Despite Billions at Stake, Few States Study Tax Gaps

As Americans file their state and federal income taxes this month, history suggests that they will pay hundreds of billions of dollars less than they should. This “tax gap”—the difference between the taxes legally owed to the government and the amount paid—is caused by taxpayers who should file but do not, who underreport their income, and who do not pay in a timely manner.

As many states face near-term budget shortfalls, long-term deficits, or both, smaller tax gaps could help to provide the revenue that states need to avoid tax increases and cuts to core services. Yet few states have measured their tax gaps, in part because of the complexities of doing so. Meanwhile, staffing cuts and hiring challenges at the federal Internal Revenue Service (IRS) and at state tax departments could drive tax gaps wider by lowering officials’ capacity to answer taxpayer questions, conduct audits, and collect unpaid taxes.

Measuring tax gaps

In contrast to most states, the IRS does estimate the size of the federal tax gap—and regularly finds that Americans are shorting the U.S. Treasury by hundreds of billions of dollars. The most recent IRS tax gap report found that in 2022, taxpayers initially paid $696 billion less than the $4.6 trillion they actually owed. The IRS estimates that after audits, late payments, and enforcement actions, it will eventually collect $90 billion of that sum, leaving a net tax gap of $606 billion. If that figure proves accurate, federal taxpayers will have paid only about $7 out of every $8 they owed the government.

Few states, however, produce equivalent estimates of their own tax gaps. In 2020 and 2021, Rob Warren, a retired IRS criminal investigation special agent who is now an assistant professor of accounting at Radford University in Virginia, contacted all states with income taxes asking whether they had ever estimated their tax gaps. His findings, published in a January 2025 article in Tax Notes, found that only eight states had done so since 1992. “The problem is that states are ignoring their tax gaps—wholesale ignoring,” Warren said in an interview.

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Part of the reason for this lack of analysis is that estimating the size of tax gaps is methodologically difficult. Taxpayers underreporting their income account for most of the gap—77% in the IRS report—but that portion of the problem is especially challenging for analysts to measure. To account for revenue lost because of underreporting, the IRS has long conducted random audits of a representative sample of taxpayers. But audits are expensive, and conducting them randomly reduces auditors’ ability to target returns with the most money at stake—such as those of wealthy individuals and large corporations—or those that tax staff members judge to be suspicious. As a result, conducting enough random audits to achieve a representative sample is probably cost-prohibitive for states; even the IRS has reported declining sample sizesin recent years. States also levy a variety of taxes that the federal government does not—sales taxes most notable among them—and have to devise methodologies for estimating tax gaps for these revenue sources.

Yet the amount of money involved is so significant that even imperfect estimates are probably preferable to no data at all. In Connecticut, a 2023 law required the state’s Department of Revenue Services to begin producing tax gap estimates. The first study under the requirement relied on a mix of audit data and other methods to estimate that the state had a nearly $3 billion net tax gap in 2022 on $24.1 billion in tax liability—a gap that is proportionally similar to the federal one. To put that amount into perspective: With that $3 billion, Connecticut could have paid nearly the entire state share of Medicaid benefits—and, in doing so, provided health insurance to more than 1 million residents.

Growing gaps?

Without data, most states do not know whether their gaps are growing or shrinking. But there are reasons to think the problem of tax noncompliance could get worse.

Research suggests that increased tax agency staffing results in increased revenue—for example, with more auditors, agencies can conduct more audits and bring in more of what taxpayers owe. However, a 2024 Federation of Tax Administrators survey of state and local revenue departmentsfound that the “top challenge faced by tax administrations is overwhelmingly hiring and retention.” Compounding that problem: Much of the tax department workforce is approaching retirement age, with a third of employees aged 55 and older, according to the survey.

The IRS also faces challenges. In a January 2026 memo, the U.S. Treasury Department’s Office of the Inspector General pointed to “concerns regarding the IRS’s readinessfor the 2026 Filing Season,” including delays resulting from the October 2025 government shutdown; new technology initiatives that might not be implemented in time; and reduced staffing—as of October, the IRS had 19% fewer employees than it had a year earlier.

Terri Steenblock, director of tax and revenue administration with the Federation of Tax Administrators, said in an email that federal cuts could reduce state tax revenue in two major ways. First, while states fund and conduct most of their tax enforcement efforts, they also rely on information from federal agencies—because, for example, someone misstating income on federal returns is likely to do so on state returns, too. As a result, less federal enforcement could mean less state enforcement.

Secondly, taxpayers depend on receiving timely and reliable information from the IRS—such as answers from employees staffing call centers—to file accurate federal and state returns, because federal adjusted gross income is often the starting point for state taxes. Such services encourage taxpayer compliance—accurate, voluntary, on-time filing—which the whole tax system depends on. “If taxpayers don’t have the information and tools they need at the federal level to file an accurate return, that will flow through to the state’s tax returns and could cause a greater gap in compliance,” Steenblock said.

Whether these challenges translate into larger state and federal tax gaps remains to be seen. Barry Johnson, the IRS’ former chief data and analytics officer and a nonresident fellow with the Urban-Brookings Tax Policy Center, pointed out that nationally, the percentage of income earners who voluntarily pay in full and on time has long remained steady. But Johnson also worried that reduced IRS audit capacity would cause long-lasting declines in voluntary compliance and thus revenue because research shows that tax enforcement helps to encourage individuals to voluntarily file accurate returns.

At both the state and federal levels, one hope is that technology can compensate for the loss of staff. For example, the IRS is using models that rely on machine learning and other AI-based methods to more accurately identify taxpayers to audit. But technology can do only so much: “Knocking on someone’s door and saying, ‘You owe a million bucks,’ that has to be done by a person,” said Warren.

Steenblock emphasized that both technology and people have an important role. “Taxes are complicated, and ensuring they are administered appropriately is not just a science, but it’s an art,” she said. “It’s a balance of the entire tax administration cycle, which includes the appropriate mix of human and technological resources to foster compliance and reduce the tax gap.”

Final thoughts

If a state’s revenue suddenly fell by 12% or 13%, policymakers would treat the decline as a major fiscal crisis. Yet the IRS and Connecticut tax data suggests that governments routinely fail to collect this amount of money—sometimes without state policymakers even being aware of the problem. Full taxpayer compliance might not be a realistic goal, yet if states collected even a few percentage points more of what they are legally entitled to, they could afford to cut taxes or invest in priorities in good times—and avoid tax hikes and service cuts in bad ones.

Michael Galliher, who leads the Research, Analytics and Forecasting Unit at Connecticut’s Department of Revenue Services, said he hopes that future tax gap reports will allow the state to track its progress in reducing the gap. He said that his department always tries to encourage greater tax compliance but that the report allowed them to document and organize those efforts—including producing a separate report on ideas for closing the gap. Studying the tax gap “did get us to focus on our business, on how best to audit to reduce the gap, how best to collect underpaid tax amounts, how best to pursue our collections efforts,” Galliher said. “I think it allowed us to look inward and improve our core business.”

Josh Goodman works on The Pew Charitable Trusts’ state fiscal health project.