The authors of the wonderful book Freakonomics: A Rogue Economist Explores the Hidden Side of Everything (Stephen J. Dubner & Steven D. Levitt) turn their attention on the tax gap in a New York Times article:

And when you take a look at who does cheat and who doesn’t, it becomes pretty clear just why people pay their taxes at all. The key statistic in the I.R.S.’s study is called the Net Misreporting Percentage. It measures the amount that was misreported on every major line item on those 46,000 returns. In the "wages, salaries, tips" category, for instance, Americans are underreporting only 1% of their actual income. Meanwhile, in the "nonfarm proprietor income" category — think of self-employed workers like a restaurateur or the boss of a small construction crew — 57% of the income goes unreported. That’s $68 billion in unpaid taxes right there.

Why such a huge difference between the wage earner and a restaurateur? Simple: The only person reporting the restaurateur’s income to the IRS is the restaurateur himself; for the wage earner, his employer is generating a W2 to let the IRS know exactly how much he has been paid. And the wage earner’s taxes are automatically withheld from his every check, while the restaurateur has all year to decide if, and how much, he will pay.

Does this mean that the average self-employed worker is less honest than the average wage earner? Not necessarily. It’s just that he has much more incentive to cheat. He knows that the only chance the IRS has of learning his true income and expenditures is to audit him. And all he has to do is look at the IRS’s infinitesimal audit rate — last year, the agency conducted face-to-face audits on just 0.19% of all individual taxpayers — to feel pretty confident to go ahead and cheat.

For more, see the Freakonomics web site.  For Neil Buchana’s review of Freakonomics, see here.