As Californians put the finishing touches on their income tax returns, tax collectors say the state's $9.2 billion deficit would drop to zero if all taxpayers submitted what they owe.
That means every resident claiming the market value of tattered jackets donated to charity. Every business reporting every dollar of income they receive even when paid in cash. Every service worker reporting every tip. And every resident paying use tax on Internet purchases.
But full compliance does not occur.
In a new estimate, the Franchise Tax Board says that $10 billion in state income taxes go unpaid each year, often when workers receive payments under the table, businesses skirt reporting requirements or people take deductions for which they do not qualify. The state Board of Equalization says an additional $2.3 billion in sales and use taxes go unpaid.
"It's our way of investing in society for the various benefits we receive," said Jerome Horton, who helps oversee the state's two major tax agencies as chairman of the Board of Equalization and board member at the Franchise Tax Board. "When we find folks aren't, it places an unfair burden on everyone else playing by the rules."
Dennis J. Ventry, a tax law professor at the UC Davis School of Law, said that as much as tax agencies like to call the system voluntary because people file their own returns, he doesn't consider it so.
According to a 2005 Legislative Analyst's Office report, taxpayers report about 99 percent of their wage income as employers withhold taxes and document income on W-2 forms. But when people self-report their income streams, compliance dips below 70 percent.
"If you ask me what keeps people in compliance, it is the withholding regime and the reporting regime," Ventry said.
The state's $10 billion income tax gap and $2.3 billion sales and use tax gap total 13 percent of the state's 2010-11 general fund budget, the year for which they were estimated.
The Franchise Tax Board, which oversees income tax collection, does not have precise statistics on the state gap. The board points to a recent Internal Revenue Service study upon which the state's findings are based.
The federal study of the 2006 tax year found the IRS received 83.1 percent of taxes through voluntary compliance and 85.5 percent after accounting for people who paid late or after being audited.
The bulk of the $450 billion federal tax gap came from underreporting, a broad category that ranges from hiding income to abusing deductions to not paying self-employment tax. The rest of the gap: people who didn't file at all or paid less than they owed.
Estimates of the tax gap come largely from studying audit data on compliance and applying statistical techniques to determine how much businesses and individuals fail to pay their full share.
Horton believes the gap is significantly larger, because the estimates do not consider income from illegal activities such as selling drugs or counterfeit goods.
To Ventry's point, the analyst's report suggests that the less "visible" a payment is, the less people comply.
"This is clearly the case in cash transactions, as well as in other areas where there is a lack of adequate independent reporting requirements," the report notes. "For example, when businesses do not accurately report payments to subcontractors, tax agencies have no way in which to verify the income."
The state tax board routinely reports on cases in which Californians are caught cheating on their taxes. In 2008, a couple who ran two El Dorado County painting companies failed to report more than $547,000 in taxable income. The couple faced jail time, community service and probation in addition to having to pay back taxes and penalties.
A Brentwood couple who owned seven sandwich shops and a newspaper distribution business last year pleaded no contest to tax evasion. They did not file tax returns for four years and hid more than $800,000 in income, partly by opening a bank account with false Social Security numbers.
The tax board has the advantage of piggybacking on IRS efforts to find income tax cheats. But the state is also trying to conduct more of its own data-sifting to detect where California taxpayers are not reporting income.
One instance is a pilot program started in 2008 that flags people who register vehicles worth at least $25,000 with the Department of Motor Vehicles but fail to pay income taxes. The DMV forwards car registration data to the board, which then cross-checks the list against its own records.
Some of those flagged never filed tax returns, while others owe back taxes. Since 2008, the state has collected nearly $37.9 million through the enforcement program.
"It's an indicator that someone is in the state and may have the means through some other sources to pay their tax debt," said FTB spokeswoman Denise Azimi.
Horton is pushing Senate Bill 1185 with Sen. Curren Price, D-Los Angeles, to create a "Centralized Intelligence Partnership" that would coordinate data across state agencies to flag tax evaders and people selling illegal goods and services. It would incorporate data from agencies ranging from the DMV to the Department of Consumer Affairs.
To increase tax compliance and reduce deficits, lawmakers have offered proposals in the past that would have required businesses to withhold taxes on payments to independent contractors. None passed.
In 2009, former Gov. Arnold Schwarzenegger vetoed a budget plan that would have raised an estimated $300 million annually. Business groups said it would have been too burdensome.
"Businesses would have had to spend time, labor and a lot of money to implement withholding systems and comply with some very complex tax laws," said David Kline of the California Taxpayers Association. "Other companies operating out of the state would not have faced the same costs, so it would have been one more example of making it difficult to do business for a California company."
For years, Democrats have tried to force Amazon and other online retailers to collect sales tax from California shoppers. A Board of Equalization report last year showed that only 0.42 percent of taxpayers paid use tax on their personal income tax forms, though others may have paid elsewhere.
In a deal last year with Amazon, lawmakers agreed to delay a new law requiring online sales tax collection until September 2012. Amazon is expected to collect sales tax on California purchases at that time, and the company is believed to be working on a 1,500-employee distribution center in western Stanislaus County.
With this year's tax filing deadline just days away, The Bee's Claudia Buck talks to the IRS about tax fraud in general and spousal obligations in particular. Sunday Business