need more transparency and choice regarding the allocation of their federal income taxes.2 They don’t need the stick; they need the carrot.

The difference between estimated “true” tax liability for a given period and the amount of tax that is paid on time – the money the IRS is shorted each year – is referred to as the gross tax gap.3 The tax gap generally consists of three components: nonfiling (tax not paid on time by those who do not file on time), underreporting (tax understated on timely filed returns), and underpayment (tax that was reported on time, but not paid on time).4 The United States tax gap is considered quite large for a rich country, as the IRS has determined the gap is about 15 to 20 percent of the total amount due.5 For the period of 2017 to 2019, the IRS estimated this gap at $560 billion dollars yearly and in 2022, this number reached $696 billion dollars.6 Over a 10-year tax collection cycle, this noncompliance deprives the government of over 7 trillion dollars.7

The Inflation Reduction Act of 2022 contains provisions to shrink the gap, but it continues the emphasis on stick-like enforcement measures, rather than emphasizing positive incentives.8 This kind of enforcement strategy underestimates or fails to recognize a growing trend: Americans are increasingly searching for more options in their interactions with the federal government, not less. Exhibited through demand for broader political discretion in trends like ranked choice voting and the growing rates of Independent voters, Americans are generally dissatisfied by what they see as limited options from their federal government. In evaluating the collection of taxes, enforcement measures that seek to shrink the tax gap should recognize this growing demand from Americans for more choice.9 To increase tax compliance and civic engagement while decreasing tax punishments, the federal government should give American taxpayers more options regarding where a portion of their federal income taxes are spent. While not a wholly new concept, tax choice will capitalize on Americans’ desire for choice and leverage already existing mechanisms to allow taxpayers to allocate 5 to 10 percent of their federal income taxes to the executive departments of their choosing. According to research conducted by Professor Cait Lamberton at the University of Pennsylvania, the government could generate “significant increases in taxpayer satisfaction” by allowing taxpayers to allocate even this small percentage of their income tax to personally selected components of the discretionary federal budget.10 

There are successful versions of this concept in other countries. For example, to ensure a more even spread of government funding throughout Japan, rather than maintaining the disparity of centralized wealth in cities and funding deserts in the “hinterlands,” furusato nozei (the “hometown tax”) allows Japanese citizens to donate to a town outside their city center to receive a deduction from their personal taxes and, oftentimes, a personal gift from that town in return.11 This system satisfies several goals: it redistributes income from large urban areas and helps to increase tax compliance because those who donate will only receive the rewards by filing their tax returns. However, it also presents drawbacks of small towns devoting time and money toward advertising their potential gifts to city dwellers to garner more donations. 

An American version of this tax choice system could seek to capitalize on these benefits while minimizing the drawbacks, and a small version of this tax choice already exists in America on federal income tax returns through the Presidential Election Campaign Fund (PECF).12 Enacted in 1971, the PECF allows taxpayers to allocate three dollars of their taxes to presidential election campaigns.13 Similar tax choice proposals have been introduced in Congress, but none have gained traction.14 Despite this lack of traction, by allowing American taxpayers to have more choice over where a portion of their taxes are allocated, specifically to particular departments of the federal government, the United States can lower the tax gap, decrease Americans’ general frustration with having to pay taxes, and increase civic engagement.

First, in capitalizing on the system already in place from the PECF, the IRS can expand the system to a series of selections on the electronic filing forms that allow citizens to allocate portions of 5 to 10 percent of their federal income tax to one or several of the 15 cabinet departments. With 95 percent of taxpayers filing electronically during the 2023 filing season, this could be largely as simple as a webpage with each department listed next to a blank box to be filled with the taxpayers’ desired allocation percentage.15 Moreover, to ensure taxpayers understand the merits of the departments to which they would be allocating their taxes, this system can be made slightly more complex. Each of the 15 departments can be charged with creating, for example, a 60-second overview of their planned budgets and projects for the forthcoming year; taxpayers can also be presented with default options from their Member of Congress and U.S. Senator to align with the priorities of their elected representatives. 

A federal taxing system that provides individual taxpayers more choice in this way will increase transparency, accountability, and civic engagement while shrinking the tax gap through increased compliance and maybe some increased satisfaction with paying taxes.16 First, this system would require department heads to produce digestible information for the taxpayer, allowing taxpayers to more accurately evaluate whether the federal government has been a good steward of their taxes. A concern regarding this increased transparency is that it will result in a corresponding increase in taxpayer dissatisfaction when projects advertised are not completed. However, this increased accountability engenders greater civic engagement, making Americans more cognizant of projects undertaken by various departments and helping create a better-informed electorate.17 Allowing taxpayers to also see the “ideal” allocation vis-à-vis their representatives will help stimulate attention to how taxpayers’ representatives are actively representing those interests. 

Additionally, tax choice can decrease Americans’ general dissatisfaction with paying taxes by providing them a choice. Americans feel discomfort when their freedom is constrained, which plays a big part in taxpayers’ dislike of taxes.18 This discomfort – or psychological reactance – can generate antipathy toward the government, even among taxpayers who otherwise benefit from it.19 As Professor Lamberton has written of her study, “people given the opportunity to allocate a portion of their tax dollars had a weaker sense that paying taxes was a restriction on their freedom – they had lower general reactance toward taxes.”20 In reducing taxpayers’ general frustration toward paying taxes, people may be more willing to comply across the nonfiling, underreporting, and underpayment categories. 

While tax choice ran through this department-centric approach contains the above benefits of accountability, engagement, and shrinking the tax gap, some commentary has expressed concern about large fluctuations in government budgets, an entrenching of democratic concerns when money is speech, and taxpayers making informed decisions. As aforementioned, and supported by Professor Lamberton’s study, these concerns are either unfounded or capable of mitigation.21 For instance, small allocation amounts of 5 to 10 percent of a taxpayers’ federal income taxes are generally not enough to create such drastic swings in the allocation of the federal budget. Less than thirty percent of federal spending each year is discretionary spending, meaning a large majority of department funding each year will remain unchanged as part of mandatory spending.22 Moreover, Professor Lamberton’s study demonstrated that the largest shift in funding allocated from the introduction of tax choice most affects the current beneficiary of about half of all discretionary spending – the military.23 As the largest beneficiary of all discretionary spending, the shift the Department of Defense might see upon the introduction of tax choice nationally would likely be mitigated by the current size of spending already geared toward the military.24 

Additionally, concerns regarding giving the wealthy more say in these departments would be mitigated not solely through the 5 to 10 percent allocations, but also through a cap deriving from their total amount of federal income taxes. A potential cap to this number could involve the average federal income tax paid in a given taxpayer’s state; for instance, if Taxpayer X lives in Michigan where the average federal income taxes paid were $14,954 in 2023 but 10 percent of Taxpayer X’s federal income taxes surpasses this number, their tax choice could still be limited to no more than this state average.25 

Finally, concerns about ensuring taxpayers are making informed decisions are mitigated through the department-focused information campaign that would occur upon taxpayers’ attempt to electronically file. Transcripts and any associated visuals would be made available in print copy to the 5 percent of taxpayers who do not file electronically.26 Consequently, taxpayers will be at least somewhat informed, without needing to conduct any outside or personal research, about the projects intended for the fiscal year from the allocation of their tax dollars.

As Americans seek more choices in their daily lives and in their interactions with the federal government, an initiative such as tax choice would not just help decrease the widespread vilification of taxes and the tax gap, but could help boost government accountability and civic engagement as well. The “sticks” aren’t working; it’s time to try the carrot.

  1. Internal Revenue Service, Research, Applied Analytics & Statistics, Tax Gap Projections for Tax Year 2022, Publication 5869 (Rev. 10-2024), Page 4, Washington, D.C. (Oct. 2024). ↩︎
  2. Freakonomics Radio, How to Hate Taxes a Little Bit Less (Replay), Freakonomics (Mar. 29, 2023), https://freakonomics.com/podcast/how-to-hate-taxes-a-little-bit-less-replay/. ↩︎
  3. Internal Revenue Service, Research, supra note 1. ↩︎
  4. Id. ↩︎
  5. Letter from Janet L. Yellen, Sec’y of the Treasury, to Hon. Richard E. Neal, Chairman, House Ways and Means Committee (Sept. 14, 2021), https://s.wsj.net/public/resources/documents/YellenInformationReporting091421.pdf; Tax Policy Center, What is the Tax Gap?, Urban Institute and Brookings Center (2024), https://taxpolicycenter.org/briefing-book/what-tax-gap (last visited Apr. 6, 2025). ↩︎
  6. Internal Revenue Service, IRS: The Tax Gap, Internal Revenue Service, https://www.irs.gov/statistics/irs-the-tax-gap (last visited Apr. 6, 2025). ↩︎
  7. U.S. Department of the Treasury, The American Families Plan Tax Compliance Agenda at 1, 3 (May 2021). ↩︎
  8. See The White House, Office of the Press Secretary, Empowering the IRS: Understanding the Full Potential of the Inflation Reduction Act’s Historic Investment in the Internal Revenue Service, (Feb. 8, 2024), https://bidenwhitehouse.archives.gov/cea/written-materials/2024/02/08/empowering-the-irs-understanding-the-full-potential-of-the-inflation-reduction-acts-historic-investment-in-the-internal-revenue-service/ (explaining the IRA provided $80 billion in additional funding to the IRS, “much of which is dedicated to closing the tax gap by specifically enforcing tax compliance by the wealthiest tax evaders”). ↩︎
  9. See Andrew Yang, Americans Want More Choices for President. The Time for Ranked Choice Voting Is Now, Newsweek (Oct. 7, 2024) (explaining the “desire for options and choices outside the duopoly hasn’t gone anyway . . . certainly not for a future where more and more voters identify as independents”); Joseph Cerrone, Research Brief: Growing Cohort of Independent Voters Becomes Critical Segment of Electorate, Unite America (Nov. 15, 2024) (explaining “independents are a growing cohort of voters” as “Americans are increasingly dissatisfied with the choices offered by the two-party system”). ↩︎
  10. Cait P. Lamberton, Your Money, Your Choice, Democracy: a Journal of Ideas (Spring 2011, Issue 20), https://democracyjournal.org/magazine/20/your-money-your-choice/. ↩︎
  11. Freakonomics Radio, supra note 2. ↩︎
  12. R. Sam Garrett, Cong. Rsch. Serv., RL34534, Public Financing of Presidential Campaigns: Overview and Analysis (2014). ↩︎
  13. Id. ↩︎
  14. See, e.g., Taxpayers’ Choice Debt Reduction Act, H.R. 5349, 106th Cong. (2000); Opt Out of Iraq War Act of 2007, H.R. 3190, 110th Cong. (2007); Put Your Money Where Your Mouth Is Act of 2011, H.R. 1541, 112th Cong. (2011). ↩︎
  15. Treasury Inspector General for Tax Administration, Final Results of the 2023 Filing Season at 4 (Nov. 9, 2023). ↩︎
  16. Cait P. Lamberton, A Spoonful of Choice: How Allocation Increases Satisfaction with Tax Payments at 15 (June 5, 2012). ↩︎
  17. Id. at 34. ↩︎
  18. Lamberton, supra note 10. ↩︎
  19. Id. ↩︎
  20. Id. ↩︎
  21. Lamberton, supra note 16, at 30-35. ↩︎
  22. Congressional Budget Office, Discretionary Spending in Fiscal Year 2023: An Infographic (Mar. 5, 2024), https://www.cbo.gov/publication/59729. ↩︎
  23. Id. ↩︎
  24. Id. ↩︎
  25. National Priorities Project, 2023 Average Federal Income Taxes Paid by State, Institute for Policy Studies, https://www.nationalpriorities.org/interactive-data/taxday/average/2023/receipt/ (last visited Apr. 6, 2025). ↩︎
  26. Treasury Inspector General for Tax Administration, supra note 15 at 4. ↩︎

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