• IRS chief Charles Rettig told Sen. Elizabeth Warren that relying on banks to report on their customers' accounts could help cut the tax gap.
• Rettig, a Trump administration holdover, touted a provision in the American Families Plan that would require banks to report on their customers' withdrawals and deposits.
• The IRS estimates that for every 1% improvement in voluntary tax compliance, federal annual revenues could increase by about $30 billion per year.

The head of the IRS believes more rigorous disclosures from the nation's banks could help fix a yawning tax gap and recoup billions in owed revenues.

In a letter viewed by CNBC, IRS Commissioner Charles Rettig told Sen. Elizabeth Warren, D-Mass., that relying on banks to report basic information about their customers' deposits and withdrawals could put a big dent in annual tax evasion.

A source provided CNBC access to the letter, which is expected to be released Thursday. The source disclosed its contents on condition of anonymity.

The IRS chief told Warren in Friday's letter that years of budget cuts have left the agency unable to prosecute those who fail to pay their fair share in federal taxes.

"Every measure that is important to effective tax administration has suffered tremendously," Rettig wrote, referring to years of budget reductions.

However, President Joe Biden's American Families Plan and the bipartisan infrastructure deal "would result in significant volumes of new data regarding financial transactions," said Rettig, a Trump administration holdover. "The new data will provide the IRS with a lens into otherwise opaque sources of income with historically lower levels of reporting accuracy."

Specifically, Rettig touted one provision in the American Families Plan that seeks to shrink the tax gap by requiring banks to report on their customers' withdrawals and deposits instead of relying on the taxpayers themselves. The tax gap is the difference between taxes paid and taxes owed by law.

Rettig noted that for every 1% improvement in tax compliance, federal annual revenues are projected to increase by about $30 billion per year. Overall tax compliance — defined as, voluntary, accurate and on time — is estimated by the IRS to fall in the 82% to 84% range.

Sens. Bernie Sanders, I-Vt., and Sheldon Whitehouse, D-R.I., joined Warren last month in requesting that the IRS and its commissioner offer a detailed report on how better enforcement could help generate billions for the federal government in owed taxes.

"This new information from the IRS makes clear that unless we significantly increase IRS funding, wealthy tax cheats and big corporations will be able to continue to avoid paying their fair share to the tune of billions of dollars per year while everyone else suffers," Warren said of Rettig's reply letter. "This is why congressional leadership must include in the budget reconciliation package significant, multiyear funding for the IRS to boost enforcement and bring in billions more in revenue each year."

The IRS analysis "makes it clear we need new reporting requirements in order to improve tax compliance among the wealthiest Americans, and to reduce the burden for honest taxpayers," she added.

Central to Rettig's argument is a simple behavioral problem: Few people enjoy paying income taxes.

That statement is likely even more pertinent for Americans with annual incomes greater than $1 million. Those high-income earners are required to pay a greater percentage of their income to the IRS, and therefore have a greater incentive to find ways to skirt the taxman.

The banking industry, which would bear the burden of sending the U.S. government more data, protested the provision in May.

In their springtime letter, the American Bankers Association, the Bank Policy Institute, the Consumer Bankers Association and others argued that the "new reporting requirements for financial institutions would impose cost and complexity that are not justified by the potential, and highly uncertain, benefits."

"Furthermore," the trade groups added, "we believe additional reporting requirements guided by subjective criteria have privacy and fairness implications and the potential to put financial institutions in an untenable position with their account holders."

The collective suggested that financial institution reporting is "already robust" and that providing more funding for audits would be a more efficient and fair approach.

Complicating matters for the budget-strapped IRS is the fact that wealthy earners tend to have access to a variety of ways to obscure the true value of their income or otherwise have more complicated tax returns. The tax return of a business owner, for example, is far more complicated than that of an employee whose hourly wage or annual salary can be verified by third-party reports.

While the specific disclosure requirements would ultimately be hammered out by the Treasury Department, they could inform the IRS about the size and frequency of deposits and withdrawals from those accounts.

On the upside, if the tax gap is caused by human error — honest mistake or intentional — more thorough communication between U.S. banks and the IRS could ease the problem.

Right now, any person who earns $10 or more in interest from an account at a U.S. bank, brokerage firm or mutual fund is required by law to tell the IRS about those earnings. That document is called a Form 1099-INT.

If banks themselves are compelled to provide the IRS with information about their customers' deposits and withdrawals, those customers may be more likely to fill out their returns accurately. And, if not, the IRS would now be armed with information to prosecute those less than honest.

That, Rettig says, could spell a big win for the tax collector.

"Taxpayers are more likely to be compliant when they know the IRS has the information necessary to pursue them should they not meet their tax obligations," the IRS chief told Warren. "Our research shows that compliance is as low as 45 percent when income is subject to little or no information reporting or tax withholding. When there is substantial information reporting, compliance rises above 95 percent."

Using banks to crack down on unreported income would likely represent just one step in narrowing the gap. Simply knowing how much money flows through an account doesn't necessarily alert the IRS to unreported income. People can receive nontaxable gifts or spend on deductible business expenses, which the tax collector would need to consider.

Still, the benefits of moving forward with the provision could offsets the hurdles.

That fact isn't lost on some of the nation's most prestigious economic authorities. Former Treasury Secretaries Tim Geithner, Jacob Lew, Henry Paulson Jr., Robert Rubin and Lawrence Summers all defended President Joe Biden's effort in a recent New York Times op-ed.

"Relying on financial institutions to relay some basic information about account holders is a sensible way forward," they wrote in June, after the White House had published the American Families Plan. "With better information for the I.R.S., voluntary compliance will rise through deterrence as potential tax evaders realize there is a risk to evasion."

The IRS letter also noted that the wealthiest taxpayers are also the most likely to have accounts at international banks that may not provide U.S. regulators with regular access or adhere to the same standards.

"Increased technology funding is essential to link foreign-held assets back to their beneficial owners and to detect potential non-compliance," Rettig wrote. Added resources will enable the IRS to build "analytical systems that use information reporting to detect unreported income and identify when account holders or foreign financial institutions may be engaging in non-compliant or fraudulent behavior."

In advocating for additional funds, Rettig reiterated the need to modernize IRS technology not only to fend off "increasingly sophisticated cybersecurity attacks," but to increase the agency's speed, reduce errors and allow operations to continue all day instead of relying on staff availability.

The years of budget and staffing cuts have left the IRS with about 74,000 full-time employees, a level not seen since 1973. But the challenges facing the agency, especially in the last 16 months, have only grown, Rettig said.

There is perhaps no better way to document demand for IRS services than the number of customer service phone calls. In 2021 alone, the IRS has received over 199 million calls, about 400% more than the agency receives in an average calendar year.

The agency has answered nearly 50 million of those calls between live "assistors" and automated providers. The IRS received 42 million calls in 2018, 40 million calls in 2019 and 55 million calls in 2020, according to Rettig's letter.

In totality, such fixes could over time generate hundreds of billions in owed revenues.

The Treasury Department's own analysis shows that efforts to close the tax gap will generate $700 billion in additional tax collections over the first 10 years of budgetary relief and an additional $1.6 trillion over the course of the second decade.